Harry Potter and the Disappearing Channels

This is going to be, to some extent, a repetition of previous items I’ve written. But there have been some interesting developments that indicate that it is time for an updating and review of the Two-Per-Channel Theory.

I've often advanced this theory (as have others), which says that we are moving toward a retail landscape in which there will be only two significant outlets in each channel. I've used as examples:

• Best Buy/Circuit City
• Home Depot/Lowe's
• Barnes & Noble/Borders
• Target/Wal-Mart
• Kroger/Super-Valu
• etc.

There are a corollary and a variant to this theory. The Manufacturers’ Corollary holds that there will be only two suppliers in each product category. The logic behind this is that suppliers will have to be large enough to deal with the retail giants, and is supported by the tendency of the retailers to want to improve efficiency by winnowing their supplier base. Supporters of this corollary point to P&G’s acquisition of Gillette. They argue that P&G was already bigger than its competitors, so the acquisition was not intended primarily to strengthen their hand vis-à-vis Unilever, but rather its purpose was to allow them to sit at the table with Wal-Mart as equals.

Which brings up the Wal-Mart Variant to the Two-Per-Channel Theory. It holds that the final two in each channel will be:

• Best Buy/Wal-Mart
• Home Depot/Wal-Mart
• Barnes & Noble/Wal-Mart
• Target/Wal-Mart
• Kroger/Wal-Mart
• etc.

Neither version, of course, takes into account channels that utterly disappear, as the music stores have, and as has seemed possible at times with toys.

I've expressed my concern frequently for anybody running third in their race, but it seems that perhaps running second may be little better, and that the Wal-Mart Variant might be the stronger version of the theory, based on recent rumblings from two prominent #2s.

Circuit City: This chain’s problems have received a lot of press lately. Even after the negative publicity on their big layoffs, the bad news has continued:

… Circuit City Stores Inc., the nation's second-largest consumer electronics retailer, said it expected a pretax loss of as much as $90 million this quarter and revised its forecast for the first half of 2007.

The news sent the company's shares down more than 7% in after-hours trading.

Sales in April were "substantially below plan," the company said.

Problems in this channel go beyond Circuit City, as BusinessWeek's summary of both cause and effect make clear:

Last "Black Friday," for its annual post-Thanksgiving sales blitz, Wal-Mart Stores decided to slash the price of one of the hottest electronics items for the holidays—the 42-inch flat-panel TV—to $988. The world's largest retailer had staked similarly audacious positions before, in numerous product categories, as part of its quest to remain U.S. retailing's "low-price leader." In turn, Wal-Mart's move caused a freefall in prices of flat-panel televisions at hundreds of retailers—to the glee of many people who were then able to afford their first big-screen plasma or liquid-crystal-display model.

Now, it is becoming apparent that Wal-Mart's calculated decision to break the $1,000 barrier for flat-panel TVs triggered a disastrous financial meltdown among some consumer-electronics retailers over the past four months.

The fallout is evident: After closing 70 stores in February, Circuit City Stores on Mar. 28 laid off 3,400 employees and put its 800 Canadian stores on the block. Tweeter Home Entertainment Group, the high-end home entertainment store, is shuttering 49 of its 153 stores and dismissed 650 workers. Dallas-based CompUSA is closing 126 of its 229 stores, and regional retailer Rex Stores is boarding up dozens of outlets, as well as selling 94 of its 211 stores.

It’s so bad that Radio Shack’s CEO said that he has no idea how the chain manages to stay in business: Well, okay, he didn’t really say that, but The Onion, as is true of the best satire, captured the mood of the consumer electronics channel in a few paragraphs:

"I'd like to capitalize on the store's strong points, but I honestly don't know what they are," Day said. "Every location is full of bizarre adapters, random chargers, and old boom boxes, and some sales guy is constantly hovering over you. It's like walking into your grandpa's basement. You always expect to see something cool, but it never delivers."

Added Day: "I may never know the answer. No matter how many times I punch the sales figures into this crappy Tandy desk calculator, it just doesn't add up."

But it isn’t just consumer electronics.

Borders: Both the big book chains are hurting, as we’ll discuss, but Borders is in serious pain:

Borders, which reported a loss in the quarter, announced a dramatic shakeup of its business -- it plans to cut its number of Waldenbooks stores in half, to about 300 by the end of next year, and is considering the possible sale of most of its international businesses.

Why?:

Competition from discounters such as Wal-Mart Stores Inc., which can afford to slash prices on books, has squeezed profits at Barnes & Noble and Borders, which have responded with their own discounts.

In this channel we see the clearest parallels to the record biz, and the possibility is strong that bookstores may likewise just go away. Harry Potter tells us why (in case you were wondering when I was going to finally get around to justifying the title).

The book world has been eagerly anticipating the publication of the newest Harry Potter book, but indications are that booksellers will see no profit from it, as reported in the UK's Times:

HMV Group gave warning yesterday that Harry Potter would not fly to the rescue of the ailing retailer this summer as it revealed further sales declines at its Waterstone’s bookstore chain.

The seventh and final adventure of the young wizard, Harry Potter and the Deathly Hallows, comes out on July 21 and Simon Fox, the chief executive, said that Waterstone’s had already sold nearly as many by preorder as were sold in total of the sixth Harry Potter book.

He said that it was vitally important for Waterstone’s to offer the book at a competitive price but because it was selling it at £8.99 – half price – it would be “hard to make money”.

So why are they selling a product for which there is great demand at a no-profit price? Glad you asked:

Mr Fox’s comments reflect the fears of Kate Swann, the chief executive of WH Smith, and Philip Downer, the retail director of Borders, as the high street prepares for a Harry Potter price war with the supermarkets and online stores such as Amazon, which is already offering the book for £8.99. Asda and Tesco will deliver the Bloomsbury publication for 12p less, plus postage and packing.

The retailers admit that the preorder price may fall to a 55 per cent discount closer to the publication date.

The big boxes are skimming off the cream, the bestsellers, and leaving the remainder to the booksellers – which is almost exactly what killed off the record stores (digital music and piracy were the other ingredients, but those factors aren’t far off for book stores – we await only a good reader for e-books to fill the role of the iPod). It’s also not dissimilar to the effect on Circuit City, et al. of Wal-Mart’s flat panel move.

As I look at these examples, I move more to the idea that the Wal-Mart Variation may be more likely than the original Two-Per-Channel Theory. Or perhaps the final two, in every channel, will be Wal-Mart and Amazon. That would be interesting.

The effect on trade promotion? We know what has happened to trade spending in the last couple decades, as retail concentration has grown. Presumably, we would see a continuance – to the point where we would equal Australia, where two huge chains have dominated for a long time. There, trade spending has topped 30%.