No. 327: The Gilded Age 2.0

Mark Twain once wrote, “History doesn’t repeat itself but it often rhymes.” According to historians, the groundwork for the New Gilded Age began in 1990. Nearly 30 years later, the age of the “robber baron” industrialist and the cutthroat financier has returned. Since that time, there are few industries that have seen the magnitude of disruption that housing and retail have endured. Nearly 26,000 stores have closed in the past three years; 2019 will double 2018’s closures. There are echoes of this bifurcation throughout the physical and digital spaces of commerce. Contrary to popular opinion, retail isn’t dying. Instead: changes in earnings, increased debt loads, and decreased consumption rates are beginning to polarize some consumers. The middle is being squeezed and retail failed to anticipate this socio-economic shift.

“The retail reckoning has only just begun.” Those are the words of reporter Jack Hough who released a blockbuster, paywalled report for Barron’s. But reckoning and death are not necessarily synonyms in this context. Retail is not dying, it is bifurcating. In The Ballad of Victor Gruen, the boom and bust of retail real estate is explained through the lens of socio-politics and tax policy:

Source: Barron’s

According to CNBC reporter Lauren Thomas, apparel mall retail profits are at recession levels. As of June 2019, Macerich, Simon Properties, Kimco, Washington Prime Group, and Taubman properties are trading at five-year lows. There aren’t enough viable challenger brands (DTC) to fill the 67,000+ store closures projected by 2026. So, it’s difficult to determine whether or not an American retail empire built on post-war consumerism, suburbanization, and accelerated depreciation will return to its former glory. But when we wonder how the “retail apocalypse” happened, look to 1954.[1]

Per capita, America is over-retailed; it always has been. But for nearly 60 years of suburban retail expansion, it seemed as though the industry would never contract. According to Randal Konik, an analyst with Jefferies: “There are about 1,350 enclosed malls in the United States but only 200 to 400 are needed.” But while retail stores shutter, sales are expected to grow 3.5% to $3.7 trillion. According to reports by UBS, it may take ten years to reach the equilibrium (1,350 to 200). The investment bank forecasts 75,000 additional stores closing in that time.

To better understand who the store closures are targeting, we must first consider the definition of the middle class – a shrinking cohort of the American consumer. There’s a great chance that if you’re reading this, you are statistically in the upper middle and wealth classes and gaining. That group earns greater than $140,901 in annual household income.

Income | Source: Pew Research and CNN
Typical consumption | Source: Pew Research and CNN

But for many hard working, middle Americans, something is lost in translation. With inflation, under-employment, rises in college tuition, mounting consumer debt, and healthcare costs – typical consumption has fallen. And families who earn a comfortable wage are living closer to the lower end of the middle-class range or below. In short, levels of wealth are polarizing and retail’s bifurcation is following suit.

Understanding the Gilded Age

The times of mining bonanza kings, railroad barons, merchant princes, bankers, generational trusts, and utility tycoons were rife with brute capitalism and a stark economically inequality that America hadn’t seen before. The country began to lead the world in the production and refinement of valuable goods and services. For the select few who benefited, new, economic monarchies were forged. For everyone else, life seemed more like scene from Sinclair’s “The Jungle.”

If you’ve ever had the good fortune of visiting Newport, Rhode Island – you’d recognize something peculiar: The Gilded Age presents itself in certain areas of the city like the era was never replaced by the middle-class boom. Between 1870 and 1900, three of the largest and most extravagant homes in America were constructed along the shores of the beautiful New England city. Of these palatial homes is what many consider the crown jewel: The Breakers. On 14 acres, the 65,000 square foot mansion serves as an archetypal memory of the age of industrialism. Cornelius Vanderbilt II bought the land for $450,000 in 1885 and finished construction on the 70+ room “summer cottage” in 1895.

As a student, I walked the halls of The Breakers with several of my classmates. We’d never seen anything like it before. Frankly, I was in shock. Growing up squarely in the middle class, I could barely imagine living in 4,000 square feet. But in the structure that harkened to the Italian renaissance, we marveled at a family’s home that spanned an entire acre of land. I didn’t know that this level of wealth existed and I surely had yet to see any of modern derivatives of that boom’s past. Castles were for history books and midieval films, or so I thought.

The rich get richer and the poor get – children.

F. Scott Fitzgerald

There are a number of Gilded Age-era homes across the United States; many have been repurposed into public buildings and monuments to the era. San Francisco has the mansions of their Big Four. Just a ways away, you’ll find the Hearst Castle. Connecticut is home to the Lauder Greenway estate. Massachusetts has The Mount. And of course, the streets of New York are peppered with homes like the Arden, Indian Neck, Olana, and Woodlea – the now-home of the Sleepy Hollow Country Club. In all, there are nearly 80 homes of this caliber in America. Not one was built after Jay Gatsby’s 1920s. That is, until recently.

There’s a paragraph in the recently published The Triumph of Money in America by Jack Beatty:

But, brazen as it was, inequality then conformed to the pattern of the unequal past. Not so inequality in what publications from the Atlantic Monthly to Seattle Weekly have denominated the “New Gilded Age,” when for every additional dollar earned by the bottom 90 percent of the income distribution, the top .01 percent earn $18,000. From 1950 to 1970, they erned $162. […] Paul Krugman notes, “Not since the Gilded Age has America witnessed a similar widening of the income gap.

The Gilded Age was a salicious spectacle of glory and tragedy. It seems that we are on the precipice of another flashpoint, where years of quiet build-up led to an “aha!” moment. Housing, mounting middle-class consumer debt, and retail trends all seem to point in that direction. Consider last mile delivery services like DoorDash or GrubHub, a luxury experienced by the upper-middle and wealth classes. But a job that takes advantage of the underemployed – many of whom are likely white collar professionals fighting to remain somewhere in the depleting middle.

There is an polarization of American wealth and it’s progressing at a dizzying pace. Look no further than San Francisco, where the newly homeless camp against the walls of four and five star hotels. The dichotomy is striking. Or consider New York City, where there may be slightly less of a wealth disparity (to the blind eye). Yet, the city’s private helicopter traffic is growing noisier while the subway system is failing many who are fighting to remain in the middle class. There are as many last mile workers on the streets of New York as there are pedestrians at times. A noticeable number of New York’s miles of retail storefonts lie vacant.

In 2018, USA Today reporter Rick Hampson wrote: “That time (roughly 1870-1900) shares much with our time: economic inequality and technological innovation; conspicuous consumption and philanthropy; monopolistic power and populist rebellion, […] and change —  constant, exhilarating, frightening.” Understanding the mirrored socio-economic patterns of then and now should profoundly impact the retail operations of today.

Gilded AGE 2.0 And Modern Retail

Sears, the once-famed retailer earned its beginning in the Gilded Age. Richards Sears, a railroad worker, founded R.W. Sears in Minnesota. Operating as a reseller of jewelry and watches, early success moved the business to Chicago where he met and hired Alvah Roebuck. The retail founder and the watchmaker built an innovative business: they’d own products and brands and sell direct to consumer. A predecessor of eCommerce, today. On the heels of direct-sales and catalogue success, the retailer went public in 1906 [2].

Sears went public with preferred shares selling at $97.50 each, or more than $2,500 now. Goldman Sachs managed the offering. That year, Sears also opened a mail-order distribution center on Chicago’s West Side that, with three million square feet of floor space, was among the largest buildings of its kind in the world.

The boom of Sears’ brick and mortar growth relied the boom of rural and suburban penetration throughout America. Nearly sixty years of fortune followed. Richard Sears adjusted for the times. A business built for the wealthy became a symbol of the burgeoning middle-class. He saw the opportunity, I suppose.

Online retail sales as percentage of total retail | Source: eMarketer 2018

Fast forward to 2019 and retail’s lines of my demarcation are clear as ever. Online retail has been adopted by nearly a quarter of Chinese citizens and across the country’s economic strata. In the United States, the makeup of online retail customers skews towards the affluent. Amazon Prime’s membership boasts over 110 million users, or a third of all of American households. Of all internet consumers, 66.3% of those who earn over $150,000 use Amazon Prime. Just 31.6% of those who earn $35,000 annually have purchased the membership.

The suburbs are overstored and undershopped, and experts say only the top 20% of malls are thriving.[WWD]

Online retail and “Tier A” malls attract an affluent consumer. Off-price physical retailers and “Tier C” malls skew towards the economically-distressed. Between 2018 and 2019, the following specialty retailers have shuttered en masse: Nine West, Claire’s, Brookstone, Samuel’s, Mattress Firm, Sears, David’s Bridal, Charlotte Russe, Payless, Gymboree, Topshop, J. Crew, J.C. Penney, Pier 1 Imports, and DressBarn.

More closures are to come. Of them: GAP and L Brands will accelerate closures, further diminishing middle class retail. Not only are we witnessing a polarization of American wealth at a dizzying pace, it is now reflecting in retail real estate. The institutions for the affluent have remained steady, in some cases contributing to a growing retail sector. The institutions for the economically-distressed are also doing quite well. Historically, off-price and luxury retail were at the periphery. If these trends continue, these two cohorts may become the collective majority.

There are implications for digital-natives. Consider the rising customer acquisition costs of today’s direct to consumer business. Facebook, Instagram, and Google’s advertising inventory have remained static while the volume of DTC founders who launch companies continues to rise. Rather than a go-to-market that appeals to a growing number of modern luxury consumers and HENRY’s (high earners, not rich yet), many DTC brands optimize message, branding, and ad spend to reach a contracting number of middle-class consumers. Or worse, off-price consumers who’ve yet to fully adopt online retail as a method of consumption. It’s unclear whether or not this dynamic is contributing to a rising CAC but the shifting dynamics of an audience should concern marketers.

Meanwhile, off-price digital natives like Brandless and have struggled as they focus on forms of bargain-driven promotion. While over 100 million Americans use Amazon Prime, we’re still at 11-13% of retail being attributed to online transactions. The United States is still in the early stage of eCommerce adoption; as such, off-price consumers continue to lag behind in the adoption curve. It’s reasonable to assume that this contributed to what may have been an overestimation of total addressable market (TAM) for retailers in the off-price category. Brandless has since adjusted their strategy to appeal to more affluent shoppers. “The average order value today needs to move from $48 to probably $70 or $80,” the words of Brandless’new CEO who has committed to charging more for products, leaving behind the company’s bargain basement strategy.

This era has begun to reveal sharp contrasts in how Americans approach the consumption of goods and services. Net consumption continues to grow despite a catastrophic number of store closures. Some in retail and media are quietly recognizing that the most competitive approach to growth is the pursuit of the modern luxury consumer – a cohort that seems to be invulnerable to these shifts. Products have become more exclusive, with higher quality production, and superior service. As online retail penetration continues to grow from 11% to levels resembling China’s, off-price retailers will begin to see more success – a notion that should bode well for Walmart, Costco, and others.

While history doesn’t repeat itself, it does rhyme. The economically-disadvantaged deliver food, novelties, alcohol, and commodities to urban sprawls and gated suburbs – within the hour. Across the country, the net worths of the top 1% have become noticeable as conspicuous consumption of products and services have risen; the rise of platforms like StockX, Hodinkee, and Uncrate demonstrate this. For the top .01%, there are more 40,000+ square foot homes than their were in the Roaring 20’s. Retail is responding to economic realities of today. Wealth is galvanizing; retail strategies should adjust to meet the shifts head on.

The term retail apocalypse has always been an uncomfortable generalization to make. This research suggests that it’s also an innacurate one. Rather, Gilded Age 2.0 is a casualty of the middle class; a consumer that emerged in response to the industrial and financial booms of the late 19th century. The early 21st century resembles a time when the middle barely existed. It was an unfortunate time of boom or bust, feast or famine. For commerce and its adjacent industries – 2.0 is a correction that can no longer be ignored.

Read the No. 327 curation here.

Research and Report by Web Smith | About 2PM

No. 319: The Ballad of Victor Gruen

Remember this year: 1954. A Jewish immigrant from occupied-Austria was nearly 60 years ahead of his time. Victor Gruen made his name as the inventor of “the Gruen effect“, a method of storefront design that influenced casual bystanders to enter stores. His success as a designer caught the eye of Midwestern commercial developers. He later became the father of the American shopping mall. But his vision wasn’t the mall that we grew up with, it was supposed to be more.

In 2019, most of the thriving shopping centers now look like Ohio’s Easton Town Center, a real estate partnership between Les Wexner’s Limited Brands and the Georgetown Company. It’s less a shopping mall and more a self-contained town with living, dining, grocery, hotels, and an ease of mobility. Opening to fanfare in 1999, Easton is still a successful and growing development nestled in an existing suburb in Northeast Columbus. But even it is on shaky ground. This information was sourced from Mitch Nolen Retail:

Web Smith on Twitter

Here is a better visualization of your mall. 21% of these companies are headquartered in a Columbus, Ohio suburb.

Just a few miles from Easton Town Center, 21% of the above retailers are headquartered in and around the suburb of New Albany. The “town that Wexner built” is idyllic. It’s a derivative of what Gruen envisioned in the 1940’s. The city, itself, is stable, walkable, and growing. Local officials have attracted the likes of Facebook, Google, and Amazon as somewhat of a hedge against the area’s retail employment base. From Bloomberg’s recent feature:

The Silicon Valley giants will join some of Wexner’s current and former brands: Abercrombie & Fitch and Justice are both headquartered there, and Bath & Body Works has an enormous office in the park.

Attracting Silicon Valley to New Albany was a bet that is symbolic of a greater trend. Those Silicon Valley giants are as much a part of the commerce ecosystem as the drywall, steel beams, and concrete of the malls that span our country’s vast suburbs. But it isn’t the only culprit of today’s retail woes. In short, there isn’t enough demand (shoppers) to meet excess supply (stores). Retail real estate is permanently contracting. A recent headline from CNBC stated that “apparel retail earnings haven’t been this bad since the Great Recession. [1]” A capstone of all real estate developments, earnings are trading at recession levels despite a categorically booming economy.

Markets should be able to tolerate 10% hits

The GDP of the United States grew at 3.1% in Q1 of 2019. BEA analysts note that America’s economy is valued at $20 trillion, up from $15 trillion during the Great Recession of 2008. In effect, the economy of the United States is in good shape. But retail doesn’t necessarily reflect this optimism. The last enclosed mall was built in 2006 [2]. Retailers shuttered 102 million square feet of retail space in 2017, then a record-breaking year for retail closings. In 2018, brands shuttered another 155 million square feet.

In short, there isn’t enough demand (shoppers) to meet excess supply (stores).

There were 5,854 store closures in 2018. Now in 2019, we have already surpassed the previous year’s total: 8000+ retailers have already closed their doors. By April of 2019, alone, there were 5,846. Analysts at UBS suggest that the trend is only gaining velocity. The firm expects store closures to reach a pace of 10,000 per year, hitting 75,000 closures by 2026.

Consider this parallel. In 1995, the New York government began auctioning new taxi medallions, marketing them to potential drivers as long-term investments. Though the first medallion sold for $10, decades before, many of the medallions sold for $500,000 to $1,000,000. Just as the arrival of eCommerce blunted the economic viability of the mall, Uber and Lyft’s initial 10% hit on medallion prices sent the marketability of the asset into a 60-80% free fall. Mall retail is experiencing the same effect. One that will likely accelerate with additional tariffs.

New York City’s taxi medallion prices experienced forces that were extracurricular to free market forces. The government miscalculated as it waved the invisible hand. One could say the same about retail. Like New York’s taxi market and the effects of Uber and Lyft, eCommerce isn’t the only variable that contributed to physical retail’s diminished value. Government policy did.

Where it went wrong

The mall began in the American midwest. Victor Gruen designed the first enclosed shopping center in Edina, Minnesota. At 1.2 million square feet, the Southdale center was designed to challenge automobile-dependency. It was to be a sustainable, common space for the suburb of 15,000. In recent years – with increased competition for e-tailers and more modern malls, the development suffered through store closures, vacancy rates, and a fluctuating real estate market in the surrounding areas. Anchored by Macy’s, it remains viable for now. But it’s a relic of an incomplete vision. The mall was supposed to be more than what shopping center, Gruen’s vision was grander. From Business Insider:

The mall’s architect, Victor Gruen, designed the building to mimic Vienna’s outdoor squares, with plants hanging from the balconies and plenty of space for people to mingle. In the atrium, there was a fish pond, large faux trees, and a 21-foot cage filled with birds.

The founder of Gruen Associates, Gruen is the architect of the shopping mall. And if you can imagine, he disdained the legacy of his life’s work. His inspired and futuristic idealism for the town center-styled retail center (inspired by Vienna’s Ringstrasse) was overshadowed by socio-economic turmoil that he couldn’t have envisioned.

1944 – 1956

During World War II, President Roosevelt heralded the importance of consumerism as a form of patriotism. He demanded that regular Americans do their part by projecting the “American way of life.” This meant buying cars, televisions, washing machines, and new clothing – propelling our economy forward during a time of national distress. Post-war, this became a centerpiece of American life. Further, the U.S. government called on women, specifically, to adopt the belief that consumption was both a civil duty and a private form of enjoyment. With this culture-defining shift as the backdrop, Gruen made plans to build his urbanesque spaces throughout America’s growing suburbs. As troops returned home, town center-styled shopping malls were supposed to serve the women and men who served America.

Fort Worth Star Telegram – March 11, 1956

Victor Gruen wanted our suburbs to resemble urban spaces. He almost had his way. The plans from this archival newspaper article should look modern by today’s standards; many of today’s top tier malls maintain a similar inside-outside aesthetic with livability and walkability. But to understand why we’re over-malled, you must understand 1944-1956. The American shopping mall was born at the intersection of postwar capitalism, Cold War fear-mongering, and race relations.

1944: The Service Readjustment Act (SRA) succeeded the G.I. bill. With over 16 million middle-class GIs returning from WWII, the law was designed to stimulate a postwar economy by offering a state credit guarantee to veterans to purchase homes without a down payment. Over 5,000,000 veterans bought homes through this program.

1951: The introduction of the Federal Civil Defense Administration (FCDA). Between 1950 and 1951, aerial bombardment drills fed into fear and suburbanization in cities like Dallas, Philadelphia, Chicago, Detroit, Los Angeles and New York. Fearing that a foreign attack would destroy American cities, middle-class and affluent citizens began migrating to the suburbs.

Detroit was, in many ways, the context for what was to come. Deemed an “economic paradise” at the time, manufacturing was concentrated in this area. And as such, it was highlighted as a potential target for nuclear attack. In response, the city pursued aggressive decentralization, incentivizing prosperous citizens of Detroit to begin settling into suburban “safe” districts. The roads and streets to these suburban projects were carved out of working class, minority districts.

1953: According to Tom Lewis’ “Divided Highways. Building the Interstate Highways, Transforming American Life,” a certain boom occured in 1953 that enabled what happened next. Nearly 145,000 Americans installed new telephones, over 600,000 purchased a new television. But most importantly, 500,000 American families bought a new car.

1954: The U.S. Supreme Court abolished racial segregation in schools after Brown vs. Board of Education was decided. This meant that urban areas around the country were characterized as unlivable by some. Nowhere was this felt greater than in the midwest, where affluent families and government-funded veterans moved to the suburbs to allow their children to avoid certain schools. These neighborhoods were often deed restricted to secure borders. In some cases, incorporation allowed suburbs to form city governments that lorded over the rules and regulations of the area – written and unwritten. This massive exodus to the American suburbs corresponded with a construction boom in the outskirts of many metropolitan areas.

Shortly after this Supreme Court decision, Eisenhower enacted the “Accelerated Depreciation” (AD) program. This allowed the owners of commercial real estate developments to deduct building costs from their tax burdens. This new form of tax deduction enabled builders to extract wealth from their developments 10x faster than the year before. Thomas Hanchett’s “U.S. Tax Policy and the Shopping-Center Boom of the 1950’s and 1960’s” notes that there was one regional mall in 1953. No less than 25 were approved, immediately after this decision in 1954. America went from one mall to 25 in one year.

1956: Eisenhower’s administration moved forward with the Federal Highway Act, accelerating the construction of major roads and highways. Like a lifeblood to the middle-class suburbs, highways connected residents to city centers. Living in urban areas would no longer be necessary for the affluent. In an excerpt from the Quarterly Journal of Economics (Vol. 122, No. 2): Between 1950 and 1990, the aggregate population at the center of American cities declined nearly 17% while population grew by 72% in the suburban areas.

The Result

From Centers for the Urban Environment : Survival of the Cities by Victor Gruen

Victor Gruen never quite accomplished his vision for Minnesota’s Southdale or Detroit’s first mall: Northland. With malls as a new wealth vehicle for well-heeled developers, shopping centers no longer needed to be well-thought out: no green spaces, or hotels, or schools, or condominiums to help each shopping center thrive. Multi-use developments died – for a time – with 1954’s legislation. This was a turbulent time in America that Gruen couldn’t have possibly accounted for. His idea of imparting the wisdom’s of Vienna’s Ringstrasse gave way to massive buildings of aimless use, often competing with another massive building – just 5-7 miles away. This, during the century’s automotive boom, a phenomenon that he foresaw as a detriment to society.

Between 1955 and 1975, shopping mall development exploded. Though, development was no longer tied to demand. Many were built as extractable retail assets only to be flipped for massive profits. This meant that development was no longer tied to population growth. From the Annals of Commerce by Malcolm Gladwell:

Cortland, New York, for instance, barely grew at all between 1950 and 1970. Yet in those two decades Cortland gained six new shopping plazas, including the four-hundred-thousand-square-foot enclosed Cortlandville Mall. In the same twenty-year span, the Scranton area actually shrank by seventy-three thousand people while gaining thirty-one shopping centers, including three enclosed malls.

Today, multiple malls and shopping centers exist for every small suburb in America, designed and constructed with no expectation to achieve sustainable demand. Meanwhile, America is accelerating into urbanization with our growing GDP as the wind at its back. Direct-to-consumer brands are developing, eCommerce has grown to nearly 18% of all retail sales, and urban town centers are popping up – each taking cues from Gruen’s original vision. In a recent conversation with CNBC’s Lauren Thomas, Retail Metrics founder Ken Perkins said:

These are all mall-based retailers experiencing traffic issues.

According to Thomas, apparel mall retail profits are at recession levels. As of June, Macerich, Simon Properties, Kimco, Washington Prime Group, and Taubman properties are trading at five-year lows. This is inline with the numerous data points mentioned above. There aren’t enough viable challenger brands (DTC) to fill the 67,000+ store closures projected by 2026. So, it’s difficult to determine whether or not an American retail empire built on post-war consumerism, suburbanization, and accelerated depreciation will return to its former glory. But when we wonder how the “retail apocalypse” happened, look to 1954.

We moved tens of millions of Americans to empty parcels of land with cars and more stores, per capita, than any place on earth. And we told ourselves that the bubble would never pop.

Read the No. 319 curation here.

Research and Report by Web Smith | About 2PM