Deloitte Research

REINVENTING RETAIL
The challenge of demand chain innovation

A consumer business viewpoint by Deloitte Consulting and Deloitte & Touche

For the past decade, supply chain management has been the mantra of successful retailers. Continuous supply chain improvements have reduced costs, expanded market share, and driven industry consolidation. But what comes next? What happens when supply chain efficiency has squeezed every last dime, drachma, centime and pence out of the global supply chain? Without cost reduction and market consolidation, retailers will have to look to some combination of organic revenue and margin growth to raise profits. To accomplish that task, they will have to turn to demand chain innovation. This Deloitte Research Viewpoint looks into the both past and future demand chain innovations to provide retailers with a road map to this very different future.

CONTENTS
Reinventing Retail ...............................................................................................................1 Speed Kills ..........................................................................................................................2 Supply Chain Innovation ......................................................................................................4 Demand Chain Innovation....................................................................................................5 The Future of Demand Chain Innovations ..............................................................................6 Short Attention Span Retailing .............................................................................................7 Antagonistic Cooperation: Consolidating Services Around a Customer .................................... 8 Strategic Pricing ..................................................................................................................9 Conclusions, Observations and Questions ............................................................................ 11 About Deloitte Research ..................................................................................................... 12 About Deloitte Consulting and Deloitte & Touche.................................................................. 13

Much of the retail innovation in the past has come through steady improvements in the supply chain. By pushing costs down, retailers gained a price advantage that they used to expand market share. Today, we face evidence that the easy improvements in supply chain innovation have, for the most part, been achieved. Retailers will have to look to the demand chain to find the kinds of innovations that will be needed to sustain them into the future.

Why has retail reinvention become so critical in todays marketplace? Because all strategies eventually fail. No matter how successful a strategy may have been in the past, there comes a point in time when the business fails to adapt to a critical change in its competitive environment, and it fails. In many ways, past success makes the process of reinvention all the more difficult. It does not take much managerial complacency, in the face of accelerating change, to produce a failing business where a successful one stood before. It is the speed of business failure, compressing the lifecycle of all retail innovations, that makes the current business situation so different from the past. The original department stores were great family businesses that started in downtown business districts after the Civil War. They were great mercantile emporiums that sought to be all things to all people. Bearing the founding familys name, the ownership and management of these institutions was passed from generation to generation. From their origins to maturity, department stores have endured for more than 100 years. That maturity has been marked by industry consolidation and bankruptcy. The hundreds of department store businesses at the peak of the department store lifecycle have been reduced to but a handful today.

Deloitte Research Reinventing Retail

REINVENTING RETAIL

Speed Kills
Faster, faster, until the thrill of speed overcomes the fear of death
Hunter S. Thompson

Changing organizational and competitive dynamics have accelerated the speed by which retail innovations move through their lifecycle. From a market perspective, the success of any concept attracts imitators. At the same time, the number of core consumers and the number of potential real estate locations limits the size of the market. As both the original innovator and its imitators grow, the market becomes saturated. In order to continue

Retail strategies are created, they expand, they reach maturity and then they decline, in accordance with the dynamics of the retail lifecycle. At each stage of that lifecycle, the pace of growth and profitability is different, as are the criteria for success. Competitive challenges change over the lifecycle, as do customer expectations. As a firm ages, the demands on management change. What is critical in the early stages of development can be irrelevant when the business has matured. Some businesses are good for just a brief moment. Others are good for a year. Still others seem like the Eveready Bunny and go on and on forever. The longevity of any retail business is closely tied to the ability of the firms leadership to manage the process of innovation as the business moves through the retail lifecycle. While the department stores took more than 100 years to
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to grow, the appeal of the concept has to be broadened to a larger group. As the appeal broadens, the concept begins to lose focus and the appeal to the original core customer group diminishes. Loss of market share is the clearest quantifiable measure that a retail concept has reached maturity.

reach maturity, warehouse clubs reached maturity in less than 10. Conceived in the early 1980s, dozens of companies scrambled in a land rush to establish, site, open and then operate warehouse clubs. By the early 1990s, only three warehouse club businesses were left standing. The rest either failed or were consolidated into the surviving three. More recently, the original e-retail businesses drove through their lifecycle, going from innovation to growth, maturity and decline in less than five years. Quite clearly, the longevity of any new retail innovation has been compressed.

Signs of Maturity
From an organizational perspective, maturity begins to creep into a retail concept as part of the natural process of growth. As a business grows it becomes more complex. In order to deal with that complexity, management has to build a bureaucratic infrastructure. That infrastructure separates, and in many cases drives out the original entrepreneurial management. Innovation, which was the key to the success of the new concept, becomes harder to generate and maturity sets in. What separates the survivors from the rest? Execution is part of it. But good execution in a business that is in the decline phase of its lifecycle wont get it back into a growth mode. Knowing where you are in the lifecycle, and managing the business accordingly is

also important. However, long-term sustained growth that spans decades requires innovation. While all strategies are destined to fail, the longevity of a business depends largely on its ability to innovate its way back to the beginning of the retail lifecycle. At the heart of retail reinvention is the process of innovation. Innovation can be defined as a process through which knowledge is translated into new products, new services, or an increase in productivity through new operational methods. In the 1950s, department stores got a new lease on life when they began to shift their base of operations from downtown business districts to suburban regional malls. Discount department stores got a second wind in the 1990s when they added groceries to their general merchandise offer.

Deloitte Research Reinventing Retail

Supply Chain Innovation

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CHART 2. DISCOUNT DEPARTMENT STORES SG&A AS A PERCENTAGE OF SALES

Over the past thirty years, the focus of most retail innovation has been on improving supply chain efficiency. These innovations have been largely operational in their focus and have come from either changes in technology or changes in format.

22 21 20 19

Technology related innovations in most cases trace their

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origins to scanning. Retailers have taken the data derived from

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scanning and sought to transform it into knowledge about consumer preferences. From category management, to partnership marketing; from efficient consumer response to collaborative planning forecasting and replenishment, the goal has been to create value by reducing costs, as reflected in inventory levels and mix, new product developments, pricing and promotion.The continued reduction in costs produced what many retailers hoped would be a never-ending productivity loop. Lower costs led to lower prices, which in turn led to greater sales and expanding market share. The weak link in the productivity loop model is its dependence on expanding market share. At some point in time, retailers consolidate their competitive market segment and run out of market share to take.
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16 1980 1985 1990 1995 2000 SOURCE: DELOITTE RESEARCH AND PUBLIC FINANCIAL STATEMENTS

bankruptcies in the 1990s. While not benefiting all retailers, the drop in costs and profitability does show up in a drop in prices for consumers.

New Formats
The other way in which retailers innovated over the past thirty years was to create new formats that in many cases facilitated the process of supply chain improvement. Each new format redefined the retail competitive environment and put the innovator at the beginning of the retail lifecycle.

Limits to Supply Chain Innovation?

A little more than two decades ago, the discount department store sector discovered the productivity loop. The concept was simple and compelling. If you drive costs down, you can lower prices. Lower prices would lead to increased volume. In the short run, retailers who were on the leading edge of the productivity loop gained market share and gross margin dollars, at least until their competitors did the same thing, which unfortunately they eventually always seemed to do. The positive aspects of the productivity loop for the discount department store industry came to an end in 1992. The ability to reduce costs as a percentage of sales ran into what seems to be a physical limit. While costs have stabilized just above 17% of sales, margins have continued to drop. It was this squeeze on operating profits due to the breakdown of the productivity loop that was one of the primary factors behind most of the discount store retail

From discounters to warehouse clubs, to category killers to hypermarkets, each innovation sought to collapse the supply chain in some way, so as to under price the cost structure of the previous retail innovation. Each new innovation created a productivity loop of its own that allowed the innovator to reduce costs, cut prices, and expand market share. While the productivity loop works for the individual retailer, when it is applied to the entire industry, the drive to lower costs becomes, over time, a zero sum game with only the consumer the winner. The productivity loop in its current form works for the individual retailer as long as there are similar, less efficient competitors from whom market share can be taken. The oligopolistic structure of retailing today limits the future application of the productivity loop. As a result, the industry leaders will be forced to look for new sources of innovation.

Demand Chain Innovation

No man is of so little value that he cant be used as a bad example.
Mark Twain

When checkout was done on a departmental basis, inventory was managed on a departmental basis. The department manager could see when certain SKUs were hot sellers and which ones were not, and adjust the flow of inventory into the department accordingly. With a shift to storewide checkout, departmental level inventory detail was lost. While overall inventory levels were rising modestly, the mix of inventory

While there has been a steady pattern of success in achieving supply chain innovations, efforts at customer focused or demand chain innovation have been fewer, with a significant number of failures along the way.

in the stores was all wrong. The drain on working capital very quickly drove the company into bankruptcy.

MASS CUSTOMIZATION: FASTER CUSTOMER SERVICE:

LEVI, GATEWAY AND TOYOTA

In the early 1990s, much was made of the idea of mass customization. The concept, while complex in its execution, was

W.T. GRANT
One of the early bankruptcies that caught both the retail and the financial industries by surprise was the 1975 bankruptcy of W.T. Grant. An early discount store pioneer, W. T. Grant was in many ways the Wal*Mart of its day. A darling of Wall Street, in the late 1960s, W. T. Grant was a top retail pick of virtually every Wall Street firm. By the late-1970s, the firm was gone, killed by a failed innovation aimed at improving customer service. In the late 1960s, the firm made a commitment to shift from a department-by-department checkout to a storewide checkout at the front of the store. The payoff to this shift would reduce the cost of customer service and improve the speed of the customer through the store, a win-win for both customer and company. After a brief testing period, the new business process was rolled out to all 1073 company stores. Front of the store checkout from the start was a great success with the customer, until it drove the company into bankruptcy. As it turned out, the more successful W. T. Grant was at implementing their new business processes, the faster they moved towards bankruptcy. The problem with front of the store check out is that it required a far more sophisticated inventory management system than what W.T. Grant had.

simple and compelling in its appeal. Build products unique to each customer. Nothing could be more customer-driven or consumer-centric than mass customization. And yet, despite this strong orientation towards the customer, the results of efforts at mass customization have been disappointing. Companies both large and small have tried to tackle the mass customization problem with surprising little success. From Levis custom jeans stores to Gateways promise to build one for you, companies have learned that the cost of mass customization rarely exceeds the added value of the customized product in the eyes of the customer. In the late 1980s and early 1990s, Toyota spent billions of dollars perfecting a customized assembly line. The result was greater complexity, higher costs and more defects. At the end of the day, all customers wanted was a high quality, low maintenance car at a good price. Rarely is there enough difference in a customized product to make a difference to the customer, even with products as complex as automobiles or computers.

Deloitte Research Reinventing Retail

HOME DELIVERY:

WEBVAN, KOZMO, AND URBANFETCH

When it came to groceries, Webvan solved the customer service problem. They developed a proprietary, state of the art distribution system that broke down pallets into parcels. The front end of the distribution system was a very customerfriendly delivery process that always seemed to get the right order to the right place at the right time. Ask anyone who was a customer of Webvan, and they will bore you for hours about the great customer service that the company delivered. Both Kozmo and UrbanFetch appealed to the sloth and desire for instant gratification of the upper income urban classes. In an hours time, both businesses were able to deliver Hagen-Dazs ice cream and the latest video release to the homebound or time-pressed urbanite. What Webvan, Kozmo and UrbanFetch failed to crack was the profitability model. In 2000, Webvan managed to lose $423 million dollars. Public shareholders have had an even tougher time. Since going public in 2000,Webvans market capitalization
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The Future of Demand Chain Innovations

Past failures at improving the workings of the demand chain should not be taken as a sign that all such future innovations will fail.They simply demonstrate that innovation on the demand side is much harder than it looks. Within the retail industry there are three different areas where we see early attempts at demand chain innovation that, while still unproven, may deliver the kinds of changes in retailing that we have seen on the supply chain side. If there is one common thread that holds these sources of future retail innovation together it is that they are all in one way or another consumer-centric. Most retailers today would argue that they are consumer-centric. In reality, they are product or real estate-centric. Success is measured and managers are rewarded on sales increases by SKU or by some geographic area, store, district or region. For a retailer, being consumer-centric means shifting the focus of innovation from the supply chain to the demand chain. The new operating model for consumer-centric retailers will be knowledge driven. Operational execution will have to be organized around the consumer.

soared to a peak of $16.8 billion before shrinking to zero, a loss that represents roughly 30% of Bill Gates net worth. Webvan, Kozmo and UrbanFetch failed, in large part, because they could not find enough households willing to pay for a world-class customized delivery service. At the end of the day, no one delivers for less, than the customer. Like many of the early participants in the Internet, the founders of Webvan, Kozmo and UrbanFetch thought they were on the leading edge of a process of creative destructive. They saw themselves as a new channel of distribution, undermining traditional retailers in much the same way as innovations had done in the past. What they really represented was a process of creative failure. Never had more effort gone into the discovery of new and more creative ways of losing money.

Short Attention Span Retailing

In the 1990s, the retail winners were big box retailers. They gained market share from more traditional mall-based retailers by offering a marketing mix that fit perfectly with the technological, demographic and economic contours of the times. Beginning with toys and running through a wide gamut of products from books to sporting goods, to home furnishings, big box retailers have won by offering the consumer a large selection from a very focused mix of merchandise at competitive prices. In the past five years, very few new big box format innovations have been tried, a clear sign that their potential for future growth is waning. Big box retailers won in the last decade for a variety of reasons. Time-pressed consumers needed a place where they knew they would find what they wanted. Big box retailers also left the impression that the economies of scale they were able to wring from their improved supply chain logistics were delivering the best price possible to the consumer. Just as big box retailers cleaned the clocks of mall-based retailers, many big box retailers are at risk in the first decade of the new millennium. Short attention span retailers will nibble away at the market share of the big box retailers as consumers with chronically short attention spans wont have the patience to shop these stores.

Short attention span consumers are not willing to wade through 120,000 square feet of merchandise in hopes of finding what they want. They want it now. In many ways, Federal Express is as much at fault for this growth of impatience as anyone. Fed Ex was the first to pander to the need for instant gratification by promising to get it there when it absolutely positively had to be there. When that promise was first made, it was the exception that was limited to package delivery. Now its the expectation that applies to everything. We love the adrenaline rush that comes from speed. But at the same time we have gotten used to over-stimulation. Like any drug, adrenalines effects wane with overuse. The dosage we need to get the same effect is higher. As a result, the hurdle of speed is only going to get higher with the passage of time.The added speed of delivery is a killer of traditional businesses and traditional ways of doing things. The new stores being tested today can best be described as retailing on at least two cups of espresso. It means putting the consumer in an environment where they are always within an arms reach of desire, but with the desire constantly changing. The store design objective is to simply overwhelm the consumers sense of sight, sound, taste, touch and smell, preferably all at the same time. There are a number of retailers who are meeting this challenge. Going to Virgin Records is like going to a large, high tech block

Instant Gratification Is Not Fast Enough

American consumers tolerance for boredom is undergoing a sharp decline. If you cant capture a consumers attention and satisfy the need of the moment in a few nanoseconds, then forget about it. Its not going to happen. Retailers who cannot adapt their business to a technology spawned high-stim environment are at high risk to those who can.

party. Rock videos and old movies play on large screens. Music is playing everywhere, technologically localized by a sound system that plays rap in the rap music section, jazz in the jazz section. The classical music section has its own specially walled off area where its mostly older clientele has a lower stim, more sedate environment in which to shop. Older consumers, who grew up in the pre-internet era, and there still are a few of us old codger around, have a lower tolerance for over-stimulation.

Deloitte Research Reinventing Retail

Sephora also meets these criteria. Walk into the store and you are overwhelmed by colors, smells, and an intense flurry of constant activity. Like Virgin, Sephora is a big box retailer, but one that is winning, not on the depth of its merchandise but on the stimulation of its presentation. Colette in Paris, and the DKNY store in New York are also highstim, short attention span retailers. Colette is on three floors, with 10k square feet, at most. It is the anti-big box retailer. It is like a Noahs Ark of retailing. They have enormous breadth but no depth. The merchandise mix includes mens and womens apparel, house wares, consumer electronics, books and stationary. All of it is presented in a very high-stim environment. There is a cafe in the basement that has soft music and indirect light, for those who suffer from stimulation overload.

Antagonistic Cooperation: Consolidating Services Around A Consumer

Someday the lamb will lie down with the lion, but the lamb wont get much sleep.
Woody Allen

The airlines started it. Both United and American tried to have their own reservation systems. The cost was great and the results were disappointing. They eventually created a reservation network that includes other airlines, rental car agencies and hotels. They were better off with an open network than they were with their closed proprietary networks. What they created by giving up control is a shared network that is customer-driven. The more suppliers on the system, the more attractive it is to their mutually shared customers. Credit card companies and banks have moved heavily into a similar type of arrangement. With a Plus System or Cirrus-based bank ATM card, you can get cash in any currency just about anywhere in the world. The arrangement benefits all participants

in the network, producing a higher level of value and lower unit cost as more banks join the network. Network co-evolution is the next step for retailing. By giving away exclusive control of a competitive advantage, retailers can make their offer of more value to the consumer. Walgreen has done it. After developing a prescription network several years ago, Walgreen had difficulty getting physicians to use it. Most did not want to lock their patients into a single prescription provider. Walgreen eventually opened up the network to competitors, losing control of the network but dramatically increasing its value and use by consumers. Walgreens now gets substantially more business from its open, competitive network than it ever got when its network was closed and exclusive.

PetsMart is taking this concept to a new level. By aggregating complimentary pet services under a single roof, they are redefining their business. They are not just selling pet-related items. They are rolling up a complementary set of fragmented services that facilitate pet ownership. These include kenneling, veterinarian services and grooming. In many ways, Kinkos has done the same thing by providing a complementary set of back-office services, all in a single location. Home Depots Expo is another example of aggregating complementary home decorating and remodeling services around the customer. Expo does not sell just home decorating and remodeling products.They also provide a broad set of services that enable the customer to plan, design, subcontract, and complete the project. Ironically, most of the now failed consumer-oriented Internet companies were, at their core, consumer- centric businesses. Like the other examples cited here, they were organized around the consumer.Their failure was due to many different factors, but their strong orientation towards the consumer was not one of them. Similar kinds of business aggregations that would include a retail dimension could be developed around health care, financial services or even mobility. One company could provide the car, insurance, maintenance, even gasoline. And why would it have to be just one car. You may want something with good gas mileage for your commute to work, an SUV for the summer vacation and a nifty sports car for that weekend drive in the country. No one really wants to own all of these cars, all you really want is access.

Pricing takes on a whole new dimension in a consumer-centric world. In a product-centric world, one price fits all. Pricing is used as a means of managing inventories. When inventories get too high, prices are cut; when inventories are too lean, prices are held. In a consumer-centric world, price is a strategic weapon. In an ideal consumer-centric world, every customer will pay a different price. The airlines have understood the importance of strategic pricing for years. The airlines dont compete on customer service, comfort, or high-quality food service. They compete on price. They have avoided product commoditization by having intimate, detailed, real-time knowledge about customer demand and competitive pricing. They price every seat in their inventory accordingly. Following the airlines, many retailers will begin to charge consumers different prices for the same product depending on their knowledge of the consumers shopping habits. Not all consumers are the same. And not all of them want a particular product or service with the same intensity or at the same point in time in the products lifecycle. Learning to discriminate on the basis of price will be one way that retailers bring their knowledge of the consumer to bear. Discrimination can be done by channel, by time, by product or service mix, by region, by specific store location, or even by season. Price discrimination is becoming rampant on the Internet, as customer purchase behavior becomes better understood.

Deloitte Research Reinventing Retail

Strategic Pricing

Price Management
More effective price management represents an enormous opportunity for driving improvement in retail profitability. There are two primary approaches to price management: price optimization and markdown optimization. The goal of price optimization is to set the right price from the outset to optimize the price/volume tradeoff and maximize profitability, either through a set of business rules or analytical techniques. Price optimization applications can produce value across a broad spectrum of retail products. They have particular value when applied to products like food, staples, and non-seasonal items, that have either a short shelf life or more certain demand patterns. Retailers offering SKU-intensive assortments or having multiple stores will derive benefits from pricing optimization. The complexity of price optimization lends itself to an analytical approach that takes a wide variety of different variables into account, including varying demand by store, competitor pricing, a retailers long-term price positioning, sales and margin objectives, and consumers sensitivity to changes in price. Price management solutions can also help retailers in establishing pricing for private label programs in relation to the
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Markdown Optimization
The goal of markdown optimization is to extract the maximum gross margin dollars from a product over the course of a season or the products life cycle, by taking merchandising constraints, category goals, and sales trends into account. Markdown optimization is appealing for promotional, fashion-oriented, or seasonal products. Markdown optimization seeks to balance pricing with inventory levels on a store-by-store, category-bycategory basis. The optimization application continues to refine its forecasts based on current sales patterns, and will enable maximization of gross margin dollars. Price and markdown optimization take on added importance in a retail world that will be dominated by price deflation. A deflationary cycle has taken hold in a growing number of product categories, from apparel to consumer electronics, from autos to home furnishings. Very few managers in the retail business today have ever operated in a deflationary environment. In past downturns, a decline in the real volume of business was masked, in part, by rising inflation. A company may have sold fewer units, but the dollar volume of sales still rose. Inflation masked many of the problems of the business. It meant that even though the business probably had too much inventory, given the level of customer demand, the value of inventory was rising. Inflation also created a buy now mentality on the part of consumers wanting to avoid higher prices later on. In a deflationary environment, falling prices accentuate the decline in business volume, making the problems of the downturn more severe. Just as inflation creates a buy now mentality among consumers that adds to the inflationary cycle, deflation creates a sell now mentality on the part of business in order to sell more product to make up for the decline in price.

comparable branded items at a store, region, or on the national level. The software solution can recommend pricing options versus leading brands in the region, or even the specific store, depending on what pricing strategy is being utilized.

Conclusions, Observations and Questions

If there is one constant all retailers have to deal with, it is change; change in technology; change in consumer tastes; change in the competitive landscape.The only sustainable competitive response to change is innovation. Over the past thirty years, much of the successful retail innovation has focused on improving supply chain efficiencies. There have been numerous attempts at demand chain innovation, but few have succeeded. While supply chain innovation will continue, the stabilization of SG&A costs as a share of sales over the past decade suggests that the biggest gains to be made there have already been achieved. What remains is the demand chain something that is more difficult to penetrate.

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About the Author

CARL STEIDTMANN

Tel: 212.492.3951 e-mail: csteidtmann@dc.com As chief economist for Deloitte Research, Carl Steidtmann is a writer, lecturer, and consultant on a wide range of issues including technology, culture, and economics. He has been a student, a teacher, a systems engineer, a management consultant, and a Wall Street economist. His research has been quoted extensively in the Wall Street Journal, The New York Times, Business Week and USA Today. He was on the 10-year plan at the University of Colorado where he earned four different degrees in three different subjects: history, statistics and economics.

About Deloitte Research

Deloitte Research is the thought leadership group within Deloitte Consulting and Deloitte & Touche. The group is dedicated to identifying and analyzing major strategy, organizational, regulatory, and technology issues that affect companies world-wide. Made up of both senior consulting practitioners and dedicated research professionals, Deloitte Research offers a powerful combination of deep industry knowledge and innovative thought leadership. Research topics address areas most critical to executives around the world to help them position their organizations at the forefront of a rapidly changing marketplace, and to improve the performance and competitiveness of their business. For more information about Deloitte Research and complete listing of our publications, please visit our web site at www.dc.com/research or contact the Global Director of Deloitte Research, Ann Baxter, at 415.783.4952 or abaxter@dc.com.

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Recent Deloitte Research Thought Leadership

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Please visit www.dc.com for the latest Deloitte Research thought leadership or contact us at Tel: +1.212.492.3791 or e-mail: delresearch@dc.com.

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