If you believe the hype, it is only a matter of time before brick and mortar retail succumbs to its online competitors. Recent decisions made by several stalwart retailers appear to support this theory: Macy’s recently announced that it would close 15% of its stores, The Sports Authority and Radio Shack each conducted full chain liquidations as part of their respective chapter 11 bankruptcy cases, the Gap has announced the imminent closure of 175 stores and even Walmart is slated to close 269 stores by the end of 2016.
Yet, despite all of this seeming doom and gloom, of all sales in the first quarter of 2016, physical stores accounted for a whopping 92.3% of such sales. As further (and, perhaps, more meaningful) evidence of the staying power of brick and mortar shops, several originally online-only retailers have either already opened physical locations or plan to do so within the coming years. Last November, e-commerce giant Amazon opened its first brick and mortar bookstore in Seattle and will open more (maybe many more in the next few years. Other online retailers, including Bonobos, Warby Parker and Blue Nile, have opened physical store locations with great success. Notably, brick and mortar order sizes at Bonobos, a men’s apparel retailer, tend to be twice the size of online orders. For many online retailers, the expansion from online-only to brick and mortar operations is the logical next step required for existence in the coveted omni-channel space– also known as “bricks and clicks” (or “clicks and mortar”) retail operations – in order to optimize the consumer shopping experience.
While the expansion from online to brick and mortar may sound like a return to tradition, some of these retailers are opening physical stores that are anything but traditional. Bonobos is among the retailers who are treating their brick and mortar stores more like showrooms, “Guideshops” in Bonobos parlance, where customers can go to actually feel and inspect the merchandise up close, try on the various styles and make a purchase, but walk out empty-handed as their purchases will be fulfilled at on offsite warehouse and then delivered to whichever address the customer provided (probably the next day). Customers of Bonobos and the like appreciate the convenience of being free to enjoy the rest of the day without being laden down with cumbersome shopping bags. However, these showroom-like operations may prove to be less convenient for one party in interest – a landlord entitled to percentage rent under its lease.
Retail leases that provide for the payment of percentage rent require a determination of how to define “gross sales” for purposes of calculating such rent. Historically, sales of merchandise, food or services made in, at, on or from a particular retail store constitute gross sales, with certain exceptions negotiated by tenants, such as employee discounts, bad debts and charges imposed by credit card companies that may be passed off to consumers. In the simplest example, a customer buys a shirt from a retailer, the shirt is stocked at the premises and the consumer completes the sale transaction by paying the purchase price and walking out with the shirt in a bag. This sale would be included in gross sales from the store for purposes of determining percentage rent owed to the landlord. In a showroom-type operation, however, the salesperson essentially is completing an online order for the customer, the merchandise is not stocked onsite and the consumer will likely walk out without the purchase in hand. It would seem rather disingenuous for a retailer that is obligated to pay percentage rent in its lease and is operating a showroom location at which sales are routinely made online and fulfilled by inventory offsite to then argue that its typical sales should not constitute gross sales for purposes of percentage rent (as well as any kick-out right that such retailer may have negotiated for itself). The reverse situation can occur when a retailer provides its online shoppers with the ability to have orders delivered to (but not fulfilled at) a brick and mortar location to save on shipping costs. Landlords would certainly like such sales to be included in the store’s gross sales amounts. Tracking the genesis of online orders for purposes of determining gross sales presents another challenge related to showroom stores, one which was discussed on this blog a few weeks ago.
Ultimately, what does and does not constitute “gross sales” remains a negotiation between landlords and tenants, one that will evolve as retailers get more creative with the use of their physical space and rely more heavily on online transactions, both offsite and within their brick and mortar locations. The silver lining for all parties involved – landlords, retailers and consumers – is that such discussions signal that while the in-store experience may change with the times, as long as consumers still value experiences (and they do), brick and mortar retail is not in danger of extinction.