KURT SALMON REVIEW Retail. Consumer. Private Equity. Strategy. IN THIS ISSUE Why full- and off-price stores make good neighbors 4 How to pick best-of- the-bunch organic brands 24 Bringing store performance into focus with new KPIs 32 Small fitness studios, big opportunities 42 Issue 05 Retail and Consumer Edition I II From the Editor We all know that the retail and consumer industry has changed significantly—and that the pace of change will only continue to accelerate. But many players in this constantly evolving industry have continued with business as usual or have made only small adjustments. When faced with an industry—and a consumer—in the midst of revolution, the only prop- er response is dramatic transformation, change that will impact the entire organization. In this issue, we explore innovative new ways of doing business across many categories and parts of the organization. In “Close Encounters,” we detail why retailers’ historical fear of letting their outlet doors creep too close to their full-price counterparts is misguided and, using Nordstrom as an example, show why retailers need to totally revamp their off-price real estate strategy. Meanwhile, “Unchained” explores why and how large chain retailers must take a totally new, big-picture approach to their products and customer experience by thinking small. This David vs. Goliath concept carries over into “Sweating Small,” which recounts how boutique fitness studios are shaking up the industry—and how investors can get a piece of this hot market. As always, I hope you find this issue insightful and look forward to hearing from you. Best regards, Bruce Cohen Senior Partner and Head of the Private Equity and Strategy Practice 1 TABLE OF CONTENTS issue 05 FEATURES Close Encounters 4 Moving full- and off-price stores closer together creates sales opportunities for both. Unchained 14 Big retailers need to think small. Green Field 24 How to pick best-of-the-bunch organic brands with room to grow. Bringing Store Performance into Focus 32 In an omnichannel world, new KPIs add perspective on consumer behavior. 2 IN BRIEF Sweating Small 42 Deal Ideas at a Glance Boutique fitness studios are creating Ideas for investing in spa and wellness big investment opportunities. services 54, active nutrition 56, and better chicken chains. 58 Making Consumers Feel Good, One Way or Another 48 Take 2: Some Situations Inside three hot emerging CPG categories: Require a Second Look 60 probiotics, cold-brew coffee and cannabis. A real-world example that challenges assumptions on store rationalization. 3 4 CLOSE ENCOUNTERS MOVING FULL- AND OFF-PRICE STORES CLOSER TOGETHER CREATES SALES OPPORTUNITIES FOR BOTH Conventional wisdom says that a brand’s off-price, or outlet, stores cannibalize its full-price counterparts and drain brand equity. This thinking has led retailers to try to put significant distance between their full-price and outlet doors—pushing outlets far from most major cities. 5 Full- and off-price doors can coexist in urban markets and may even have a mutually beneficial relationship. But full- and off-price doors can coexist in Hansen and The Limited, with Rag & Bone, urban markets and may even have a mutually Alex and Ani, and Alice + Olivia among likely beneficial relationship. Only some of the fresh faces for this year.3 same shoppers frequent both, helping a Now, the weed part. Despite the channel’s retailer expand its consumer base, and when growth and profitability, many retailers try to they do shop both, the retailer is not only contain their outlet channel, making sure it able to capture a higher share of wallet, but doesn’t creep too close to their full-price the off-price door can serve as a way for new doors to reduce the risk of cannibalized sales consumers to try the brand, leading to and diluted brand equity. increased sales in full-price stores. This channel separation often also extends A Fertile Market for Outlets to the online world. In a recent audit, Kurt The $40 billion, high-margin outlet channel Salmon found that only 28% of 67 retailers is growing like a weed. with physical off-price doors had an outlet First, the growth part. Forty new centers e-commerce presence. have opened between 2006 and 2014, and But with the outlet channel reaching a year-over-year sales growth is consistently in greater state of maturity, outlet stores are the double digits.1 In many cases, margins are inevitably beginning to encroach on full- consistently as good or better than full-price price stores. doors because rents are lower, unplanned For example, Tanger recently began con- markdowns are typically rarer and products struction on a new outlet center 15 minutes are sourced specifically for the outlet from Memphis,4 while Simon is building channel, driving costs down. centers 25 minutes from Tampa and 30 The market shows no signs of turning fallow. minutes from Tucson.5 And a Kurt Salmon Forty-eight new centers are expected to open analysis found that 75% of the 7 million by the end of 20172 as established outlet people in the San Francisco Bay Area live brands expand their doors and new retailers within a 30-minute drive of an outlet mall. enter in search of green. Recent entrants This trend holds true on an individual include Chaps, Diane von Furstenberg, Helly retailer level as well. Take Coach. Back in 6 2004, its outlets were usually located 50 to In fact, a whopping 64% of Rack stores are 100 miles from major cities. But by 2012, that within five miles of a full-price Nordstrom distance had shrunk to just 30 miles.6 and 42% are within one mile.7 This encroachment into historically full- Clearly, the company would not risk this priced urban areas, coupled with the level of channel overlap if the strategy was temptation for brands to continue growing not paying off. In fact, the company says, their outlet sales, is making it challenging to “Many of our best Rack stores are across maintain the historic level of separation and the street from our best full-line stores. forcing many retailers to rethink their We know our customers like the conven- off-price channel strategy altogether. ience of shopping both.”8 But perhaps no retailer has exemplified Why does this work so well? It starts with and embraced this urban transition more differentiated consumer positioning and than Nordstrom. experiences as well as differentiated prod- ucts. Rack is a mecca for treasure hunters Nordstrom Racks Up Growth that features distinct products. Indeed, only Early on in the development of its Nordstrom 20% of Rack’s products are clearance items Rack concept, Nordstrom recognized the from Nordstrom’s stores and website; the rest value of placing its off-price doors close to its are bought specifically for Rack, often from full-price stores within major metropolitan vendors looking to clean house.9 areas to capture a wider range of consumers and a greater share of their wallets by This differentiated positioning and offering diversifying its retail offering. allow the company to pull in a wider overall mix of consumers. The stores have somewhat Today, that idea is manifested in places like different, yet complementary, audiences, Seattle, where Nordstrom and Rack are with Rack drawing younger, aspirational located in the same shopping center, or in Nordstrom consumers that hope to—and do, Cerritos, Calif., where a new Rack is opening in some cases—transition to the full-price across the street from a full-price Nordstrom brand. This strategy extends to the online this fall. world, with Nordstrom’s purchase of 7 While serving primarily two different consumer groups, roughly 30% cross-shop between Nordstrom and Rack. HauteLook in 2011. Courting this younger ecosystem. … I’m not sure this is quite so audience makes long-term sense, as Baby much an off-price strategy as it is kind of a Boomer spending power will peak in a few customer strategy and a way for us to attract years and brands will hunger for younger, customers at perhaps an earlier point in their loyal consumers to take their place. lifecycle … about a third of our Rack custom- While serving primarily two different ers shop our regular-price business.” consumer groups, roughly 30% cross-shop Rack now accounts for nearly 25% of between Nordstrom and Rack. Having both Nordstrom’s sales. And while Rack has a banners in close proximity not only allows the lower gross margin than full-price Nord- company to capture a larger share of wallet strom stores, Rack is more profitable, with among these cross-shopping consumers, but its operating profit margin estimated to be also drives trial of new products. This is the around 15% to 16%, compared 10% to 11% case because, for some consumers, Rack for full-price stores11 because real estate and functions as a kind of introduction to the labor are less expensive. Rack’s sales per Nordstrom brand and the bridge and luxury square foot are also higher—$552 vs. $371 brands carried by both retailers. In fact, the for full-price stores.12 company says Rack is Nordstrom’s biggest Given these impressive results, it’s no source of new customers, pulling in almost 4 surprise that Nordstrom is aggressively 10 million. These customers get to try new expanding its Rack stores. After opening a luxury brands at Rack and fall in love with combined 49 Racks in 2013 and 2014 vs. them, eventually driving them to Nordstrom three full-price stores in the same time for a fuller assortment of the latest full-price period, Nordstrom now has 118 full-price and offerings from the same brands.