6/26

Three hypotheses for the new year and next few years:

• Demand growth will be more geographically concentrated.
• Demand volumes will experience increased volatility and related unpredictability, especially in areas experiencing the most demand growth.
• Supply systems -- especially retail distribution/fulfillment -- will focus comparative advantage on speed, reliability, and customization.

Wealth is increasingly concentrated in fewer locations. Six metro areas — New York, Los Angeles,Chicago, Washington D.C., Dallas and Houston — account for almost a quarter of the US economy. Add the next seventeen largest cities and roughly half the national economy is generated within the fairly narrow, often overlapping, boundaries of two-dozen metro areas.

Moreover, even within the economically most robust urban areas, demand growth will be much more prominent in select locations.  As recently summarized in The Atlantic:

The Atlanta metro area is a notable example of a “thriving” place where per capita income has nonetheless fallen farther and farther behind that of cities like Washington, New York, and San Francisco. So is metro Houston. Per-capita income in metro Houston was 1 percent above metro New York’s in 1980. But despite the so-called “Texas miracle,” Houston’s per-capita income fell to 15 percent below New York’s by 2011 and even at the height of the oil boom in 2013 remained at 12 percent below. It’s largely the same story in the Mountain West, including in some of its most “booming” cities. Metro Salt Lake City, for example, has seen its per capita income fall well behind that of New York since 2001.

Increase in Per Capita Income for Three Cities Compared to Rise for U.S. as a Whole

There are several factors causing this divergence, but regardless of cause these trends have been building for two decades and are unlikely to reverse in the next few years.

Even within the narrow category of wealthy urban areas there can be considerable difference in the potential for demand growth. The key factor is availability of real disposable income. For example, fifty-seven percent of households in the San Jose-Sunnyvale-Santa Clara (CA) Metropolitan Statistical Area have incomes over $75,000 compared to barely forty percent of those in the Philadelphia MSA.  Almost 48 percent of Boston area households have incomes over $75,0000, while less than thirty percent of households in Bakersfield, California. Housing is much more expensive in the Boston and San Jose than in Philadelphia or Bakersfield, but the higher cost also reflects a greater sense of economic confidence and likely liquidity.

Retail turnover--and \potential demand growth--is also amplified when affluent consumers are concentrated within walking distance (less than one mile), as is the case in Boston, San Francisco, New York, and increasingly Washington DC. Concentrations within concentrations.

Demand is increasingly volatile. Within these fertile concentrations of affluence, demand can experience sudden flood or drought. Greek yogurt can move from less than 1 percent of the market to over 35 percent in less than five years. Macy's is closing stores while Zara might claim to be driving demand.  In early 2016 the mere rumor of declining demand for the Apple iPhone 6s and 6s plus has stock prices tumbling across the product's entire supply chain. 

Some suggest that over the next several years the entire ecology of the retail sector -- generating roughly $5 trillion in annual economic value -- could be transformed by a combination of demographic trends and online behavior.  But not necessarily online purchasing.  While digital will be critical, it will not decimate every storefront.

According to Women's Wear Daily:

Millennials are forcing brands to engage with them differently — over social and digital channels versus in more traditional ways — but they are still making their way into stores. In fact, more than 92 percent of Millennials expected to shop in stores at least as often in 2015 as they did in 2014. Additionally, it should come as no surprise that Millennials crave personalized attention and instant gratification. They have bought in heavily to the concierge economy — the idea that services and goods are available and brought to you almost instantly, at the click of a button. When asked if they would make online appointments with retailers, 59 percent of Millennials said “yes” — the highest of the demographics surveyed. With Baby Boomers favoring in-store shopping and Millennials demanding increasingly customized assistance, the shift from online buying to in-store service can only be expected.

The WWD author is in a slight state-of-denial regarding the growth potential of online purchasing, but the data -- from The State of Retail -- is persuasive that cultivating a meaningful digital relationship is an increasingly decisive factor in which brands are engaged by consumers: online or off. 

According to Treacy and Wiersema (and their disciples since) firms operate along three value dimensions: “operational excellence”(cost), “product leadership” (innovation), or “customer intimacy” (customization).  Until about 2007 we were supposed to choose one.  Now retailers (and many others) must compete on all three fronts and do it both face-to-face and as Facebook friends. Cost is important for perceived commodities. Innovation and customization are crucial for everything else.

Volatility is the friend of those able to ride the crest sweeping away their competitors.

Innovation and customization of supply will be a principal way to compete on cost.  Effective integration of digital processes for monitoring demand and targeting supply will be critical to meeting consumer expectations in a financially sustainable way.

Trucking and other forms of delivery are likely to remain in tight supply. The biggest suppliers will manage risk through longer-term contracts with 3PLs and increase ownership of delivery capacity. Experimentation and investment in alternative delivery formats will proliferate. All of this will increase marginal costs. Those that can not afford these costs will pay the ultimate price. At least fuel prices are likely to remain low.

Warehouses, distribution centers, fulfillment operations and related properties will continue to enjoy high demand.  Lease prices will climb. Demand for such properties reflect both growing and changing needs -- especially for locations closer to populations that are a source of demand-growth -- and hesitation to invest in new construction.  According to the Wall Street Journal:

Jeffrey Havsy, CBRE’s chief economist for the Americas, said that the crunch is a result of steady growth in demand as the economy improves, paired with the fact that few new warehouses are being built.

“We didn’t build a lot coming out of the Great Recession, and it’s only recently that rents have gotten back to where people can justify building new space,” Mr. Havsy said. “Global trade is still growing, though slowly… We’ve been taking small bites, over a long period, and when you’re not building a lot, after a while, you end up eating up a big chunk of the available space.”

Builders completed construction on 41.5 million square feet of industrial space last quarter, down 13.6% from the same quarter a year earlier. By contrast, construction completions never fell below 50 millions square feet per quarter during 2006 and 2007, before the recession struck. Rents, meanwhile, have risen 15.4% over the last eight quarters, CBRE says.

E-commerce is also driving demand for smaller, older industrial properties that are closer to population centers, Mr. Havsy said, as users lease more warehouses that can help fill orders for same-day delivery.

Property development, truck purchases, and hiring/training drivers will continue to lag major market movements.  How existing properties are utilized and how current trucks and drivers are deployed can, however, potentially lead the market. 

In a Forbes piece, Greg Petro claims, Zara --a retail brand of Inditex group-- :

... focuses solely on following the latest trends as soon as they appear, using an extremely agile supply chain to meet customer demand. It doesn’t matter that the trends change so quickly – Zara is already ahead of the curve. Zara broke the traditional fashion supply chain rules by cramming the entire production process into a 10- to 15-day time span. The Spanish company uses its arsenal of automated factories located in its home country as well as a network of over 300 small finishing shops through the Iberian peninsula, North Africa and Turkey. The automated factories constantly create unfinished “greige goods.” As soon as Zara pulls the trigger on a new design, the greige goods are sent to the finishing shops and turned into products ready to ship – a textbook example of applying “just in time” manufacturing to fashion.

Outsourcing, near-sourcing, flexible finishing, and fast delivery allows Zara to optimize specific advantages across the global supply chain to fulfill the often fickle interests of urban consumers with higher than typical disposable income. Medical Goods suppliers, such as Owens & Minor, offer a similar process to serve the needs of particular surgeons and surgeries.  Kroger will source Chilean blueberries and local blueberries and bake in-store blueberry torts; responding to whatever wants are emerging. 

Moreover what Zara, O&M, and Kroger all share is the human and financial capital needed to capture and make-meaning of customer data -- not just purchasing data -- to anticipate where markets are moving.  While others wait to see, those that own the data are setting up pop-up shops, new displays, or website screens... whatever it takes to engage the customer.

Next: Implications for Supply Chain Resilience