The Great Retail Shrinkage: Will Smaller Stores = Higher Profits?

(Retail shrinkage article updated with Staples small-format plans.)

NEW YORK ( TheStreet) -- You can supersize soft drinks, French fries and giant rolls of paper towels, but the era of supersized stores may be coming to an end.

Indeed, after decades of big-box stores that housed everything from food to clothing and appliances, retailers are realizing bigger might not be better.

Looking for ways to cut costs amid the recession, retailers tightened inventory levels, slashed jobs and shuttered stores. Now as the consumer slowly returns, the sector continues to seek ways to squeeze the most profits out of its business.

The surge in online shopping is also pushing retailers to shift a chunk of their brick-and-mortar business to the Internet and to reduce overhead costs. In these smaller spaces, retailers need fewer workers and building costs tend to be cheaper.

While for some this model might prove fruitful, getting smaller isn't the answer to all retailers' problems. If consumers are unwilling to shop or if a retailer doesn't have the right merchandise, it doesn't matter how small the package gets.

Despite some likely benefits, our conclusion is that shrinking is not a winning strategy," Nomura analyst Aram Rubinson wrote in a note. "In our view, the solution to a discerning customer and the e-commerce threat is great merchandising."

Given this, here's a look at retailers shrinking their footprint in the hopes of driving profits....

Kohl's

As Kohl's continues to aggressively expand across the country, the mid-priced department store is focusing on smaller stores.

Following its first-quarter earnings report earlier in the month, Kohl's said it plans to open 40 new locations this year, 30 of which will be in smaller models. These pared-down stores will be about 60,000 square feet large, compared with the 90,000 square feet of a typical Kohl's store.

Such stores are well suited for densely populated neighborhoods and urban markets, and Kohl's plans to open one of these stores next spring along the Hudson River across from Manhattan.

Kohl's expects smaller-format stores will be the norm for the company going forward.

This, it's worth noting, isn't necessarily a new trend for Kohl's, which has been rolling out smaller stores for nearly a decade.

Staples

Staples ( SPLS) revealed on June 23 its plans for smaller stores.

At an analyst conference in New York, the office supply retailer said the new stores will be between 15,500 and 16,000 square feet. This is smaller than its current prototypes, which range from 18,000 to 24,000 square feet.

As the office supply sector struggle, Staples is hoping to lower its costs and increase sales productivity. The company also plans to expand its break rooms.

Best Buy

Best Buy ( BBY) is attempting to ease investors' concerns regarding overheard costs, with plans to shrink some of its larger stores and open more locations in the U.S. in its smaller format.

The company is looking to reduce its square footage by 10% over the next three to five years as it expands its online business.

The news comes as the electronics retailer struggles to reclaim market share from discounters like Wal-Mart, Target and Amazon ( AMZN). As more consumers research electronics on the Internet, big-box stores are losing their relevance.

As a result, Best Buy has shrunk the space it dedicates to less profitable merchandise like CDs. It is also increasing its selection of televisions online and reducing the number it displays in the stores.

"We are exploring and redefining what the optimal big-box footprint is for us," CEO Brian Dunn previously said on a call with analysts.

Best Buy is also concentrating on its mobile stores, with plans to open 150 of these smaller locations this year. That would bring the total number of Best Buy Mobile locations to 325.

Best Buy Mobile stores are about 1,500 square feet compared with the 38,000 square feet of a typical big-box location. The company is keeping its square-footage growth of traditional stores to less than 1%.

The company is also introducing kiosks in airports and other strategic locations.

Ann

Ann ( ANN) is shrinking its square footage by as much as 40% with the rollout of its new concept stores.

These new Ann Taylor locations are about 4,000 square feet, and the women's apparel retailer has said the first pilot test of test of these stores has greatly exceeded the company's expectations.

This year, Ann is accelerating the roll out of these new locations and also plans to downsize and remodel some existing stores. Overall, it plans to open about 45 of these namesake concept stores in 2011.

Ann has budgeted about $25 million for the downsizes and remodelings, largely associated with the accelerated conversion of select Ann Taylor stores to its new, smaller format, and $20 million for store renovation and refurbishment programs, primarily for Loft stores

"This strategy represents a very significant opportunity to drive increased sales and profitability across the chain, as well as to create a store experience for our clients that reflects an aspirational aesthetic and best showcases our product," CEO Katharine Krill said during a conference call with Wall Street.

Wal-Mart

Wal-Mart ( WMT), which ostensibly invented the supersize store, is keenly focused on aggressively rolling out its smaller models.

The discount giant, which has been struggling in the U.S., said it plans to add "hundreds" of smaller-format stores over the next three years. Wal-Mart plans to add 30 to 40 smaller units in rural and urban areas in 2011.

The new stores will include mid-sized "neighborhood market" locations, renamed Walmart Markets, which will be between 30,000 and 60,000 square feet. The move will reduce the average size of its superstores to about 180,000 square feet.

Wal-Mart, which rose to dominance with 195,000-foot behemoths, is also scheduled to open its first Express store in June, which will be about 15,000 square feet or less and carry convenience items.

Target

Target ( TGT) announced late last year its decision to open its first small store in Seattle in 2012.

This pared-down location will be between 60,000 and 100,000 square feet, compared to a typical Target store of between 125,000 and 180,000 square feet.

Next year, Target will open similar stores -- to be called CityTargets -- in several markets around the country, including Chicago, San Francisco and Los Angeles. These stores will sell everyday items like food, housewares and apparel.

Office Depot

Office Depot ( ODP) has started opening stores as small as 5,000 square feet, about one-fifth of its traditional stores.

On average, the office supply retailer is taking its 24,000-square-foot stores down to 15,000 to 17,000 square feet, a 30% to 38% decrease. The new stores will focus on the office supply retailer's best-selling items, with an emphasis on technology and print and copy services.

These remodelings are taking place in Florida, Maryland, Washington D.C. and Virginia.

Office Depot, along with the entire office supply sector, has struggled in recent years as its core small business consumer reduced corporate spending.

The three big players in the sector all reported disappointing first-quarter earnings, leaving Wall Street to question the relevancy of the group.

Sears

While Sears ( SHLD) isn't necessarily shrinking its stores, it is giving up some of its space to other tenants.

Most notably, the struggling department store announced a partnership last year with privately-held Forever 21 . It is also experimenting with renting out space to Whole Foods Market ( WFM).

The goal for Sears is to turn its real estate into cash as it struggles to turn sales in its retail segments.

--Written by Jeanine Poggi in New York

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