On the Margin
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Struggling retailers offer warning to restaurants

Blog: Oversupplied retail world shows consumers have only so much capacity for buying

This post is part of the On the Margin blog. 

2017 isn’t starting off all that well in the retail world. Just this week, Macy’s announced plans to close 68 locations. And then Sears, which has been shrinking for years, said it plans to close 150 Kmart and Sears stores and sell off its iconic and popular Craftsman brand.

Macy’s CEO Terry Lundgren told TheStreet’s Brian Sozzi that “America is still over-stored.” 

It’s a situation to which restaurants should pay close attention.

The problem is simple: Internet-based retailers like Amazon and Wayfair are taking business away from traditional brick-and-mortar concepts like Sears and Macy’s. Consumers can easily shop for prices online, and can often find better deals. Traditional shops have higher capital and overhead costs.

Over the years, retailers aggressively built new locations as developers opened up shopping malls and strip centers. As demand for those locations waned, they’ve been slow to close them. Walk into a Sears at any particular moment and you wonder how that store remains open.

The Internet isn’t having the impact on restaurants that it is having on retailers — it’s too fragmented a business with too many potential occasions for that to happen. In fact, the Internet arguably holds the potential to help restaurants’ business, as innovative concepts like Domino’s Pizza Inc. and Starbucks have already proven.

But restaurants are definitely “over-stored.” Last year proved that. And the problems in retail are actually contributing to the supply.

Many consumer investors are flocking to restaurants, in part because there’s a perception that the Internet won’t have the impact on restaurants that it has with many other industries, like retail. Institutional investors, private equity groups and even lenders have flocked to restaurants’ relative safety.

This is helping fuel growth in the restaurant industry. When a private equity firm spends $20 million to invest in a 10-unit fast-casual chain, for instance, that firm is going to want to sell that investment for $100 million a few years later. And the only way to do that is by promoting unit expansion.

Investment in the space has thus helped increase restaurant development, increasing the supply of restaurants. That’s come along with development by more mature restaurant chains, continued openings of new locations by independents and the growth in the market for prepared food at grocers and c-stores.

Even when restaurants do shut their doors, other companies are quick to move in. Buffets Inc. filed for bankruptcy last year and closed dozens of locations. That included several of its Old Country Buffet brand in Minnesota, where I live. Other concepts have since filled most of those closed locations.

Restaurant industry same-store traffic was weak or falling for most of 2016. It’s not a stretch to say that the growth in the number of locations, at least for the year, has outstripped market demand and contributed to that weakness.

To be sure, there are still incentives for brands to grow. Yet those struggling with traffic should be faster to slow unit growth. And when those struggles persist, they should be quicker to close struggling locations.

That strategy works. Arby’s Restaurant Group slowed unit development and closed hundreds of locations going into and during the recession. With stronger locations, Arby’s went on a long, same-store sales winning streak. Its same-store sales have increased for 24 straight quarters and have outperformed the quick-service sector for 15 straight quarters.

Jonathan Maze, Nation’s Restaurant News senior financial editor, does not directly own stock or interest in a restaurant company.

Contact Jonathan Maze at [email protected]

Follow him on Twitter at @jonathanmaze

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