How can department stores adapt to the digital age of retailing?

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House of Fraser recently announced that it is seeking emergency funding from specialist lenders to save its struggling UK retail business, as its Chinese owner is in talks to sell a large stake of its ownership share. This comes on the back of a recent spate of administrations and store portfolio closure programmes among several of the UK’s other best-known department store operators and retailers.

As the current challenges in the department store sector are increasing, the question is whether the department store model, in its current form, is sustainable and relevant in the current retail market. Is its decline inevitable, or can it possibly be reversed? What could be done to address the many challenges it faces and make it fit for purpose in the modern age of retailing?

Commercial history

Department stores have existed in Britain for centuries. The first one, believed to be Fortnum & Mason in London, first opened its doors in the 18th century, although many of them have been around since the mid-19th century. They have inevitably evolved over the centuries as consumer tastes have changed and developed to offer a convenient ‘one-stop shop’ to the customer spread over several different departments.

For the last forty years or so, department stores have not only been in prime high street locations but have also served as major anchors to shopping centres and retail parks, attracting other retailers around them as they have acted as a major draw to shoppers. However, in recent years consumers have become much more sophisticated, as well as price-sensitive, in their tastes, at the same time as the market has evolved to be much more competitive. This has primarily been due to the strong growth of e-commerce, which has resulted in many department store chains struggling to remain profitable. Some have failed because they have not adapted to the changes and invested in upgrading their stores and tailoring their offer to keep it relevant and fresh.

The current market environment 

The vast majority of UK department stores cater to the mass market. As such, many of these operators are failing because customers can often buy their goods cheaper online and do not need to go to a department store where there is often less choice of products and brands, the store looks tired and outdated and the whole retail experience fails to excite them and entice them to spend their money.

Recent examples include the collapse of the department store chain BHS, which suffered from high levels of debt and financial mismanagement, as well as under-investment in its stores and a failure to adapt to modern tastes in retailing. Debenhams is another example of a department store operator, which is struggling to adapt to the structural changes caused by online shopping and changing consumer preferences. These mass-market department store operators have too many stores nationally and too much space within their stores. Increasingly this space is becoming redundant as customers refuse to climb escalators on multiple floors and walk across large floors in order to find the item they are looking for.

Property fundamentals 

From a property perspective, department store retailers are typically renting space from landlords on long leases, so it is difficult for them to exit from their lease obligations until they reach either a break option or the end of the lease. In the past, this arrangement was often favourable to the tenant because if they were a key anchor of a shopping centre, for example, they often paid no rent or it was heavily subsidised by the landlord in order to attract other retailers around it. In today’s highly competitive market, however, the tenant is facing a number of additional costs, such as increased import costs as a result of Brexit-related inflationary pressures, higher business rates and higher staff wage costs as a result of an increase in the minimum wage. All of this is putting additional pressure on already stretched profit margins.

In contrast, pure online retailers pay lower taxes as well as having zero rent or other property-related costs. To compete with these players, department store retailers also have to invest in a full multi-channel offering, including click and collect facilities in physical stores, to be able to provide what the customer wants, in terms of being able to shop anywhere, anytime.

There are some bright spots

Not all department store operators are struggling though. John Lewis is an example of a major department store retailer, which has adapted and embraced the change by investing in a full multi-channel offering, with 50% of its sales now coming from online purchases. It has also expanded its presence through new specialised stores such as John Lewis at Home, which is out-of-town focused.

While the mass-market operators have been hit by competition from the discounters, the high-end premium operators such as Selfridges have maintained their relevance by increasing their premium offer and also offering a great customer experience. This has been achieved through hosting new, exciting luxury brands, organising special events, increasing its choice of upscale in-store cafes, bars and restaurants (its London store now has at least seventeen places to eat and drink!) and providing a premium, personalised customer experience.

Clearly this works in a prime location in the West End, trading in a highly diverse, international tourist and domestic shopper environment, but it would not work in many other locations.

Demographics will be more complex in the long-term

As with all retailing, being in the right location and tailoring your offer to the local demographics and economy in the catchment area are critical to department store retailing, but as online retailing has become an important part of the overall retail mix, analysing local catchment area demographics and expenditure potential, becomes more complex and less relevant.

Property consultant Cushman and Wakefield estimate that we will have a national oversupply of retail space in the UK of 20-30% of all space in the next five to ten years, so department store retailers need to reduce their store portfolios and focus on a smaller number of targeted stores in prime destinations and major shopping centres, in order to stay profitable. In addition, in this highly competitive, multi-channel environment, it has become more challenging for department store operators to continue to trade successfully and remain relevant. But they can succeed if they focus on offering a great, personalised, seamless multi-channel experience to the customer, both online and in their stores.

They also need to think creatively about the use of space in their stores, adopting an holistic approach and working with landlords, designers, planners and local authorities to think about reconfiguring their space to the best use to match demand in that local area, which may be residential, retail, office, food and beverage, urban logistics or mixed use. This is because the boundaries between the sectors are blurring, as location becomes a more important driver of performance than sector, and a greater focus on mixed-use community living, working and wellbeing is increasingly required. This is known as ‘placemaking’, with developers focusing on creating a sense of place and community in one location.

The reality is that we are likely to see fewer department store operators in fewer locations, as secondary locations continue to become obsolete. Only those, which have embraced the change, reinvented their store portfolios and are passionate about providing a unique customer in-store experience, which cannot be replicated online, are likely to survive and thrive.

Important Information

The value of investments may fall as well as rise and investors may not get back the amount invested. 

The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments.

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CLI01155 Expiry 5 April 2019

Joanna Turner

Joanna Turner

Head of Property Research

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