Retail Dogma

The Economics of Retail Expansion

Some of the biggest wealth creation stories have been, and continue to be, achieved through retail businesses. This is because retail trade is a scalable business by nature. It is not uncommon for even the smallest retail businesses to start expanding into two, three and four locations shortly after starting out and seeing how the economics of retail expansion work.

Retail Expansion Economics

Previously we have discussed the different types of retail growth strategies, and in this article we will focus on retail expansion through opening more store locations; i.e expanding the footprint of the retail business.

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Retail Expansion Benefits

While businesses in general need to keep growing, in order to keep up with inflation and protect their marketshare, there are other benefits of retail expansion that make the numbers work better with more strategic store locations. (We will explain why we say “strategic” below).

Spreading Common Retail Overheads

Retail expansion and spreading overheads in P&L
Download Multi-store P&L template from members area

The overheads or operating costs for a typical retail business are segregated into store-level overheads and common overheads.

The store overheads are costs related to each store location, such as:

  • Store Employee Costs
  • Store Rent
  • Admin Expenses
  • Selling & Promotion Expenses (which include shopping bags and credit card processing fees)

The common overhead costs are costs of resources that are used for the entire business and are allocated to each store, such as:

  • Office Employees Costs
  • Warehouse Rent & Employees
  • Marketing & Advertising Costs

When a retail business expands and opens more locations, these common overhead costs get spread over more cost centers (stores) and so each store will be able to pay lower percentage and hence have a better P&L. Some stores are actually profitable on store level (see pic above) and when you add the common costs to them they become unprofitable. These particular stores stand to gain from retail expansion, due to reduction in common overheads allocated to them.

Read also P&L Management

Gaining More Bargaining Power

Retailers who open more stores start to increase their bargaining power against their suppliers and vendors. It is one thing to be sourcing products for one location and a totally different thing to be buying for 50 locations.

With more locations you will be able to negotiate better prices, better payment terms and better shipping terms vs. your competition. You will also have more power to negotiate exclusivity on some products that will be carried at your stores, which will also give you a higher pricing power over those products.

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Read also: How to Reduce Bargaining Power of Suppliers?

Higher Brand Equity & Consumer Trust

Each new location will give you higher brand equity, brand exposure and also consumer trust.

Store fronts at prominent malls and busy streets are one of the best advertising opportunities for a retail brand.

Research has also found that even customers who shop online prefer shopping at websites that have physical presence. This makes them trust the website more, and also gives them peace of mind that they can always take the item to the nearest store for an exchange or refund.

So in a new world, where ecommerce becomes a prominent channel for retailing, retailers who have more footprint on the ground, have a competitive advantage over pure online retailers.

How The Numbers Work in Retail Expansion?

When we combine all the previous benefits together, we find that the growth in profitability through retail expansion could be, up to a certain level, rather exponential than linear.

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Expenses

While each store will come with its own overheads of rent and employees, that are more or less constant as a percentage of revenue, the common overheads per store will be diminishing with each new location added. So overall expenses per location will be lower.

Margins

Furthermore, with higher bargaining power as a buyer, the business will benefit from higher gross margins that will apply to all stores. For example, instead of sourcing products at a 57% intake margin, now the business can negotiate prices and terms and source at 65% margin. This will then benefit all the locations.

Marketing Costs

Additionally, with each new store acting as an advertising space for the brand, the marketing expenses will be lower, not to mention that it will also be spread over more locations.

Cash Flow

With the favorable payment terms that can be negotiated after expansion, the business will be able to display and sell products before even paying for them. That’s what big retailers like Walmart and Amazon get to do.

Read Also: Cash Flow Management

Retail Expansion Considerations

While the above scenario and explanation sound great, it comes with a condition, and that is: to expand strategically.

There is a very thin line between strategic expansion and slipping into over-expansion, which comes with a lot of problems for retailers.

The U.S. has fallen into this over-expansion problem, with the highest retail space per capita in the world, and it is the main reason the retail industry has been struggling over the past few years.

Read also: Why Retail Stores Are Closing?

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Each new location that doesn’t add profit to the bottom line of the business actually takes away from it. That’s because, as we explained above, each location comes with its own overheads as well. Not to mention that if the new location is not right, it could also affect older locations through cannibalization.

When a location is not selected carefully and no due diligence or financial projection is done before opening to prove that it has high probability of being profitable, this becomes a burden on the business.

So in order for retail expansion to work in favor of the business, its investors and the store owner, it has to be strategic and calculated. The numbers need to make sense for each new location.

Access our members area and read our real-life case study on how a new store location seemed to tick all the right boxes, but careful due diligence allowed us to dodge a bullet.

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