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BIG BOXES SHRINKING IN ORDER TO GROW

AS CHAINS STRIVE TO BOOST THEIR PERFORMANCE, SMALLER STORES CAN MEAN MORE PROFIT PER SQUARE FOOT AND MORE CENTERS INTO WHICH THEY CAN FIT

By Steve McLinden

If bigger stops being better for big boxes, THEY may have to start calling themselves “not-so-big boxes.” For years large retailers have been downsizing a store here and there when necessary to fit inside a small urban site. Now, though, they are shrinking their footprints across the board, to control costs and cope with Wall Street’s relentless demand for growth and efficiency. The trend is especially evident on the consumer electronics scene, with Best Buy and Circuit City shoehorning into spaces that are, in some cases, half the size of their usual superstore format.

As late as 2004, Best Buy stores generally occupied 45,000-square-foot boxes. This year, however, two-thirds of the 90 stores the chain is opening will measure 30,000 square feet or smaller. In fact, 10 of these will cover just 20,000 square feet, says Justin Barber, a Best Buy spokesman. Similarly, about half of the roughly 65 domestic stores Circuit City plans to roll out by March will measure just 20,000 square feet, less than two-thirds the size of its 34,000-square-foot floor plate.

Tests of the smaller format “indicate reduced capital expenditures and operating expenses, resulting in higher returns,” the company noted in its June 20 earnings statement. Circuit City plans to open 100 more stores next year, with roughly a third of those replacing outmoded units.

How does all this shake out for shopping centers? Well, on the plus side, smaller stores give developers more opportunity to incorporate the popular consumer electronics category into lifestyle centers that could previously not contain them, says Scott Rehorn, managing partner of leasing at Scottsdale, Ariz.-based RED Development, which has 13 retail projects in the works. One of RED Development’s new middle-market power centers contains several newly downsized retailers, including a small-prototype Bed Bath & Beyond. “This just adds more tenants for us, and the consumer gets more variety in the process. Sometimes the economics work better with smaller stores.”

On the negative side, smaller stores can hurt developers in deals where tax increment financing and similar incentives are based on the total sales a project is anticipated to generate, says Rehorn. Dimensional reductions could also have a negative impact on a center that was banking on the bigger prototypes, says Brad Hutensky, principal of the Hartford, Conn.-based Hutensky Group, a property development and management firm that oversees 1.85 million square feet of retail space. Many downsizing tenants are going back to landlords to renegotiate long-term leases, and some will simply opt to move out, he says. “We all recall when the major drugstore chains suddenly decided they needed drive-through lanes and then started moving out of centers wholesale.”

Though some departures are inevitable, it is unlikely that reduced-size requirements will cause a mass exodus from top-flight centers, says Robin Walker-Gibbons, executive vice president of leasing at Developers Diversified Realty Corp. “If it’s good real estate, they won’t want to abandon it,” she said. “But with that said, landlords must always stay creative in adjusting to these changes.”

Retailers generally pay less per square foot for larger anchor spaces than for smaller ones, so some centers will benefit from reductions if they are nimble enough to fill the abandoned space quickly and gainfully, sources say.

Best Buy and Circuit City are not the only retailers reducing a footprint. In 2004 Office Depot started rolling out its 17,500-square-foot M2 (Millennium2) prototype, which is down a third in size from its 26,000-square-foot standard. Since the spring, roughly half of Office Depot’s approximately 1,200 North American stores were operating under the M2 format, lowering by about $1 million the yearly sales volume per store needed to break even. Rival OfficeMax now has three store prototypes, the largest of which is only 18,000 square feet.

A few years ago Home Depot began building “neighborhood format” units that are about a fourth the size of the standard 105,000-square-foot store and carry fewer lower-margin commodity products, such as lumber. DSW Shoe Warehouse recently unveiled a 19,000-square-foot prototype that is one-fourth smaller than its standard design. About a quarter of grocer Supervalu’s new stores are the smaller Limited Assortment units, and Tesco and Publix are rolling out their own reduced-size formats.

Wal-Mart Stores says it will cut the number of Supercenters it plans to open in 2008 by a third. “It used to be Wall Street was more concerned with more sales per square foot,” said Rehorn. “Now they’re more concerned with cannibalization, especially in Wal-Mart’s case.” Because Wal-Mart is constantly seeking ways to increase efficiency, a smaller Supercenter footprint may be in the offing, Rehorn speculates. “If you can cut down 200,000 square feet to 170,000 square feet, well, that represents a huge savings at the volume they build,” he said.

The smaller-store strategy was inevitable, according to retail consultant George Whalin, president of Retail Management Consultants, San Marcos, Calif. “Once retailers get to a certain size, they have to go to places where they can’t build big stores, in order to achieve growth objectives,” he said. Reductions in staffing costs, while a side benefit, are not the biggest force driving the issue for retailers, he says. “It’s just that big metro store space is so hard to come by.”

Sometimes product evolution spurs store-size change. Consumer electronics devices, with the exception of home-entertainment systems, have been getting smaller and thus require less shelf space. Reduced demand for CDs, the result of increased purchases of music online and through mass merchandisers, is spurring Best Buy and Circuit City to constrict their store formats. Merchandise varies slightly from format to format, with the 20,000-square-foot stores displaying fewer large-screen TVs, major appliances and similarly bulky goods. “Obviously, you can’t have a full selection at smaller stores,” said Barber. A few years ago Circuit City ditched washing machines and the like when it winnowed its store sizes to 30,000 square feet from 45,000 square feet, says Walker-Gibbons. Rising construction and real estate costs added impetus to the chain’s latest round of reductions, she says.

“Clearly, we’ve found that retailers are still looking to expand, and one of the best places they’ve found are ‘C’ and ‘D’ markets,” said Richard Hollander, president of the customer ID division of Fort Worth, Texas-based Buxton Corp. But most of those retailers are not opting for smaller markets and footprints simply for the sake of uniformity, he says. Customer analytics, not instinct, are dictating these decisions in many cases, he says. “The smart retailers are asking themselves, ‘How do I best serve these markets while still meeting brand demand and customer-service demand and still getting return on investment for our shareholders?’ ”

Marc Pearl, executive director of the Consumer Electronics Retailers Coalition, says retailers must be careful not to cut back on customer service and product education in their drive to shrink in size. “Products change immensely in this area, and you always want to lower customer confusion while increasing customer choice,” said Pearl. “And that’s a difficult balance to reach. Retailers have to become educators. The last thing a consumer electronics retailer wants to do is push a product that consumers don’t want.”

Retailers have learned to adapt to industry changes through creatively fitting their concepts into unconventional sites in redeveloped areas in New York City, Chicago and comparable cities, says Dave Brennan, co-director of the Institute for Retailing Excellence at the University of St. Thomas, in Minneapolis. “They’ve become accustomed to doing build-ins instead of build-outs,” Brennan said. Best Buy’s original store prototype was just 15,000 square feet, he says. “It went to 30,000 and then 45,000. They even tried a 58,000-square-foot store but found it to be too unwieldy.”

Sometimes smaller-store formats stem from anti-sprawl ordinances. Though many U.S. municipalities have adopted caps limiting superstores to 100,000 square feet or less, others are restricting big-box sizes to far more modest footprints; among these are Boxborough, Mass. (25,000 square feet), and Damariscotta, Maine (35,000 square feet).

For the most part, smaller stores are just another way for retailers to shore up the bottom line as the industry continues its evolution, says Walker-Gibbons. “Retailers are simply figuring ways to be more profitable,” Walker-Gibbons said. “In the case of Circuit City, they have addressed what they needed to address, and that has been painful for them. But they had to make some tough decisions and are moving forward.”

Hutensky, who has Circuit City and Best Buy in several of his centers, agrees. “In the big picture, it’s always good for retailers and developers and the whole industry when retailers right-size,” he said. “For us there is always an opportunity to accommodate a retailer’s changing needs and to capitalize on those changing needs.”