In our opinion, Amazon’s purchase of Whole Foods was symbolic as an admission that online-only retailing was not sustainable.

Competitors, such as Wal-Mart and Alibaba, are moving toward omnichannel platforms, blending brick-and-mortar and online retail together.

Similar to retailers, there will be winners and losers within the retail real estate space.

High-quality and well-located strip center REITs will play a pivotal role as the cheapest touch points for retailers.

It seems every day a negative news article is written about brick-and-mortar (B&M) retailers, questioning the future of retailers and retail real estate due to the impact of e-commerce (also read “Amazon” (NASDAQ:AMZN)). As a result, the S&P Retail sector ETF (NYSEARCA:XRT) is down 5.9% year to date, and the Bloomberg REIT Shopping Center index (BB: BBRESHOP) has returned -10.9%, as of July 31, 2017.

We believe e-commerce will continue to have an outsized impact on the retail sector. However, it is not as much an argument of online-only versus B&M, but of retailers willing to blend the two into an omnichannel strategy versus retailers that are stuck in their old ways. Some of the world’s largest retailers, such as Amazon, Alibaba (NYSE:BABA), and Wal-Mart (NYSE:WMT), have made billion-dollar bets on this new direction for retail, and it is even spreading to grocery, an industry previously perceived to be resistant to e-commerce. Similar to retailers, there will be winners and losers within the retail real estate space, where high-quality and well-located retail center REITs can attract the winning retailers and thus maintain occupancy and rent growth at the expense of lower-quality centers.

Online-only versus Omnichannel

E-commerce is known for competitive prices, as well as “free” returns and “free” shipping. Yet, with profit in mind, it should be difficult for the three to coexist.

According to Jerry Storch, CEO of Hudson’s Bay Company (OTCPK:HBAYF, TSE: HBC), direct-to-home supply chain costs for online-only retailers are three times more than a B&M based model. Even Amazon has struggled to be profitable in its retail business due to high costs. In 2016, Amazon’s shipping losses were over $7 billion, as shipping revenue (even after including a portion of the amounts earned from Prime memberships) only accounted for 55% of the costs. So, unless AMZN charges more for items than they would be in a store, it will be difficult for the company to be as profitable as a B&M retailer.

Returns are a vital, but often forgotten, aspect of omnichannel retailing. Not only do physical locations provide a quick and easy exchange process or return of money for the customer, but research has shown that 70% of online shoppers make an extra purchase when returning items in-store. Whether it is on the delivering or receiving end of the supply chain, as retailers continue to focus on customer convenience to drive sales, B&M locations will play a pivotal role as the cheapest, and thus most profitable, touch points for retailers. Otherwise, the costs of shipping returned items, assessing quality, re-stocking inventory, and selling at a potentially discounted price will offset “savings” from not having to pay rent for a storefront.

An omnichannel distribution network incorporating the physical store, online, pick-up, and delivery looks like the only way to sustain profits in the long term. Contrary to online-only, it gives the company a structure to win over customers through convenience and investors through profitability. Though it has yet to proliferate to the majority of retailers, there are already multiple case studies of positive results achieved by adopting an omnichannel strategy. For example, Best Buy (NYSE:BBY) was struggling to maintain growth, while its EBIT (Earnings Before Interest & Taxes) margin fell 250 basis points from 2011 to 2014 in the face of competition from e-commerce. After all, electronics is often mentioned as one of the easiest industries to be disrupted by e-commerce and has the highest penetration rate among all retail sectors. In response, Best Buy’s management team decided to embrace omnichannel and, in 2012, changed its view of its B&M locations from merely a “store” to mini distribution hubs that can also be a store. The change in perception allowed the company to better serve the needs of customers, while also saving costs due to more efficient inventory management. As of 2017, 40% of online sales are either picked up at or delivered from a storefront, and the company has posted positive annual same-store sales comparisons for the past three years, driving stock performance of +468% from 2013 through July 2017.

Omnichannel – The Next Step Forward

If there was any doubt that omnichannel was the next step in retail, one should just look toward the strategies of some of the world’s most dominant retailers. Wal-Mart, the largest retailer, has been primarily a B&M retailer since 1962. However, after 16 years of struggling to incorporate e-commerce on its own, the company purchased for $3.3 billion in 2016. was one of the fastest growing e-commerce companies in the country, and Wal-Mart was able to gain Jet’s co-founder Marc Lore as part of the acquisition (who was quickly appointed CEO of Wal-Mart E-commerce US). The talent and innovative pricing technology of, which saves both the customer and company money on online orders, has become the backbone of Wal-Mart’s new omnichannel platform. Since, Wal-Mart has continued to accumulate e-commerce brands and talent by acquiring companies such as ModCloth, Moosejaw, ShoeBuy, and Bonobos. Though it’s early in Wal-Mart’s shift to omnichannel, the changes are already beginning to show up in top-line numbers, as US e-commerce sales were up 63% in Q1 FY2018 versus Q1 FY2017. For comparison, AMZN’s online retail product sales were up 16% in the same period.

Alibaba, China’s largest e-commerce company and the sixth-largest retailer in the world, was one of the early adopters of blending online and offline shopping experiences in what it calls “new retail”. In contrast to Wal-Mart, Alibaba started as an online-only platform and has had to make B&M acquisitions to implement its omnichannel strategy. Though it may sound contrary to the media’s onslaught on B&M retailers, Alibaba believes that online-only retailers will soon face “tremendous challenges”. In response, the company bought Intime, a Chinese operator of 29 department stores and 17 malls, for over $3 billion in 2017 (including a stake bought in 2014). Additionally, BABA purchased an 18% stake in Lainhua Supermarkets to enter the grocery business, as well as a stake in an electronics B&M retailer, among others. We believe many US retailers will emulate BABA’s concepts in order to succeed in the world of “new retail”.

Though Amazon has been an innovator, it is actually behind its peers…