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‘Digital tipping point’ set to hit retailers who over-rely on stores, warns leading law firm

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Retailers who over-rely on bricks and mortar stores at the expense of their online operations are “particularly vulnerable” to future financial turmoil, a leading law firm has warned.

Magic Circle firm Freshfields, Bruckhaus Deringer warns of a “digital tipping point” where online growth is hitting those high street businesses that struggle to compete.

It says around a third of FTSE 350 retailers are too dependent on physical sales. Online sales for this group of retailers have grown by an average of 29% in the last five years, while physical sales have flatlined at 1%. Those who do not diversify that flat high street growth are at risk, says the firm.

Yet while high street sales have not grown, the total number of physical stores has risen by an average of 6%, suggesting retailers have too many stores.

“Against a backdrop of sector financial pressures, UK retail insolvencies have surged by almost a quarter (24%) in the first half of 2012 compared to the same period last year and by 42% on 2010,” said Adam Gallagher, a Freshfields restructuring and insolvency partner. “Retailers that are overly dependent on bricks-and-mortar operations and that do not have an established online revenue stream appear particularly vulnerable to further financial turmoil.”

The firm’s analysis shows that in 2011/2012, FTSE 350 general retailers’ online sales made up 24% of their total revenues. That’s higher than the UK retail industry average of 9%. But at around a third of these businesses, online sales still make up less than 10% of their turnover.

Jonathan Isted, head of the consumer and retail sector group, said: “As economic uncertainty continues to dent consumer confidence and credit remains tight, retailers are contending with difficult trading conditions.

“While physical stores will always be important, we are increasingly reaching a digital tipping point where the online growth witnessed over the past few years is having a knock-on effect on high street brands struggling to compete online.

‘Retailers that are overly reliant on bricks-and-mortar operations will struggle to maintain profitability unless they adapt their investment levels and business models to take account of changing consumer dynamics. And with some mainstream brands generating around a third of their revenues online, the digital space is becoming ever more crucial in enabling the financial viability of any retail offering.”

Adam Gallagher added: “Online is not the only competitive threat to the high street. Rent rolls comprise a significant proportion of retailers’ ongoing liabilities and we’ve already seen how the expense of maintaining a large number of stores has proved an intractable problem for some retail chains. JJB Sports and Game Group, which went into administration this year, both expanded heavily during the economic boom.

“While insolvency levels among retailers are rising, there is some comfort to be taken that comparatively few have disappeared from the market altogether. Although no longer on the high street, the likes of Woolworths, MFI, Adams, Allied Carpets and Zavvi have found new homes online, with their buyers relying on brand longevity to generate sales.

“However, the high street seems to be feeling the effects of the digital tipping point. Many buyers of struggling retailers are continuing operations with a smaller physical footprint, which has ultimately led to some shrinkage in capacity across the sector.”

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