Merchants seek to shrink store space

Retailers have a new strategy to increase profits: shrink to fit.

For two decades, mall-based apparel companies saturated the market, aggressively adding more stores and building them bigger. Chastened by the recession, however, retailers including Gap Inc. and AnnTaylor Stores Corp. are poring over their holdings, looking for stores they can cut down to size.

The effort marks a new phase in the industry's response to the weak economy. After consumers snapped shut their wallets in the fall of 2008, sending sales plummeting, retailers laid off waves of employees and slashed inventory.

Now, many of them see re-evaluating their real estate, one of retailing's biggest expenses, as a critical step on their path to recovery.

"During the '90s era, everybody wanted a bigger box," says Kay Krill, AnnTaylor's chief executive. "Now, all of us are trying to get out of those bigger boxes."

Ms. Krill says she is shrinking square footage at AnnTaylor's new namesake stores by a third. Her reasoning: "I like productivity."

Average sales per square foot at American malls, a closely watched measure of retailers' productivity, peaked in 2007 at $454, according to research firm Green Street Advisors Inc. By the end of 2009, the average had fallen to $401, wiping out five years of progress.

For many retailers, the decline has been even steeper. Between 1999 and 2009, sales per square foot at Gap, the country's largest apparel retailer, fell 40% to $329. Total square footage for the company, which also owns the Banana Republic and Old Navy chains, jumped 62% over that period, even though its number of stores increased just 2.6%.

Gap is dealing with "a hangover of yesteryear," says Chief Financial Officer Sabrina Simmons.

Some of the stores that now run to 18,000 square feet could be just as productive cut to 8,000 to 12,000 square feet, she says.

"Quite frankly, it's just not as positive of a shopping experience as a smaller box that's a more intimate experience," Ms. Simmons says.

In locations where Gap has multiple store formats, such as GapKids or Gap Body, in addition to a conventional Gap store, the company aims to consolidate them into a single store.

Lengthy lease terms can make it difficult to close stores outright. But mall landlords often can be persuaded to accept downsizing, because it keeps the retailer in place, avoiding a dark storefront.

Gap has extra leverage because it is a commonly named co-tenant on other retailers' leases. That means those stores can demand rent breaks if Gap leaves a shopping center, says Kimberly Greenberger, managing director of softlines apparel research at Citigroup. Gap also typically signs five-year leases, about half the industry's average term.

Not only can smaller stores help to cut costs, they can also force retailers to choose their wares more shrewdly. "Filing a 10,000-square-foot box with good ideas is a lot more difficult to do then filling a 3,000-square-foot box with good ideas," says Paul Lejuez, senior retail analyst at Credit Suisse.

Mr. Lejuez says he believes the Gap brand's larger stores forced it to broaden its offerings for a wider age range, muddling its image.

"They had to find something to put in it," he says of the space. "It really made them change their strategy, and they're still feeling the effects of that 10 years later," he says.

Gap wouldn't comment on how store size affected its strategic choices.

Glenn Murphy, who joined Gap as CEO in mid-2007, has made shrinking its real-estate portfolio a priority. Last year, Gap pared roughly 2% of its total store space, which peaked at 39.9 million square feet or the equivalent of 693 football fields in late 2008. Next year it plans to remove an additional 3%. Mr. Murphy says he hopes to cut between 10% and 15% of Gap's sprawling footprint.

At the same time, some chains with strong sales trends are expanding their stores. Both overall sales and sales per square foot have rocketed during the recession at bargain-priced teen retailer Aeropostale Inc., whose stores are among the smallest for a typical mall. Of Aeropostale's roughly 950 stores, 170 have sales exceeding $800 per square foot, Co-CEO Tom Johnson said earlier this month.

Aeropostale is looking "to increase the square footage in a number of these highly productive locations," he said.

For chains that are shrinking, smaller stores aren't without their challenges, says Matthew Katz, head of the retail practice at consulting firm AlixPartners. In particular, having less space for inventory forces retailers to speed up the flow of product from their suppliers or devise new ways of storing and displaying merchandise.

Still, retailers whose sales are flat or declining have little choice but to think small. Those companies that are able to close underperforming stores, either as their leases expire or by making deals with their landlords, are doing so.

AnnTaylor, which also runs the Loft brand, has been shutting stores and otherwise pruning its real-estate portfolio. Sales at the clothier sagged before the recession because customers didn't go for its staid, boxy women's suits.

Economic turmoil made things worse. The company says sales per square foot hit a two-decade low last year of $337, down 33% from 1999. Square footage over that period rose 135%.

In recent months, the company's new more feminine, more tailored merchandise has improved sales and restored gross margins. Meanwhile, says Ms. Krill, AnnTaylor plans to open a new, smaller store format starting this fall with two locations in Atlanta and Bellevue, Wash.

The new 4,000-square-foot stores will be roughly a third smaller than the company's current average. "With the focus on wear-to-work, versatile separates, you don't need a 6,000-square-foot box to do that," Ms. Krill says.