Cover page

Table of Contents

Web page

Title page

Copyright page

Foreword

Introduction

Chapter 1: A Brief History of Retailing

The mercantile era

The modern era

The digital era

Chapter 2: Technology: The Crucial Retail Enabler

How retailers add value

Connecting the chain

Knowing what you know

A succession of evolutions

Chapter 3: Game-Changing Technologies

Revolution

The next era of technology change

What it means for consumers

Chapter 4: Consumer Empowerment

The consumer decision journey

Customer empowerment tools

Retailers' response to consumers' changing behavior

Chapter 5: Toward A New Retailing Paradigm

The changing role of the physical store

New contenders

The power of information productivity

Chapter 6: The Future of Retail

Stand-alone archetypes

Building on the stand-alone models

Chapter 7: A Call to Action

Leapfrogging

The way forward

Making it happen

Acknowledgments

About the Authors

Index

For more information about this book please visit http://reshaping-retail-book.mckinsey.com

Title page

Foreword

Mobile Internet access is growing at 20 percent annually. Seventy-five percent of all shoppers research purchase-related information online. The world's top five social networks have a combined total of 2.5 billion members, and millions are joining their ranks every day. Why should retailers care about these trends?

Because they put powerful technology in the hands of shoppers—to compare prices, place orders, and post reviews—anywhere and anytime. In effect, the power balance between those who sell and those who buy is shifting. Even seasoned retail executives are in awe of the fundamental nature of this change. Their questions go to the very core of the retail industry: What is the future role of the physical store? Which of today's retail formats will survive? What will set the winners apart from the losers? How can retailers benefit from evolving technology and changing shopper behavior? In short: How, if at all, can retailers survive the technological revolution we are witnessing?

In this book, five of our most distinguished retail experts from around the world consolidate McKinsey's perspective on those pressing questions. James Naylor of London, Stefan Niemeier of Hamburg, Roger Roberts of Palo Alto and Marco Catena and Andrea Zocchi, both of Milan, have joined forces to compile our latest thinking regarding, for example, constant connectivity, the next big data frontier, cloud computing, channel convergence, and the emergence of an “internet of things.” To challenge and expand their own observations and conclusions, the authors have also invited leading practitioners to provide their perspectives on how technology is changing the face of the industry, from big box retail and online pure play to content aggregation and search.

In 2011, Retail Marketing and Branding: A Definitive Guide to Maximizing ROI, now in its second edition, launched our book series Perspectives on Consumer Industries and Retail to great acclaim. It is my privilege to present the second book in the series, Reshaping Retail. Like the best of its kind, this book is rooted in a profound understanding of technological trends, but it truly stands out by examining their impact from the perspective of the CEO. I hope you share my excitement about this compendium—and will be encouraged to seek out future volumes in the series.

Klaus Behrenbeck

Director, McKinsey & Company, Inc.

Leader of the European Consumer Sector

Introduction

The modern retail system has worked to dazzling effect. From the 19th century, store owners emerged from small beginnings to set in train an industry that has seen some operators become nationally, even globally, dominant. Along the way, they turned retailing into an art, and then a science. Their development was assisted by the lowering of tariff borders and the multiplication many times over of international trade in consumer goods. Efficiency gains enabled by improved production techniques, communications, and information technology reinforced a virtuous cycle of lower real costs and thus prices. Now retailers in emerging markets appear to be repeating the story all over again, except on a scale and at a speed beyond anything we have seen before.

Given all of this, it is hard for those of us who work in retailing to accept that the industry as we know it is living on borrowed time, on the brink of transformation. But that is the view that prompted us to write this book, a view that has been sharpened and reinforced as we researched it. We have spoken to many of our clients and colleagues who are engaged directly in this intense period of transition. What they told us further confirmed both the urgency with which conventional store-based retailers must now act and the extent of the challenges this change represents in strategic, organizational, and above all technological terms. For the industry is in the grip of a revolution powered by digital technology. This will be as big in its effects as the mercantile revolution that saw the birth of retailing as we know it, and the Industrial Revolution that kicked off the modern era.

Retailers' operations have long been underpinned by technology—telecommunications, bar codes, electronic data interchange—so why the commotion now? From our perspective, there are two reasons for it. First, technological innovation hitherto has served primarily to help retailers do what they have always done, but better. They have become ever more powerful intermediaries between suppliers and customers, able to operate at ever-greater scales. Paradoxically, today's technology threatens that power and hence the entire business model. Second, many traditional, store-based retailers still do not understand today's technologies, let alone tomorrow's—they are retailers, not technology companies—and so are unprepared for the speed of change that is about to hit. That is why the subject merits a book that puts the developments into context and describes the driving forces behind them, the nature of the change, and what store-based retailers must do to transform their strategies and operations to thrive.

To begin the book, we pull the camera back a long way, showing how deep are the historical roots of today's business model. Since the Middle Ages, retailers have relied on what is largely a push system of stock movements. The retailer, be it a merchant with a horse or the operator of a nationwide supermarket chain, anticipated future demand, selected the goods to meet it, and then organized delivery in a place where people would buy—first the marketplace, then dedicated stores. Technology did not interfere with this process. It just made the process more efficient.

To understand why this is changing, it is, we believe, important to grasp the underlying technological drivers of change at a reasonable level of detail and to learn how a particular combination of separate innovations has been so powerful. So we describe the ways in which advances in computing power, storage capacity, and network connectivity are driving three preeminent, parallel, and mutually reinforcing trends that will define the digital era of retailing. The first, mobility, will be powered by the availability of technology everywhere: in stores, at home, on the go. The second, measurability, will see far more activities in the value chain, not least consumers' behavior, being measured more accurately. And the third, agility, will come from the development of cloud computing, which enables companies to develop systems (often the roadblock that slows progress in improving business processes or pioneering new business models) with speed and ease.

The technology generating these trends will help retailers improve their processes and contrive new experiences for consumers to a degree previously unimaginable. But it is also ushering in new competitors and empowering customers. And it is customers who are the focus of much of this book, for retailers of every hue will have to contend with the power that now lies in customers' hands. Individuals can browse, select, pay, and take possession, all without entering a store. But this is only a small aspect of what has changed. Far more significantly, new technologies have put an end to the information asymmetry between retailers and consumers. In short, customers have been empowered at the expense of swaths of retailers.

It is not all bad news—far from it. Consumers will still want to visit certain stores for many of the same reasons they already do: convenience, sociability, and even the ability to buy cheap goods (yes, we believe that some store operators will be able to match online rivals on some goods in a digital world). And the measurability that technology delivers will make information productivity as important as capital and labor productivity have been to the industry, helping to drive retailers' efficiency and their ability to serve their customers well to new heights. But at the center of the business model will be the customer. This is not customer care. It is customer-centricity. Absolutely everything in the operating system—pricing, promotions, assortment—will be touched by customers' needs recorded in real time, requiring a degree of responsiveness most commercial directors would find impossible today. In some respects, customer-centricity means returning to the kind of thinking that prevailed when owners of small stores bought the merchandise they knew individual customers would like. Retailers sacrificed this intimacy in favor of scale, as technology emerged to help them manage more complex operations more efficiently. Now they have to manage both.

This will place extraordinary pressure on retailers, because all sorts of skills and practices and ways of making decisions, in some ways unchanged for a century or more, are fast becoming redundant or are only partly sufficient for profitable success. Perhaps toughest of all for many of today's store-based operators will be the technology requirements. Organization-wide fluency in and with technology will be a critical success factor for retailers everywhere, and the robustness and flexibility of their IT systems and the transparency and ease of use of their digital interfaces will be as important as the aspects of physical retailing that are familiar to us today: location, store format, size and layout, point-of-sale design and capacity, in-store promotions, and more.

Ultimately, success will hinge on more than competence; it will come down to a way of thinking. Customer-centricity will need to be valued not just by the store owner, as in the past, but also by all employees in the organization. It will need to become embedded in their daily tasks. The same applies to technology, which must be at the center of the organization and recognized as such by everyone. As one senior executive of a global online retailer told us, “If I were forced to choose, I'd say we were a technology company rather than a retailer.” Store retailers will, in essence, need to change their DNA. We hope this book helps them understand why—and inspires them to make the transformation now.

Chapter 1

A Brief History of Retailing

Co-authored with James Naylor

Today's senior retailers have endured a series of profound shocks and changes. During their careers, they have witnessed the dot-com bubble of the late 1990s, been swept along by a credit-fueled consumer boom, felt the pressure of financial markets' expectations of cross-border retailing, and been blasted by the macroeconomic consequences of a capital market crash and its aftermath. Those who struggle for economic survival day by day and week by week may feel they have had enough history already. Nevertheless, although these words may be of little comfort, the events have been merely the birth pains of a new era in retailing in which the retail landscape will change completely.

To understand this assertion, it helps to consider the nature of today's changes in the context of the history of retailing. We can organize our thinking by dividing the time line of retailing into three eras: the mercantile, the modern, and the digital. The era of medieval mercantilism was born of an embryonic banking system that made capital funding available for the first time and steadily increased the scale and scope of trade over centuries. The modern era, from the Industrial Revolution to the turn of the 21st century, ushered in mass production and the consumer society. In the present era, which got under way 15 or so years ago, another revolution is taking place: the conventional ways of retailing laid down and consolidated over the course of centuries are being thrown over in favor of a new order founded on three technological pillars—computing power, networking, and data storage capacity. We refer to this as retailing's digital era.

Retailers are by definition intermediaries, helping suppliers to find a market for their goods and customers to buy what they need or desire. In the mercantile and modern periods, retailers' role as the intermediaries between suppliers and customers—adding value to both and extracting profit for themselves in the process—was necessarily a narrow one. Retailers served a small, elite class of people until, progressively, more members of society moved beyond subsistence to become consumers. With the help of capital, new management techniques, and new technology, they grew steadily more skilled in that role, and steadily more powerful. The more skilled they became, and the greater the demand, the greater the scale at which many were able to operate while still delivering on the most fundamental requirement of a successful retailer: to match the flow of goods with information about supply and demand in order to earn the highest possible return on the money invested in inventory.1 This was as much the challenge for the merchants of the Middle Ages who bought wool in England and sold it in markets in Bruges or Ghent as it is for today's retailers who operate hypermarkets of up to 220,000 square feet.

But in the digital era, the retailer's role as intermediary is under threat. Fifteen years ago, the new technologies that promised so much for e-commerce did not quite deliver, and the dot-com bubble burst. Today, a mature range of digital technologies is sending the industry a clearer signal. And these technologies are game changing. Traditional retailers no longer hold the monopoly on marrying information about supply and demand with the appropriate flow of goods. That truth is already apparent in the declining importance of the bricks-and-mortar store, which once embodied the convergence of the two. A new army of online retailers now harnesses the power of computing and the Internet both to aggregate demand online and to fulfill it. Understanding how retailers' power as intermediaries grew through the course of history helps explain why today's technology is so disruptive and brings home the magnitude of the changes afoot.

The mercantile era

The traveling merchant of the late Middle Ages was the first recognizable retailer in the sense we understand the term. For centuries, his predecessors in trade had taken products they had made to markets and fairs, by foot or horse or ox, and sold them directly to local people. In contrast, the retailer who emerged in Europe in the 13th century was a middleman, buying goods from producers and selling them from town to town and village to village. For most people, however, many if not all of their material needs were provided through self-sufficiency. In a largely urban, post-industrial society, we readily forget a world of smallholdings and subsistence, in which informal barter was as important a means of exchange as money transactions.

Under the most basic model of business in this era, the merchant financed his own operations and carried out his own freighting activities. He bought goods from specialist centers of production (such as linen from Reims), organized mule trains to traverse mountain and plain, and distributed his wares through markets, fairs, and networks of peddlers. The expansion in money supply as silver production in Europe increased in the 13th century enabled him to go farther and expand his business. Venture capital had arrived, increasing the scale and scope of trade and bringing about the first wave of internationalization.

Eventually, sea routes pioneered by the great voyages of discovery in the 15th and 16th centuries enabled this merchant's successors to reach around the globe, exchanging an ever-widening variety of goods. By the beginning of the 18th century, Europeans had become accustomed to fabrics from India, tea and porcelain from China, lacquer work from Japan, and tobacco from America, as well as more locally produced imports, such as wine from France. Of course, these were luxury goods, or at any rate staples only for the very rich.

At the same time, these retailers were gradually being relieved of the need to spend long periods away from home, thanks to resident merchants, who began acting as agents for purchase in sourcing markets such as Bruges, Genoa, and Casablanca. And the emergence of dedicated providers of transport freed merchants to concentrate on selling their goods. Two types of generalist businesses took root: mercers, who provided haberdashery items such as silks and linens, and grocers, who supplied dry food provisions, household goods, and hardware. There were dealers and the precursors of what we would call shops, but for several centuries, there was little separation between wholesalers and retailers. Business was carried out in proximity to both domestic living areas and workshops for craft production. Gradually, particular towns and even streets became associated with specific commodities: London's Haymarket was home to traders of hay and straw, for example.

The founding of the great international trading enterprises, following the great voyages of discovery, brought a surge of imports into Europe and a progressively stricter delineation between wholesale and retail. The East India Company, established in 1600, cleared its stock with regular auctions, consciously rejecting the opportunity to develop a full “retail” activity. That opportunity was available for others to take.

Hence, by the 18th century, shops had become a common feature of London and Paris. In London, certain streets, notably Cheapside, were becoming dedicated to retail, while in Paris, covered shopping arcades, or passages, were established. The shop owners understood what goods were available and selected those that would meet customers' needs or that customers might like, because much was new to the market. And because each merchant knew most customers by name, it was relatively easy to purchase stock that was likely to sell. There was little that resembled mass production, even by the middle of the 18th century.

Craft manufacture remained entwined with merchandising and selling: a shop would have a workshop behind or above it, and products tended to be made to order and customized. But the merchant-retailers who owned a general store in the village or town spread their sourcing footprint wide in order to link producers as well as other merchants with consumers. The accounting records for one such store—Abraham Dent's shop in Kirkby Stephen, a small town in Yorkshire, England—show just how extensive sourcing networks were. During the period covered by the accounts, 1756 to 1777, Dent stocked a range of dried grocery items (tea, sugar, flour), as well as wine, brandy, soap, candles, and a limited range of textiles.2 He could loosely be said to have commissioned his own “private label” for stockings. What is most striking is that Dent drew his stock from 175 suppliers in 48 towns and cities across England. The mercantile era had advanced a long way.

The modern era

The onset of the Industrial Revolution in the mid-18th century marked the beginning of a long wave of change and technological innovation, from the telegraph to the computer, which endured until the turn of the present century. It saw the development of retailing from Abraham Dent's provincial general store to the hypermarket chain bent on overseas expansion and the vertical retailing model of the Spanish clothing brand Zara as globalization shrank the world at the close of the 20th century. Each development in between—the department store, the mail-order catalog, the self-service supermarket, the edge-of-town category killer—represented an advance in consolidating the power of the retailer as mediator between supplier and consumer. Only the retailer could match supply and demand on a large scale and thus sell at low prices, profitably.