The death of big box retail?

If recent profit downgrades in Australia and the US experience are signs of things to come, big box stores like Harvey Norman and Myer run the risk of being too big to survive.

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If recent profit downgrades in Australia and the US experience are signs of things to come, big box stores like Harvey Norman (ASX: HVN) and Myer (ASX: MYR) run the risk of being too big to survive.

The news has gone from bad to worse lately as a slow economic recovery, increased competition from online channels, and a failure to adapt to new market conditions have a number of retail chains on the ropes, and with uncertain futures.

The writing is on the wall
In some things, Australians are global leaders – we are early adopters of technology, have an enviable record of scientific discovery and a resurgent cricket team hopefully on a path back to world domination.

For much of the rest of our economic existence, we tend to follow the trends of our North American and European cousins. We've been lucky enough to escape much of the economic pain they've suffered, but our businesses and economic institutions tend to follow the lead of those overseas.

If that trend continues, it mightn't be good news for our big box retailers.

Department store blues
The company whose name once graced the tallest building in the world has surely fallen from great heights. Sears Holdings (NYSE: SHLD), parent of department store Sears, discounter Kmart (no relation to the Australian business of the same name) and other familiar brands, recently announced it would be closing up to 120 stores.

Same-stores sales have declined remarkably, sliding every year since 2005 and the retailer has reported negative net income for three straight quarters. With revenue declining and management in a revolving door, Sears runs a real risk of being consigned to the history books.

Booking losses
In bookselling, Barnes & Noble (NYSE: BKS) recently announced this year's loss would be twice as large as previously expected. The bookseller's Nook e-reader, on which the company's last hopes seem to be riding, sits in a purgatory. The company has announced a partnership with The New York Times (NYSE: NYT), in which the Times will subsidise the Nook for readers in exchange for a full year's digital subscription to the newspaper.

Even if the deal benefits both parties, B&N is already taking an overall loss on the Nook. As online giant's (Nasdaq: AMZN) sales grow at a blistering pace, up over 40% in its latest quarter, it's hard to see how Barnes & Noble brings itself back to life.

Best Buy is anything but
Turning to electronics and Best Buy (NYSE: BBY), the ubiquitous US electronics retailer, posted a 1.2% decline in same-store sales in December. Its share price dropped over 15% after a disappointing third-quarter report, which included a 29% drop in net earnings.

Industry-wide, consumer electronics sales in the US fell 5.9% over the holiday season after dropping by 6.2% in 2010. With smart phones and tablets fulfilling many of the functions of yesterday's stand-alone technologies like camcorders, video players, and GPS devices, the days of big box electronics stores may be numbered.

Retailers – and investors – beware
A perfect storm of exchange rate movements, online competition and economic malaise has put local large-format retailers squarely in the sights of the same forces that are challenging the existence of these once-dominant US retailers.

REDGroup Retail, owner of Angus & Robertson and Borders in Australia has already gone the way of Borders' former US parent into administration.

Electronics retailers Harvey Norman and JB Hi-Fi (ASX: JBH) would no doubt be keeping a close eye on Best Buy. While neither is an exact substitute – Harvey Norman has a broader home furnishings range and a different business model, and JB Hi-Fi has a discount positioning – the competitive threats and changing consumer behaviour are surely keeping both management teams awake at night.

Lastly, David Jones (ASX: DJS) and Myer would be following Sears' fortunes very closely indeed. Whether the time of large, diverse department stores is over is uncertain, but it seems clear that the competition from online retailers and specialist bricks-and-mortar players will be an ever-present threat from here on in.

Foolish take-away
As recently wrote in 'My 2012 Investing Resolutions', I'm making a conscious effort to engage with different points of view.

There is a very plausible scenario in which all of the retailers I've mentioned either go out of business, get taken over, or learn to survive in a much smaller form. The opposing hypothesis sees these established, popular names adapt successfully to the new world and become true 21st century retailers.

For now, I'm keeping my modest shareholdings in David Jones and Harvey Norman, but the US experience is cause for some concern.

Time will tell whether some of Australia's most storied discretionary retailers can successfully evolve into the multichannel retailers they need to become avoid irrelevance or death. What seems clear is that the old models are no longer enough – as always, the prize belongs to the business that can best evolve to meet the needs of modern consumers.

Are you looking for an alternative to big box retail? Motley Fool readers can click here to request a free report titled The Motley Fool's Top ASX Stock For 2012.

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Scott Phillips is The Motley Fool's feature columnist. Scott owns shares in Harvey Norman, David Jones and The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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