Posted on April 7, 2011 by David Laidlaw

In the late 1990s, the market capitalization for Amazon passed the combined market capitalization for Barnes & Noble and Borders even though Amazon sold a small fraction of books compared to its brick and mortar competitors. The meteoric rise of Amazon and fall of its traditional competitors presaged the incredible changes in Internet selling that continue to pressure the retail market today.

Borders declared bankruptcy in February and is reorganizing by closing 200 of its 650 locations. Barnes & Noble is fighting for its existence and will follow on Borders’ heels unless sales of its Nook e-reader and downloads of electronic books stave off declines in its sales of traditional books.

Aside from obvious areas of Internet retailing strength, such as books and music, more electronics sales are gravitating from stores to the Internet. Bestbuy’s stock peaked about five years ago and sales of flat screen TV’s are increasingly being made through E-tailers such as Amazon.

Interestingly, mobile computing is accelerating this change. Customers are using Bestbuy’s stores as showrooms for the Internet retailers. Many shoppers are visiting Bestbuy to see which TVs look best. They are then using their mobile phones with pricing apps to compare prices for their favorite models against listed prices in Bestbuy. Given this reality, Bestbuy’s margins are falling and it has shifted its retail development to its mobile format of stores of about 2,000 square feet that are 10% of the size of its typical stores.

We doubt there is any sector of the physical retail universe that will be exempt from this transition. In pharmaceuticals and personal goods, Walgreen wisely purchased to prevent the erosion of its retail pharmacy business. Walgreen paid an acquisition premium of 113% over’s closing price when the acquisition was announced in late March.

A piece in Retail Traffic from February 16, 2011, noted that Borders’ bankruptcy reflected weakness in the large store format. Average prices per square foot for big box real estate transactions increased 8.5% from 2009 to 2010 coming out of the recession. However, it is difficult to see where future demand for these spaces will come from. Existing retailers such as Old Navy are downsizing to smaller formats. Wal-Mart and Target are also building smaller stores rather than the supercenters of the past.

We believe this trend to smaller formats will continue as more and more retailing takes place online. The current glut in retail space may even exceed the glut in single family homes as many stores are razed or fail to attract tenants.