Retail's paradoxical growth economics

Why you can't copy-paste your way from 5 to 100 stores

The tl;dr

1. Brick and mortar retail is a great way to gain leverage on your CAC

2. But like any other growth vehicle, there are diseconomies of scale

3. You can’t assume your first few stores’ unit economics will hold in the long, or even medium, term

4. Market forces and real estate inventory limitations will be a significant barrier, and are largely out of your control

5. Read on for what these barriers are, and some ways to slow down the natural and inevitable diseconomies of scale that come with fleet expansion

---

Brick and mortar retail is a great way to gain leverage on your CAC

…especially when compared to digital auction channels (eg Facebook):

Generally speaking, auction channels (eg Facebook) are variable with increasing CPMs (and therefore CACs) as you try to acquire more customers; on the other hand, stores are a fixed price channel where the total cost (rent) gets spread across more and more customers, leading to a lower “CPM” (and therefore CAC) as you grow

The chart above reflects the unit economics of a single store’s growth: whether you have 100 or 100,000 people walking through your door and transacting, your rent is largely the same in aggregate — but it gets spread across more customers, which leads to a lower rent per customer as you grow your customer base.

Digital marketing tends to work in the opposite direction: as you try to acquire more and more customers, it can get more expensive to acquire each incremental customer (much like how I’m referring to a single store’s unit economics, I’m referring to a single marketing channel here; and much like stores, you can diversify your distribution beyond that single “location” (eg Facebook) to fight the diminishing returns, or get better at converting).

Retail’s diseconomies of scale

However, something both digital marketing/e-commerce and physical retail have in common are factors that impact the underlying unit economics, which may not be obvious when you only look at the unit economics of a single location.

We’ve all heard of economies of scale (which is how I would illustrate a single store’s unit economics):

As volumes increase (whether traffic or units), the cost of each underlying “thing” gets cheaper

But in many cases, there comes a point where economies eventually reach diseconomies of scale:

What’s interesting is that while a store’s individual unit economics reflect significant economies of scale, the total retail channel — if you invest in it too much or too quickly — will end up reflecting significant diseconomies of scale.

Here’s I would illustrate this paradox:

Individual stores can produce significant economies of scale, but too much investment too quickly can quickly reverse the overall curve

Retail channels’ unit economics don’t scale linearly

One of the most common mistakes retail newbies make is to assume they can copy and paste their stores’ economic profiles to 100, and do it rapidly

Let’s say you have 3 stores, and they each do 20% EBITDA margins. Naturally the exec team is ecstatic, and they tell investors that they believe they can have 100 stores some day with the same economics across all locations (usually as an average).

Usually they think it will play out in one of two ways:

New retailers either believe that there will be dramatic improvements over time (because they’ll “get better at stores”) or that there will be some more modest improvement with each store

It’s possible, but only if you know how to pace yourself.

The reality is that there are factors within the industry, the channel, and even your company that will likely prevent you from achieving those goals. Namely, these stem from a brand’s inevitable needs to do the following 4 things: