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The Age of Experience Based Retail
By Adam Ruggiero
Associate Director, Research & Valuations
MetLife Real Estate Investors
MetLife associates have brought a broad and deep range of insights to recent NAREIM discussions.  The following analysis of the interaction between Millennials and retail is just one excellent example.
The central role that Millennials will play in our culture and economy during the next half century has made them a frequent topic of commentary and analysis.  The fortunes of commercial real estate and the retail sector in particular have already been heavily influenced by their preferences and characteristics.  The Millennial Generation’s preference for experiences, their rising spending power, and an age driven shift in spending by Baby Boomers, are all set to play a major role in determining which retail formats outperform in the future.  We believe that malls and lifestyle centers, home to retailers offering unique products and high levels of customer service, are best positioned to capitalize on the shift towards experience-based spending.
Key to understanding the impact Millennials will have on the retail sector is a clear understanding of who they are.  Born roughly between 1983 and 2001, the nation’s 83 million Millennials form the largest generation in U.S. history, substantially outnumbering Baby Boomers and Gen Xers at 75 million and 74 million, respectively (Figure 1).[i]  The oldest Millennials have just entered their thirties and the generation’s largest contingent is only now entering the workforce.  Of those Millennials over the age of 25, approximately 35% have attained a bachelor’s degree or higher, putting them on track to be the most educated generation in history.[ii]
The Millennial Generation’s high level of education does not come without a price, one of several factors weighing on their finances.  The average student loan burden at graduation has reached $35,000, with some graduates owing significantly more.[iii]  Wage growth for those in the 25-34 age group has also consistently failed to keep pace with the general population throughout the recovery.[iv]  These financial factors have highly influenced Millennial decision making with regard to both housing and consumption.  Equally impactful are Millennials’ attitudes towards marriage.  While varying between regions, ethnic groups, and religious affiliations the average age of first marriage has increased by 2.5 years in the last two decades.[v]  While Millennials are therefore spared the punitive stance that the tax code takes toward marriage, they also fail to enjoy the financial and efficiency benefits of cohabitation.  In terms of both money and time, Millennials therefore find themselves at a disadvantage to generations past.
Experiences vs. Stuff
These burdens might explain a shift in the mode and amount of Millennials’ consumption, more through e-commerce yet less in total, but they do little to explain a shift in the types of good and services they are consuming.  Where past generations were concerned primarily with the acquisition of material goods well into middle age, we believe Millennials are more concerned with the acquisition of experiences and memories and will remain so into the future.  Our analysis of consumer expenditure data from the U.S. Bureau of Labor Statistics supports this conclusion.  The analysis separates consumer expenditures into four distinct categories: essentials, experiences, stuff, and other (Figure 2).
Most relevant to examining the implications of Millennials’ retail spending are those which command the majority of disposable income, the experience and stuff categories. We believe that a marked shift has taken place towards the experience category and away from the stuff category.  Using the 25-34 age groups as a proxy for adult Millennials (30% are actually from Gen X), we calculated a ratio of spending between the two categories.  A ratio of less than 1.00 indicated higher spending on stuff and a ratio above 1.00 indicated higher spending on experiences.
Millennials not only spend a majority of their disposable income on experiences, they do so at a higher rate than generations past did at the same age.  The experience-to-stuff ratio for 2014, only the third year in which Millennials represented the majority of the 20-34 age group, was 1.14 (Figure 3).  In 2007, when Gen X constituted the entirety of the 24-35 age group, this figure was 1.01, and in 1989, when the Baby Boomers last constituted the same, it was 1.00.  By the time the age group becomes entirely Millennial in 2017 we expect this figure to rise even higher and for its impact to continue to grow.
As Millennials grow older, forming households, reducing student loan obligations, and advancing in their careers, we expect their spending levels to increase.  As of 2014 the essentials category accounted for 66% of consumer spending in the 24-35 age group, well above the 64% average paid by Gen Xers when they constituted a majority.  In the near term, we expect that figure to rise marginally higher, but as Millennials form households and realize efficiencies related to food and housing costs we believe it will fall.  With these additional savings Millennials will be able to further reduce their student loan obligations, already lower from years of active employment, and ultimately return the percentage of spending in the essentials category to one closer to that of Gen X.  If even half of this gap is closed, resulting in a 1% shift towards non-essentials spending, it will equal an additional $495 per consumer, a total of $41 billion annually.[vi]  While substantial in its own right, this figure may represent only a portion of the increase in experience based spending during the next decade.
Millennials are not the only generation increasingly spending more on experiences.  Consistently above 1.00 since the late 1990s, the experience-to-stuff ratio for all consumers began to rise swiftly in 2008, and stood at 1.29 at the end of 2014.  We believe this increase was driven by the first large wave of Baby Boomers entering their late 50s, a time when the acquisition of material goods typically declines.  We expect Baby Boomers to continue shifting their spending towards dining, entertainment, and travel and away from the material goods associated with raising children and furnishing large homes.  The Millennial Generation’s preference for experiences, their rising spending power, and the age driven shift in spending by Baby Boomers, are all set to play a major role in determining which retail formats outperform in the future.
Experience-Based Retail Formats
We believe that the formats best positioned to capitalize on the shift towards experience-based retail spending are malls and lifestyle centers.  These formats emphasize a mix of apparel, personal care, and electronics retailers with high levels of customer service and unique product offerings.  Additionally, they offer dining options like bars and restaurants and entertainment options like movie theaters and concert venues.  An analysis of data from the National Council of Real Estate Investment Fiduciaries reveals that the benefits of such a tenant mix are already being felt, with malls and lifestyle centers outperforming other retail formats in five of the last seven years.  Malls and lifestyle centers posted annual income growth 150 basis points higher than non-mall retail throughout this period, and achieved excess total returns of 290 basis points (Figures 4 & 5).[vii]
The attractiveness of malls and lifestyle centers is further compounded by their defensive positioning against e-commerce.  The experienced based nature of the goods and services their tenants offer are extremely difficult to replicate online, and thus their competitive advantages over other brick-and-mortar retailers transfer to online retailers as well.  Dining establishments lack online competition and live entertainment by its very nature cannot be replicated digitally, nor can the ability to meld shopping, dining, and entertainment into a series of cohesive and related experiences.  As important to recognizing these trends and what drives them is the ability to identify retailers able to best occupy the formats they will support.
Judging Retailer Viability
By examining quantitative metrics and qualitative differentiators we have created a set of criteria for selecting retail tenants likely to thrive in the new retail landscape.  Our criteria can be separated into three distinct categories: experience, financial, and distribution (Figure 6).
Experience
A customer’s shopping experience is affected by a myriad of factors, but we would place the greatest emphasis on a retailer’s ability to offer unique products and deliver a high level of customer service.  Apple’s stylish devices are sold by knowledgeable staff able to help customers navigate sometimes complicated electronics, and their numbers ensure that service is rapid.  Sales staff at lululemon athletica offer personalized and attentive service to consumers of the store’s versatile athletic apparel, while the friendly and eccentric staff of Trader Joe’s keep check-out lines flowing and add as much character to the aisles as the grocer’s self branded offerings.  Upscale department stores like Nordstrom’s and Bloomingdales offer free personal shopping services to all consumers, and fellow mall tenant Lush, a seller of organically produced cosmetics, offers private events and makeup consultations.
Financial
When combined with solid financial management a strong customer experience should lead to outperformance.  Retailers with above average sales per square foot, free cash flow growth, and strong credit.  Given the constant pace of change and innovation in retail historically, investors would be wise to focus on those that consistently outperform the sales of their competitors.  An analysis of free cash flows allows us to understand how these strong sales figures translate into operating performance and make assumptions about a retailer’s ability to invest in future growth.[viii]  By examining their credit ratings, credit line availability, and corporate bond pricing we can examine their ability to withstand market shocks and gauge how much time they have to innovate and re position if they lose favor to stronger competition.
Distribution
E-commerce represents the strongest competitor many brick-and-mortar retailers now face, and one of the greatest advantages of e-commerce retailers is the strength of their distribution networks.  Brick-and-mortar retailers are best able to combat this advantage by adopting an omni-channel sales strategy and constructing a highly efficient supply chain.  Retailers effectively connecting brick-and-mortar locations to online marketplaces enjoy significant benefits.  While struggling overall, Macy’s has made great strides in this direction through a well-designed website offering in-store pick up options that often include discounts on additional in-store purchases.  In addition to adopting an omni-channel strategy Macy’s and many other retailers have also invested heavily in improving distribution and inventory management, attempting to gain greater control over their supply chains.
The number of major retailers able to control their supply chain from production to sale is fairly small, but the more control a retailer is able to gain, the more opportunities they possess to improve quality and efficiency.  Retailers with large national footprints like Amazon, Wal-Mart, and Target enjoy some of the largest physical distribution networks, composed of large fulfillment centers, smaller shipping hubs, and a host of third party delivery services.  With Amazon now offering same day, and even same hour delivery in some locations, many retailers are struggling to compete.  Those that have done the best, including Macy’s, Nordstrom’s, and some single brand and specialty stores, have recognized that the value of their locations lies not only in sales per square foot, but storage and shipping capacity per square foot as well.  By doubling as nodes in larger distribution networks brick-and-mortar locations can significantly shorten delivery times, allowing them to better compete with online retailers.
A retail location’s format and tenant mix remain among the most important factors in its success, and we firmly believe in the criteria we have established for selecting both.  The Millennial Generation’s preference for experience-oriented goods and services lends itself naturally to malls and lifestyle centers.  These formats are capable of offering robust dining and entertainment options alongside traditional products like apparel and furnishings.  As Millennials grow older and benefit from rising incomes and potentially lower housing costs the impact of this preference on the retail sector will continue to increase.  Well managed retailers with unique product offerings, high levels of service, and quick delivery times will appeal to the Millennial Generation most, driving superior performance at the best centers.
The Millennial Generation’s high level of education does not come without a price, one of several factors weighing on their finances.  The average student loan burden at graduation has reached $35,000, with some graduates owing significantly more.[iii]  Wage growth for those in the 25-34 age group has also consistently failed to keep pace with the general population throughout the recovery.[iv]  These financial factors have highly influenced Millennial decision making with regard to both housing and consumption.  Equally impactful are Millennials’ attitudes towards marriage.  While varying between regions, ethnic groups, and religious affiliations the average age of first marriage has increased by 2.5 years in the last two decades.[v]  While Millennials are therefore spared the punitive stance that the tax code takes toward marriage, they also fail to enjoy the financial and efficiency benefits of cohabitation.  In terms of both money and time, Millennials therefore find themselves at a disadvantage to generations past.
Experiences vs. Stuff
These burdens might explain a shift in the mode and amount of Millennials’ consumption, more through e-commerce yet less in total, but they do little to explain a shift in the types of good and services they are consuming.  Where past generations were concerned primarily with the acquisition of material goods well into middle age, we believe Millennials are more concerned with the acquisition of experiences and memories and will remain so into the future.  Our analysis of consumer expenditure data from the U.S. Bureau of Labor Statistics supports this conclusion.  The analysis separates consumer expenditures into four distinct categories: essentials, experiences, stuff, and other (Figure 2).
Most relevant to examining the implications of Millennials’ retail spending are those which command the majority of disposable income, the experience and stuff categories. We believe that a marked shift has taken place towards the experience category and away from the stuff category.  Using the 25-34 age groups as a proxy for adult Millennials (30% are actually from Gen X), we calculated a ratio of spending between the two categories.  A ratio of less than 1.00 indicated higher spending on stuff and a ratio above 1.00 indicated higher spending on experiences.
Millennials not only spend a majority of their disposable income on experiences, they do so at a higher rate than generations past did at the same age.  The experience-to-stuff ratio for 2014, only the third year in which Millennials represented the majority of the 20-34 age group, was 1.14 (Figure 3).  In 2007, when Gen X constituted the entirety of the 24-35 age group, this figure was 1.01, and in 1989, when the Baby Boomers last constituted the same, it was 1.00.  By the time the age group becomes entirely Millennial in 2017 we expect this figure to rise even higher and for its impact to continue to grow.
As Millennials grow older, forming households, reducing student loan obligations, and advancing in their careers, we expect their spending levels to increase.  As of 2014 the essentials category accounted for 66% of consumer spending in the 24-35 age group, well above the 64% average paid by Gen Xers when they constituted a majority.  In the near term, we expect that figure to rise marginally higher, but as Millennials form households and realize efficiencies related to food and housing costs we believe it will fall.  With these additional savings Millennials will be able to further reduce their student loan obligations, already lower from years of active employment, and ultimately return the percentage of spending in the essentials category to one closer to that of Gen X.  If even half of this gap is closed, resulting in a 1% shift towards non-essentials spending, it will equal an additional $495 per consumer, a total of $41 billion annually.[vi]  While substantial in its own right, this figure may represent only a portion of the increase in experience based spending during the next decade.
Millennials are not the only generation increasingly spending more on experiences.  Consistently above 1.00 since the late 1990s, the experience-to-stuff ratio for all consumers began to rise swiftly in 2008, and stood at 1.29 at the end of 2014.  We believe this increase was driven by the first large wave of Baby Boomers entering their late 50s, a time when the acquisition of material goods typically declines.  We expect Baby Boomers to continue shifting their spending towards dining, entertainment, and travel and away from the material goods associated with raising children and furnishing large homes.  The Millennial Generation’s preference for experiences, their rising spending power, and the age driven shift in spending by Baby Boomers, are all set to play a major role in determining which retail formats outperform in the future.
Experience-Based Retail Formats
We believe that the formats best positioned to capitalize on the shift towards experience-based retail spending are malls and lifestyle centers.  These formats emphasize a mix of apparel, personal care, and electronics retailers with high levels of customer service and unique product offerings.  Additionally, they offer dining options like bars and restaurants and entertainment options like movie theaters and concert venues.  An analysis of data from the National Council of Real Estate Investment Fiduciaries reveals that the benefits of such a tenant mix are already being felt, with malls and lifestyle centers outperforming other retail formats in five of the last seven years.  Malls and lifestyle centers posted annual income growth 150 basis points higher than non-mall retail throughout this period, and achieved excess total returns of 290 basis points (Figures 4 & 5).[vii]
The attractiveness of malls and lifestyle centers is further compounded by their defensive positioning against e-commerce.  The experienced based nature of the goods and services their tenants offer are extremely difficult to replicate online, and thus their competitive advantages over other brick-and-mortar retailers transfer to online retailers as well.  Dining establishments lack online competition and live entertainment by its very nature cannot be replicated digitally, nor can the ability to meld shopping, dining, and entertainment into a series of cohesive and related experiences.  As important to recognizing these trends and what drives them is the ability to identify retailers able to best occupy the formats they will support.
Judging Retailer Viability
By examining quantitative metrics and qualitative differentiators we have created a set of criteria for selecting retail tenants likely to thrive in the new retail landscape.  Our criteria can be separated into three distinct categories: experience, financial, and distribution (Figure 6).
Experience
A customer’s shopping experience is affected by a myriad of factors, but we would place the greatest emphasis on a retailer’s ability to offer unique products and deliver a high level of customer service.  Apple’s stylish devices are sold by knowledgeable staff able to help customers navigate sometimes complicated electronics, and their numbers ensure that service is rapid.  Sales staff at lululemon athletica offer personalized and attentive service to consumers of the store’s versatile athletic apparel, while the friendly and eccentric staff of Trader Joe’s keep check-out lines flowing and add as much character to the aisles as the grocer’s self branded offerings.  Upscale department stores like Nordstrom’s and Bloomingdales offer free personal shopping services to all consumers, and fellow mall tenant Lush, a seller of organically produced cosmetics, offers private events and makeup consultations.
Financial
When combined with solid financial management a strong customer experience should lead to outperformance.  Retailers with above average sales per square foot, free cash flow growth, and strong credit.  Given the constant pace of change and innovation in retail historically, investors would be wise to focus on those that consistently outperform the sales of their competitors.  An analysis of free cash flows allows us to understand how these strong sales figures translate into operating performance and make assumptions about a retailer’s ability to invest in future growth.[viii]  By examining their credit ratings, credit line availability, and corporate bond pricing we can examine their ability to withstand market shocks and gauge how much time they have to innovate and re position if they lose favor to stronger competition.
Distribution
E-commerce represents the strongest competitor many brick-and-mortar retailers now face, and one of the greatest advantages of e-commerce retailers is the strength of their distribution networks.  Brick-and-mortar retailers are best able to combat this advantage by adopting an omni-channel sales strategy and constructing a highly efficient supply chain.  Retailers effectively connecting brick-and-mortar locations to online marketplaces enjoy significant benefits.  While struggling overall, Macy’s has made great strides in this direction through a well-designed website offering in-store pick up options that often include discounts on additional in-store purchases.  In addition to adopting an omni-channel strategy Macy’s and many other retailers have also invested heavily in improving distribution and inventory management, attempting to gain greater control over their supply chains.
The number of major retailers able to control their supply chain from production to sale is fairly small, but the more control a retailer is able to gain, the more opportunities they possess to improve quality and efficiency.  Retailers with large national footprints like Amazon, Wal-Mart, and Target enjoy some of the largest physical distribution networks, composed of large fulfillment centers, smaller shipping hubs, and a host of third party delivery services.  With Amazon now offering same day, and even same hour delivery in some locations, many retailers are struggling to compete.  Those that have done the best, including Macy’s, Nordstrom’s, and some single brand and specialty stores, have recognized that the value of their locations lies not only in sales per square foot, but storage and shipping capacity per square foot as well.  By doubling as nodes in larger distribution networks brick-and-mortar locations can significantly shorten delivery times, allowing them to better compete with online retailers.
A retail location’s format and tenant mix remain among the most important factors in its success, and we firmly believe in the criteria we have established for selecting both.  The Millennial Generation’s preference for experience-oriented goods and services lends itself naturally to malls and lifestyle centers.  These formats are capable of offering robust dining and entertainment options alongside traditional products like apparel and furnishings.  As Millennials grow older and benefit from rising incomes and potentially lower housing costs the impact of this preference on the retail sector will continue to increase.  Well managed retailers with unique product offerings, high levels of service, and quick delivery times will appeal to the Millennial Generation most, driving superior performance at the best centers.
[i] MetLife Investment Management estimates based on data from the U.S. Census Bureau.
[ii] Ibid.
[iii] The Wall Street Journal, May 2015.
[iv] Bureau of Labor Statistics.
[v] U.S. Census Bureau.
[vi] MetLife Investment Management estimates in 2014 dollars, based on the size of the Millennial Generation.
[vii] National Council of Real Estate Investment Fiduciaries.
[viii] Free cash flow when defined as cash flow from operations minus maintenance related capital expenditures.
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