RETAILNETGROUP STRATEGY ALERT No.

12 Issue
October 2008
The US Retail Scene - Winning in a Zero-Sum Environment

This week's turbulent markets have shaken us all. While the signs have been In This Issue
there for many months most people simply figured that these were all false RNG's Outlook
signals - certainly nothing that couldn't be managed. Yet it's now clear that Chain Retailers Will Gain
Share
consumption in the US has flattened at a speed and to a level that may be
Shoppers Spend on
without precedent. Needs
The Winners
RNG has forecasted overall 2008 - 2010 GDP and retail sales. Our current outlook The Losers
is for both to grow at a 1% - 2.5% CAGR including inflation--well below most Wall Shift to Optimization
St. and other analysts who are forecasting ~1% real growth. Supplier Takeaways

It is hard to get a perspective on the magnitude of RNG's low forecast. One way On-Demand
to think about it: over a 5-, 10- and 20-year time horizon, the US retail market
generally has grown an average of 5% (nominal), plus or minus 200bps (that is,
Photo Tours
with lows around 3.0% and highs around 7%). This means in an average year the
industry adds about $100b of sales. (That's a lot of bananas!) When that goes to
1% we add only $20b - or a reduction of about $80b in retail sales - the 10,000+ photos -
equivalent of Carrefour's annual sales. A few years of that and you're talking real Views of the most
money. important new stores
opened in North & Latin
More immediately, this kind of flat or declining market requires new retail America, Europe and
strategies and behaviors. We are now in what is essentially a zero sum soon the leading Asian
game: a market where every winner is offset by someone losing. We can see in markets
this years forecasts much greater clarity in the winners and losers - by channel,
segment and individual retailers and banners. We can easily see that most Filter by department -
leaders have changed their strategies from a "growth agenda" to an "optimization Search/sort photos
agenda." And optimization work--what people do and how investments are across markets and
made--is entirely different the growth agenda of the last five years. retailers by department
(for brand managers
This week's newsletter summarizes our conclusions and provides one view on looking for great ideas)

1. RNG's forecasts - overall GDP, retail sales, and chain sales and store "Best Ideas" galleries
growth forecasts that highlight the very
best ideas from across
2. Winning segments, retailers and banners all of our store galleries
3. What retailer optimization strategies mean to branded suppliers
On-Demand - Photos of
Happy reading. And remember that we continue to believe that the bottom is any store in most parts
near and the world will look a little brighter a year from today! of the world in 72 hours
or less.
Dan O'Connor
President & CEO Contact Mark Byrd at
Retailnetgroup.com mark@retailnetgroup.co
m for a free
demonstration.

Our Outlook

RNG's analysts think the US GDP will grow at 1-2.5% including inflation. There Prior Strategy
are a few major factors that we think impact this forecast
• Negative - Consumers are panicked and shopping trips in the last Alerts
two weeks are off double digits in most malls and other retailers
The Legacy Store
• Negative - Nobody in Washington knows what they are doing.
Challenge
(The good news we suppose is they left on vacation today!)
Why retail leaders are
relocating, remodeling,
• Negative - Inflation will continue to push up the cost of goods renovating, and re-
faster than retailers can pass through. We've already seen retailers prototyping
reporting increasing sales on declining unit sales. Overall, RNG is
forecasting a running inflation rate of 2.5% (to reflect some softening in Format Innovation:
oil and other commodity prices in '09 and '10). In the absence of wage Best Buy
or credit growth, consumer take-away will continue to fall in most
consumer categories. In this quarter alone Costco, Wal-Mart and others See Best Buy's new Mall
have suggested there are hundreds of pricing increases coming that will of America pilot store
push up shelf prices 8%-12%. We should assume that this will especially
impact "impulse" and "seasonal" programs (which are generally 40%- Goldman Sachs Global
50% of a retailer's gross sales) Retailing Conference
Get a quick download of
RNG's thoughts after
• Positive - Exports are very strong given the weak dollar
hearing and meeting
with leading retailers
• Positive - Many commodity prices are already weakening - eggs,
oil and other key consumables Chain Retailing 3.0
Over the next two
• Positive - US housing prices will strengthen in many markets - years, branded
There are more than 140m homes in the US. Approximately 6 million are manufacturers and
retailers will be
in trouble. 2 million are empty. While values have declined everywhere
challenged to find new
the majority of the decline is concentrated in the same 12-15 markets
ways to prosper in the
that started and continue to lead the housing crisis (Central California,
fastest changing food
Arizona, Nevada, Florida, etc.) Yet 15 of the largest markets are already retail environment in a
turning and growing again - this is already visible in the latest Case generation
Schiller monthly indices.

The data tells us that the closer we are to 60% of US households owning Mature Store Activation
a house the lower the mortgage delinquency and default rates are The new thing in retail
(always below 1% at these levels)-and the closer we get to 70% growth is old stores, and
household ownership an increasing percentage of homeowners goes how to unlock their
bust. We are almost back under 65% - which is very good economic potential to reach new
policy. shoppers and drive
wallet share with
existing shoppers
• Positive - Consumers are getting their financial cash flow into
shape - slowly . This simply means that when we measure household
level inflows and outflows we can see what is left for "discretionary" Social Networks
purchases. Goldman Sachs summarized this recently as follows Online social networking
allows marketers to
connect with new and
existing customers and
deepen the level of
engagement

Pricing Optimization
Retailers are developing
pricing as a strategic
capability, which also
raises several
opportunities for CPG
firms
 Private Label
Strategic store brand
programs are a
significant growth
strategy for retail
leaders

Express Stores
Convenience food
retailing is changing
globally as consumers
express their preference
for healthy, fresh, and
ready to go (or
consume) foods

Health Services
Explore how retailers
are trying to re-organize
the way that health and
wellness services are
provided
Goldman's analysis shows consumers reversing their household deficits
significantly over the next 12 months--a very abrupt change that will allow
consumption to grow again. Mobile Retailing
How mobile based
commerce and
marketing strategies are
being utilized by
retailers worldwide

Meet Our
Analysts

Dan W. O'Connor is the

President & CEO of the
RetailNet Group. He
• And finally, all bad news from 2008 will cycle through this year also is the Founder of
and next. As a result, any improvement in any indicator is going to be Management Ventures,
seen as favorable. Inc. (MVI), a WPP Group
company. Dan is a
So in the short run (through 2009) we may actually see GDP and retail sales widely known industry
shrink 2 or 3 quarters. However, we believe the overall 08-10 average will rise to speaker and thought
approx 1% as we move through 2009 and 2010. leader.
LinkedIn | Email

Chain Retailers Will Gain Share and Grow Faster

Despite the gloom, chain retailers will gain share and grow faster than
total retail. Independent (non-chain) retailers tend to lose share in downturns
while collectively the large chains in RNG's databases tend to gain share
(something the RNG team has observed over each of the last 3 big downturns
since the early 70's).

The number of chain retail companies and banners will stay about the
same in the best case and shrink in the most likely scenario. It is unlikely that
either will show much change other than a few new banners replacing those that
go away.
Aaron Chio is a Senior
Analyst leading RNG's
The total number of stores operated by these retailers will grow by less
development of new
than 1.8%--down from over 2.5% to 3.5% CAGR over the previous 5 years.
research, insights and
About 5,000-10,000 stores will close (or have closed in 2008 and 2009). In RNG's growth strategies in
view these will be largely offset by the growth from across the most successful Latin America.
retailers - supercenters, entertainment, health & beauty and other winners. For LinkedIn | MSN |
vendors, this cutback is a big deal due to the initial "fill" they get when a store
opens (5,000 stores a year times average $2m of initial inventory is a lot of
production).

Tim O'Connor is Vice

President at RNG,
currently responsible for
RNG's Growth Strategies
Curriculum and
European market
insights.
LinkedIn |

(Click to enlarge)

Keith Anderson is a
Senior Analyst and
Shoppers Will Spend on Needs responsible for RNG's
North American research
If you believe GDP and retail sales will remain essentially flat any spending practice and
increase in one category will be offset by another. Given inflationary pressures in transformational
food, fuel and other essentials it is likely that these retailers (e.g. supermarkets) capabilities
curriculum.
will increase their share of household spending. Those that sell
LinkedIn | Twitter |
discretionary/impulse/gifting will likely lose share.
Windows Live Messenger
This chart demonstrates the dynamic:
 (Click to enlarge)

Who Are the Winners?

Using RNG's distinctive chain segmentation it is pretty clear that within this very
difficult macro environment there is some good news for chains with highly
targeted positioning.

• Express stores including "Fresh & Easy" will continue to rapidly grow
their store base and overall sales

• Gaming stores including Game Stop are and will stay very popular. Their
"trade in" program in particular drives a huge number of trips and up-
selling into a very engaged shopper base.

• Value-based retailers such as membership clubs, Supercenters,

limited assortment grocers (e.g. Aldi, Sav-a-Lot)

• Selected specialty retailers continue to turn in good results including

some sporting goods retailers (Dick's and Modells), consumer electronics
and some apparel retailers.
 (Click to enlarge)

Who Are the Losers

Though each of the following segments are full of great companies, the following
are likely to sell much less this and next year on a per-store basis than prior
years.

Many home specialists, mass merchants, department stores, and

book/music/video retailers fall into this group.

(Click to enlarge)

Leading Retailers Shift to Optimization

In this environment, where overall consumption is capped and impulse
consumption seriously restrained, retailers will focus intensely on the key drivers
of ROI that can be influenced quickly:

• Unit margins (including acquisition costs and pricing)

 • Assets managed (including stores opened/closed and inventories)

(Click to enlarge)

This means we will see retailers take broad steps to:

• Rationalize their store base - Most chains are seriously cutting store
buildout and focusing capex on existing stores. RNG sees a record
number of retailers closing, re-positioning, re-locating, re-modeling and
otherwise trying to activate their existing store base (remember, sales at
up to 70% of the typical large chain's store base are flat or declining)

• Cut SKUs - RNG expects SKUs cuts to average of 6-8% (as a baseline).
Of course, this will reduce overall choice in categories where retailers
have decided they can't win or don't want to play-but the focus will be on
offering shoppers meaningful choice. Even some growth categories like
prepared foods will be targeted. (Target and others have been under-
inventoried for decades and think of SKU editing as an "intelligent loss of
business")

• Reduce inventory by keeping quantities tight. A few very large

retailers RNG speaks with know that competition is over-bought - which
means suppliers are over-producing. So winners are going to keep the
quantities close so the store is clean before Thanksgiving and then buy
smartly from vendors who may need to close out over-production.

• Introduce more specialists into the decision process; the buyer will
become a decision-aggregator, not a decision-maker.
○ Pricing specialists to manage price and promotional
optimization tools such as Demandtec to control retail pricing
and really sort out meaningful promotions. (See our previous
Strategy Alert on these providers)
○ Finance and Inventory specialists to optimize inventory
allocation rules and processes, deductions/returns and extended
terms and push hard for exits - retailers will negotiate harder on
the front

• Get real about marketing differently. Unfortunately for most

manufacturers, RNG does not believe that "one-off" or even category-
 specific segmentation and shopper marketing models will prevail. We
believe the retail winners are integrating their databases, building
significant proprietary shopper panels and adding new mining tools and
marketing mediums to drive sales one store at a time (much more to
follow on this topic)

• Focus on in-store experience and shop-ability - There are so many

good examples where this work is now visible and having an impact.

• Drive the power of vendor DSD networks to better target

assortments, marketing campaigns and in-stock conditions. A very
powerful tool during this important transition.

• Use private label to demonstrate innovation in packaging,

product, claims and merchandising. Pricing as well, where the
private label unit margins are higher than the brands. This is especially
true already in all of the major grocers: Safeway, Kroger, Trader Joes,
Whole Foods, etc.

• Significantly edit the number and scope of seasonal programs

Some retailers will trim the number of major seasonal programs they run
and even create a few proprietary seasons to differentiate

Retailers will go hard and deep on the seasonal programs they do

commit to.

Target for example has put tremendous emphasis on Halloween. Its

displays are enormous: 25% of the outside wall on a 220k sq ft building!

(Click to enlarge)

Everyone should expect significant order

adjustments up until the end

Focus on "attachment" and "impulse"

sales

Smart retailers will consider what sells with

what and make it easier and easier for
shoppers to "attach" more products, so that
one sale leads to at least one more on the
same trip. Impulse sales too will be a focus -
not just in terms of adjacencies but also how
use clip strips are used and the products are
merchandised (see the example at left from
 Longs - a great new clip strip program merchandising $3-$5 impulse
items from attractive clip strips)

(Click to enlarge)

• Create new revenue streams - Wal-Mart's CSI program (as described

by Cleveland Research and others) is a meaningful initiative to increase
the marketing dollars that flow to that particular retailer. One can only
assume that many retailers will pursue similar strategies as they have in
decades past.

What Does This Mean to Suppliers?

RNGs experience suggests that suppliers will want to

1. Get the facts - RNG's database quickly show you which segments,
retailers and banners are going to win and lose

2. Get the big picture right - Be aware that the big consulting firms are
selling retailers a process that classifies every category "win, place &
show". WMT, Best Buy, Home Depot, and others are now imposing this
approach on the overall store to make sure that they exit and enter the
right businesses in the right sequence. Make sure you know how your
categories are segmented. You will want to modify your selling stance
accordingly.

3. Ignore retailer comps - Split your sales analysis to look at stores over
and under 4 years old--then according to the degree the store has been
upgraded/re-modeled. Remember retailers are not transparent enough
about this and your analytics can make this much more visible.

4. Win the SKU rationalization game - Get to know Demandtec and the
other tools that retailers are using to automate this process. It is
essential that your company understands the principles retailers are
using to make these tools work (much the same as planogramming
tools)

5. Re-think seasonal & impulse - In this environment, go big or go home

6. Get localized - It is essential to get down to store-specific assortments

when and where it makes sense - DSD systems in particular have
tremendous power in this regard not available to warehouse or cross-
dock suppliers
RNG analysts are available to talk more details on these and related topics. If you
have any questions or thoughts to share please reach out to
keith@retailnetgroup.com.

Pease count on RNG to keep you up to date on these growth and optimization
strategies.

RetailNet Group is the leading insight and advisory firm focused on retail
growth strategies and consumer-facing transformational capabilities. We
are deeply experienced retail/consumer analysts and strategists working
exclusively to help brand-led businesses and large-scale retailers grow.

Sincerely,
RetailNet Group
Note: Articles contained in this newsletter are collected from a variety of sources and links can
expire over time.

Email Marketing by