Never Let a Good Story Get in the Way of the Facts: Over-Capacity Is Accelerating

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\"\"I know you are thinking I got the headline backwards. I did not. Two weeks ago I wrote a blog Store Rationalization or Price Deflation?  debunking what some experts were hopefully predicting: that the retail industry is in a period of “rationalization,” (aka shedding underperforming stores, eventually leading to a supply and demand equilibrium). My case was supported by facts with two charts contributed by Fung Global Retail and Technology, which displayed the number of announced store closings and openings in 2017. I pointed out that while roughly 500 more stores were closing than opening, (2900 vs. 2400), there wasn’t a square footage comparison, and furthermore, all of the stores opening were in the value sector (outlets, off-pricers, discount and dollar stores, etc.), which would just add fuel to the insane price promoting fire – diving every sector deeper into the price deflationary vortex.

I also pointed out the fact that even though there is no way to translate the constant stream of new website openings into retail square footage, they were nevertheless adding to overall capacity. Now I can reveal some metrics that lend support to the fact that the industry is not “rationalizing” its way to a supply/demand equilibrium, it’s actually accelerating over-capacity. However it’s happening in a way that has been fairly invisible.


Distribution Centers as e-Commerce “Stores”

One can view the Amazon marketplace as one big “store” with 90 million square feet of distribution center space in the U.S. alone (as of year-end 2016). And while all of e-commerce accounted for 33 percent of total retail sales growth over the last five years (65 percent in the last two years), Amazon-owned 60-70 percent of it. Furthermore, while accounting for a mere 4 percent of total U.S. retail sales, Amazon captured 21 percent of the five-year growth and 40 percent of the last two years. You get the picture. Across the e-commerce landscape, with Amazon as the lead horse, their distribution centers as “retail stores” are going to be expanding at a commensurate rate.

Now the enlightenment: Yes, massive store closings in the brick-and-mortar world will likely be offset by massive store openings in the value sectors, thus perpetuating over-capacity. However, as all of the major players, both offline and online, are simultaneously opening distribution centers like crazy, it’s propelling over-capacity into La La Land.

Chart #1 shows the incredible growth in distribution centers, square footage that more than offsets store closings. Note that these metrics include Walmart, Target, Kohl’s, Macy’s, JC Penney, Best Buy, Bed Bath and Beyond and Gap. On top of the 8 million square feet of retail space added since 2013, these brands added 17 million square feet of distribution space.


Chart #2 shows the 2016 square footage space of distribution centers for each of the retailers mentioned, including Amazon. And you can see that another 23 million square feet of DC space is anticipated for Amazon. It is important to note that Walmart currently has more DC space than Amazon (even though Amazon is rapidly gaining). However, if you add in the 4500 plus U.S. brick-and-mortar Walmart stores, which are functionally being transformed to operate as DC’s, the Walmart bar in that chart would be out of sight. And this takes me to another point made in last week’s article: Walmart Acquires Its Way Online the median distance to any of the 4500 Walmart stores (also becoming distribution centers) for 90 percent of the United States population is 4.2 miles. And if you add in the 120 million square feet of Walmart’s DC’s, the 4.2 miles might be reduced to under a mile.

Piper Jaffray analysts estimate that the locations of Amazon’s fulfillment centers bring it within 20 miles of 31 percent of the population. So, Walmart has a shorter “last mile” than Amazon, and their stores/distribution centers are almost within walking distance for their BOPIS customers. Reminder: Amazon has no stores; advantage, Walmart.

More Over-Capacity, More Price Deflation, More Downward Vortex

So we’re back to square-one: too much supply and too little demand leads to pricing as the basis for competition, because it is the path of least resistance to deliver short-term growth. But that alone is not sustainable. And now that we’ve added the square footage of DC’s to the supply side, it is simply a dark scenario.

I repeat: in a world producing more than people can, or want to consume, the end of this arc (not the pretty rainbow arc) is a real Japan-like deflationary cycle, and potentially a recession — or worse, depression.

The only way out of this downward vortex is for Wall Street and corporate America to agree on a new basis for competition with new performance measures. Replace revenue growth with profitability growth as the measure of a successful business — quality vs. quantity. Some suggest ROIC (return on invested capital) as the measure of a “smart” and sustainable business.

Currently, I’m finding it very difficult to imagine a colorful rainbow replacing the dark arc of endlessly deflating value.

I hope I am wrong.



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