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The Corridor and the “Retail Tipping Point”

This year is on pace to break records for store closings and bankruptcies. Why, and what does this mean for Iowa’s Creative Corridor ?

The Trends Shaping Retail

Goods on display outside vintage specialty store Copper Alligator in the Czech Village Neighborhood in Cedar Rapids, Iowa. Photo taken April 14, 2015 by Ben Kaplan.

By June 13, 2017 five major retail companies with locations in Iowa’s Creative Corridor declared bankruptcy. Those five national retailers are Gymboree, Gordman’s, Payless Shoes, Rue21, and Gander Mountain. Other major retailers with a presence in the Corridor have announced store closures in the hundreds. Sears, which also owns K-Mart stores, has stated clearly that they might not make it through the year, and analysts agree. Bon-Ton, the parent company of Younker’s, was listed by the Wall Street Journal as one of the ten retailers most likely to declare bankruptcy within the year. JCPenney and Game Stop are closing hundreds of stores. Staples is closing 70 stores this year, and has closed 350 over the past five years. Nationally, this year is on pace to break records with the number of major retailers declaring bankruptcy and the number of store closures, and is outpacing 2008 with the number of store closures across the country. As many as 8,000 retail locations could close by the end of the year.

What gives? Retail spending was up 3.8% last year and is expected to rise 4.1% this year. Stores are declaring bankruptcy and shuttering locations even though consumers are spending money. The American retail landscape we’ve had for the postwar era, one dominated by the rise of chains, franchises, malls, and big box stores, is in major decline. It’s being replaced with resurgent, experience-based, main streets, and online shopping — with mega retailer Amazon dominating that entire category. American retail is at a tipping point:

This transformation is hollowing out suburban shopping malls, bankrupting longtime brands and leading to staggering job losses. — “Is American Retail at a Historic Tipping Point?” — New York Times.

There are individual trends and economic changes that are all converging right now and deeply impacting retail. 1) Online spending and it’s impact on consumer choice and brick and mortar profit margins. 2) The rise of the “experience economy” and massive changes in consumer taste, much of it being driven by millennials. 3) A glut of retail square footage. Each of these major drivers of this economic change are worth exploring in more depth.

The Rise of Online Spending

Packages line the counter of an apartment mailroom in Cedar Rapids, Iowa. June 26, 2017 by Ben Kaplan.

I said earlier that retail spending is expected to grow 4.1% this year, but that number needs to be broken down. The vast majority of the growth in retail spending is in online spending, which is growing two to three times faster than spending in brick and mortar stores.

When you strip out gas and automobile sales — and other purchases rarely made online — the percentage of growth in e-commerce climbs even higher. The major growth in retail spending is happening online, and online sales are cannibalizing sales at brick and mortar stores.

One online retailer stands out from the rest when it comes to sheer size. Amazon is eating the retail economy for breakfast, lunch, and dinner. 25% of the incremental growth of U.S. retail goes to Amazon.

The story behind the rise of online spending is a simple one, people are shifting their dollars into online retailers instead of brick and mortar retailers. Many traditional retailers have struggled to find traction online, while they’ve also seen same store sales decline and profits erode.

The “Experience Economy”

Three men in silhouette pose for a selfie at the Freedom Festival Balloon Glow, at Brucemore in Cedar Rapids, Iowa. Tuesday July 20, 2017, by Ben Kaplan

Keeping-up with the Joneses used to mean making sure you had the right badge on your car and the right tag on your shirt; now it means a social media feed full of concerts, food, and hiking. Call it the “Experience Economy”, one where spending on things to do is preferred over spending on stuff to own. This shift in consumer culture is being driven by Millennials. According to Harris research 72% of Millennials prefer to spend their money on experiences.

While thinking of Millennials as a monolith is flawed (they are the most diverse generation in history) there do appear to be some broad shifts in consumer taste. Beyond a preference for consuming experiences, like spending at restaurants and concerts, when Millennials do purchase consumer goods they care more about the social responsibility of the brands and companies they’re shopping with than previous generations.

With social awareness firmly stamped into the psyche of this powerful market segment, companies need to change the way they do business to keep up with the trend. Millennials are used to convenience and authenticity, but they don’t like companies who choose profit over purpose. — Huffington Post

70% of Millennials are willing to pay more for a product if the product or brand supports a cause close to their hearts.

Last year spending at restaurants beat spending at grocery stores for the first time ever. What’s even more remarkable; the bigger gains went to independent restaurants and not chains. As independents surge, some chain restaurants are struggling.

Where can we see the results of these trends in Iowa?

Des Moines based Hy-Vee has been aggressive in making sure their stores are destinations.

With Amazon, Wal-Mart, Freshdirect and Instacart capturing more sales online, Hy-Vee is doing all it can to make consumers want to come to its stores instead by offering more things to do and foods to eat. These offerings also help differentiate them from other brick-and-mortar grocers who may still be selling traditional food and other household items. — FoodDive

The Indiana Business Journal highlighted Hy-Vee as a regional grocer success story, compared to the bankrupt Indiana based Marsh’s. Hy-Vee has added upscale Fresh Market Grills to many locations, expanded the variety of prepared food, and launched a service that’s a direct competitor to online meal planning companies like Blue Apron, except instead of having food shipped to your door you pop in to a Hy-Vee and pick it up. The stores are also host to events like wine tastings, trivia nights, and live music. It’s also worth pointing out that, like Instacart, Hy-Vee will deliver groceries.

Raygun is another Iowa success story. The retailer specializes in political, snarky t-shirts and hip accessories and has four retail locations, three in Iowa and one in Kansas City. All four of the chains retail stores are located in hip, historic neighborhoods. The Cedar Rapids store recently hosted a well publicized fundraiser for Planned Parenthood. 98% of their merchandise is made in the United States. Raygun has found success as a retailer because of their very public social and political values. The retailer also has a robust e-commerce presence.

We have discovered the ethical decision usually makes good business sense. — Mike Draper, CEO of Raygun

If there’s an Iowa company that epitomizes the increasing preference for experiences and a social mission it’s RadTour. RadTour plans bike rides that connect local chefs and farmers with their communities.

If the thought of a long, relaxed ride through some of Iowa’s prettiest countryside appeals to you, this ride is for you. If the thought of stopping every 10 to 15 miles to eat and drink appeals, this ride is really for you. If the thought of eating farm-raised, carefully prepared foods while walking around and stretching your legs on the very property where the food was raised appeals to you: Trust me; you want to do this ride. — Little Village

Radtour is emblematic of the kind of experience consumers are turning towards.

Consumers priorities have changed from accumulating stuff to accumulating experiences. When they do buy products they want those products to represent their values and have a social mission. Both of these trends are being driven by the Millennial generation, which is nearly equal in size to the Boomers, is the most diverse generation in history, and the oldest Millennials are entering their peak earning years.

Too Much Retail Square Footage

An empty big box store in Cedar Rapids, Iowa. Taken June 26, 2017 by Ben Kaplan

No other country on earth has more retail square footage per capita than the United States. Canada comes closest, but it’s still only half as much square footage per capita. What will happen to all of the retail stores and strip centers that get hollowed out as our economy changes?

“Retail square feet per capita in the United States is more than six times that of Europe or Japan. And this doesn’t count digital commerce”. — Urban Outfitters CEO Richard Hayne

The retailers under the most pressure are big box stores or ones typically found in malls or strip centers. That’s because many big retailers by overbuilding as a way to capture market share. Now we’re going through a massive correction. We likely had too much retail space to already, and the rise of online shopping has accelerated the collapse of retail stalwarts. It won’t be new retail that replaces the faltering firms making headlines, it will have to be something else, but what else?

Credit Suisse predicts that 20–25% of American malls will be kaput within ten years. That number might be too optimistic. CoStar, a firm that specializes in commercial real estate information, estimates that nearly one billion (yes, billion with a “b”) of retail square footage will need to “rationalized” in the near future.

Big box stores, normally square foot gluttons, are experimenting with smaller format stores. Target plans to open hundreds of smaller format stores, and has been focused on opening these stores in dense urban neighborhoods.

The major concern with this shift in retail is not what will happen to individual firms — Iowa does not need Rue21s to thrive economically — but that the underlying structure of the retail economy is shifting. 181,00 Iowans work in the Retail Trades, and retail is a major source of tax revenue. At the state level sales tax revenue brought in a little less than $3.8 billion of revenue in 2015. That’s more than income taxes. On a local level, municipalities depend on the property taxes of retail. For more on this check out Nitin Gadia’s map of Ames.

Map by Nitin Gadia.

Gadia’s map shows what percentage of property taxes are needed to pay for the street in front of the property. This map doesn’t include any other costs like schools, parks, police, sewers, or firefighters. Every property that’s red or orange is one that doesn’t cover the cost of their own streets, and every property that’s green or blue covers more than the cost of their street.

The tax revenue that big box and national retailers created is disappearing without a replacement. This is especially true when it comes to property taxes, which are one of the major sources of revenue for Iowa municipalities. While Iowa does collect sales tax revenue on online purchases it doesn’t include Local Options Sales Tax, meaning cities miss out on those revenues as well.

What does this mean for the Corridor?

Construction of a four part mixed-use complex called The Depot in Cedar Rapid’s New Bohemia neighborhood. Photo by Ben Kaplan.

Here’s how each of these three trends broadly impact brick and mortar retailers. More money is shifting away from brick and mortar to online retail, money that is being spent locally is moving towards experiences traditional brick and mortar retails don’t provide. The sword hanging over both of those trends is the cold, hard truth that many brick and mortar retailers opened up too many stores in too many places even if these economic changes had never happened.

The wave of store closures and bankruptcies we’ve seen this year isn’t because of a recession or other economic calamity, it’s because of a fundamental shift in how and where consumers are choosing to spend their money. We’re in the destruction phrase of creative destruction. One kind of economy is replacing another, just like manufacturing replaced the pre-industrial economy.

The problem is that many of the ways we measure economic health, and a substantial amount of local tax revenue comes from the retail economy. Commercial property taxes are the bread and butter of city and school budgets, and the downfall of brick and mortar retail will have a massive impact on the fiscal health of Iowa communities. Some cities in Iowa have pursued retail expansion aggressively, usually through the use of tax-increment-financing (TIF), tax abatements, and other forms of government largesse.

The hope was that these programs would spur economic growth and add jobs and citizens — that the lost revenue for the general fund would be recouped through richer citizens and sales tax revenue. The fact is that this was always dubious from a revenue perspective, and now the kind of economy that pinned up these financials models is disappearing.

The big threats from this shift in the economy aren’t unemployment, nor are our sales tax revenues under great threat, since we collect sales taxes on online purchases and the experience economy generates sales tax revenue. The challenge is going to be what happens in individual cities and towns as their traditional tax base disappears.

That’s still a huge challenge — local economic development policies and politics rewards big retail projects, and no politician wants to be labeled anti-growth. And the effects of this economic changes will be felt in different ways in communities across the state. Here in the Corridor our communities and economy are growing. We have a diverse array of industries and companies of all sizes. We also have three small private colleges, a major public research university, an excellent community college, and great public schools.

How should the corridor respond to the changing retail landscape? Transforming vacant retail space must be a top priority, but into what? It can be difficult for communities to find new uses for retail space, especially when big box stores, strip-centers, or entire malls collapse. At the same time communities need to respond to the desires of citizens who want to spend their time and money in new ways. There is a problem, but there’s also an opportunity.

In 2014 Freddie Mac did something long overdue. They made it much easier to finance small-scale mixed-use projects and multi-family developments. This is important for a number of reasons. Foremost is that these kinds of developments provide communities with a much bigger bang for the infrastructure buck. Replacing aging or unused single-use commercial space with denser mixed-use space will be key to keeping property taxes affordable while still having enough revenue to keep the lights on at city hall. Secondly, with Freddie Mac changing how it treats these kinds of developments they become much less risky for local banks to finance, because they’re now treated more like traditional mortgages. This makes it far easier to access the capital necessary, and also means that local governments need to rely far less on tax increment financing or other forms of government largesse to goose development. Finally, mixed-use buildings and development tends to be more resilient to economic changes, because the commercial and retail space is designed to be adaptable to a variety of different types of businesses. This means that it’s easier to keep that space full even if individual businesses, or specific industries, are struggling as long as the overall economy is strong. The financial mechanisms are in place to replace failing retail square footage with new development.

Consumers also still prefer shopping in store to online. As national retailers falter there is room for local entrepreneurs to come in and start their own small businesses. The increasing consumer preference to spend their money on experiences, and on products that reflect their values means there are ample opportunities to start new businesses based on the new standards of consumer taste. The craft beer and restaurant boom we’ve seen across the Corridor is one example of this. Craft breweries especially benefit from the network effects of being around other craft breweries. What we’re seeing is the rise of the “the third place” — a place outside of home and work that functions as a place to build community. The kind of place a third place can be is broad. Bike shops and running stores that organize group rides and runs count, and so do retail shops that encourage hanging out in the store whatever they sell. One of the outcomes of changing consumer tastes is that building community is now integral to financial success, and local businesses are uniquely well equipped to take advantage.

The changes in the retail landscape present a unique and historic opportunity to create a much stronger platform to build up local entrepreneurship, and a more resilient regional economy. Here’s how.

  • Change zoning codes to make it easier to redevelop failed or struggling retail space.
  • Make it easier for entrepreneurs to start a business by reducing the amount of risk they have to take to get started.
  • Invest in the kinds of services and amenities attractive to millennials.

Luckily communities in the Corridor have already started doing all of this. Cedar Rapids has come the farthest. The city has been working since last July to modernize their zoning code. The NewBo City market serves as an incubator for retail stores and restaurants, a vital stepping stone to test and refine an idea before moving into more expensive and more permanent space. The city has refurbished its downtown square, built an outdoor amphitheater, and is working aggressively to expand bike lanes and trails throughout.

Obviously, NewBoCo, is also a part of this change. While we do a lot of awesome things to encourage and promote entrepreneurship, I’d like to focus on our coworking space and prototyping lab. The Vault and Vault Labs reduce barriers to entrepreneurship by giving companies access to all of the benefits of an office, and a maker space, at an affordable cost. This greatly reduces the risk necessary to start a business, making entrepreneurship more accessible. NewBoCo focuses on entrepreneurship in tech, and on building community around tech in the corridor, but our programs don’t exist in a vacuum.

The retail tipping point is also a turning point. One kind of economy is ending and a new kind of economy is getting off the ground. How we respond to this fact (and it is a fact) will lay the groundwork for the economic success of our communities for generations to come. If we embrace this change by rebuilding our communities to be more resilient to economic changes, reducing the barriers to entrepreneurship, and investing in the amenities desired by citizens and communities (both private businesses that are “third places” and public amenities like bike lanes and amphitheaters) we’ll have laid the groundwork for a region poised for success well into the future.

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