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The Malls Get Decked: Retailers Minding Too Many Stores

The sheer volume of chain stores out there is hurting retail stocks.


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Retailers Minding Too Many Stores

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Play a little game this holiday season. See how many different


(GPS) - Get Gap Inc. (The) Report

you come across during the course of your shopping. Or count the number of office-supply or consumer-electronics stores you pass on your drive to work. You'll probably conclude that you don't lack for places to shop.

That's great for consumers. But the overstoring of America, as analysts like to call it, is a real problem for the retailing industry. Massive expansion isn't new, but when the economy slows, as it has recently, the store glut becomes an even more severe problem. Some companies already are scaling back, but a lot more will need to do the same to reverse the trend, meaning a punishing shakeout soon could descend on the retail chains.

Vicious Cycle

Retailers have really become victims of their own success. When business is great, as it was through the late 1990s, companies expand. But fast-growing companies face not only the usual problems stemming from expansion -- the logistical difficulties of planning for and monitoring more stores, for instance. When enough companies are opening stores, growth in supply comes to exceed growth in demand.

At that point, "It becomes more and more difficult to get market share without taking it from someone else," says Kurt Barnard, with

Barnard's Retail Trend Report

. Or from yourself -- too many locations can lead to cannibalization. To compete, companies may end up slashing prices, which kills margins even if same-store sales are increasing. Things get worse when the economy cools and consumer demand falls off. Then retailers are competing for even fewer customer dollars.

So why doesn't everyone just stop growing so much at the first sign of saturation? In part, it's a logistical issue; because companies commit to leases ahead of time, they can't immediately pull back. But there's some game theory at work, too.

"It's a prisoner's dilemma," says Carl Steidtmann, chief retail economist with


. "It's the same problem that OPEC has. You benefit if you cheat a little bit, but if everyone cheats a little bit, everyone gets hurt."


Retailers also want to tell Wall Street that they're continuing to open new stores and increase sales. "They're driven to meet the analysts' expectations," says Todd Slater, analyst with

Lazard Freres

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. The pressure is acute in today's growth frenzy. No one wants to buy stock in a company whose CEO says, "Hey, we think we're about the right size now and for the foreseeable future," particularly not when tech companies have seen exponential growth in sales.

Specialty retailers are among the worst offenders. Slater figures they're increasing square footage by about 11% this year, more than last year's 6.7%. Oversupply hurt retailers from Gap to

Pacific Sunwear


this summer, as excess merchandise filled store racks and was eventually sold at massive discounts. But so-called big boxes -- consumer-electronics, home-improvement and office-supply stores, and discounters -- also are overstored, says Steidtmann. As a result, retailers are in for another promotional Christmas, as they offer discounts and sales in an attempt to maintain or gain market share.

In the worst case, problems go beyond a temporary profit squeeze. When companies borrow heavily to fund expansion and then find themselves overextended, it can set off a spiral that ends in bankruptcy. Retailers aren't as heavily leveraged as they were in the early 1990s, but still, there's likely to be an increase in "problem situations" next year, including debt downgrades and perhaps a bankruptcy or two, says Barnard.

The Pullback

There are some early signs that retailers are pulling back. Gap, for its part, already has identified overexpansion as one of the problems causing it to repeatedly disappoint investors since the spring. When it reported earnings for the fiscal third quarter, the company also gave its first hint about growth for next year. In the past two years, Gap increased square footage by about 30% per year. That rate of growth "has created stress on the organization and led to some of the execution issues we've experienced recently," said CFO Heidi Kunz on a conference call with investors and analysts. Next year, Gap expects growth to slow to between 17% and 20%. "The growth rate for the next year represents an approach aimed at taking advantage of market share opportunities at a pace consistent with delivering quality results," Kunz said.

Storing Up
Limited rises as overstored Gap slides

Gap's not the only one. When

Best Buy

(BBY) - Get Best Buy Co. Inc. Report

recently warned of a weak second half, it said that though it already has signed 50 leases for next year, it would consider cutting store growth to 55 new openings from 65.



is considering closing 50 stores and will scale back its 2001 expansion plans from 54 stores to an unspecified level, while

Office Depot

(ODP) - Get The ODP Corporation Report

may close between 50 and 75 stores, according to analysts.

When it recently reported disappointing earnings,



said it would scale back its aggressive expansion. And discounter



said recently it will close 32 stores.

Christmas in July

But that may not be enough. Cutting 50 stores, for example, would reduce Office Depot's 825-store domestic roster by only 6%. And as for the Gap, Slater says that 20% growth still means an additional 6 million-plus square feet of Gaps,

Banana Republics


Old Navies

. Meanwhile, other chains are showing no sign of letting up:

Abercrombie & Fitch

(ANF) - Get Abercrombie & Fitch Company Report

, which struggled this year, still increased square footage by 36% in the third quarter compared with the year-earlier quarter. It still plans to keep rolling out its namesake store -- and it says its new surf 'n' skate-themed store,

Hollister Co.

, eventually has the potential for between 600 and 800 outlets. Will it never end?

Well, probably yes, but it won't be pretty, particularly if the economy continues to struggle. Sales and profits in these particularly vulnerable sectors could continue to suffer until capacity gets removed by a not-so-pleasant method: massive closures and bankruptcy.

And while it takes a lot of discipline to close stores when rivals are opening them,



shows you can do it and prosper. The chain has pared almost 20% of its major apparel brand stores since 1996. Now its sales and profits are picking up nicely.

So go ahead, and enjoy the bounty of stores at the mall this year -- and the discounts. But as an investor, remember that what's good for you isn't necessarily great for retailers.