How Much is a Facelift Worth?

The struggling economy might be slowing some retailers’ plans for geographic expansion, but it hasn’t quashed their efforts to keep up with the Joneses.

If anything, store remodels are more popular than ever as retailers strive to get the most bang for their capital improvement buck and outshine competitors. Renovations come in all shapes and sizes, which is causing some retailers to re-evaluate how extensive their remodeling plans should be.

At Publix Supermarkets, which renovated 124 stores last year and expects to redo at least as many this year, some relatively minor changes have received the most shopper attention, says Maria Brous, director of media and community relations for Publix, which is based in Lakeland, Fla.

“It’s the little improvements that sometimes customers notice the most,” Brous says. “For example, they appreciate the LED lighting in coolers that turns on only when customers enter the aisle. That’s a sustainable [element], and customers are starting to pick up on those things.”

With margins under pressure, many retailers are opting to renovate existing locations to rekindle interest without the full cost of new construction. And they all want to know, how can we maximize return?

“A remodel usually brings in a 5 percent to 10 percent increase in sales,” says David J. Livingston, a supermarket consultant and principal of DJL Consultants in Waukesha, Wis. “But I’ve seen stores remodel and get no increase in sales. Then perhaps the issue wasn’t with the facility, but rather with the operations or the concept. So remodels don’t always work.”

Before retailers dive into a remodel, consider the following questions: Why remodel? Which elements of a remodel are likely to pay off and which options aren’t likely to produce a financial return? What are the tax implications of remodeling?
Why Remodel?

Stores remodel for countless reasons, but most boil down to competition. When a competitor has a fresher concept, introduces an expanded deli or enters a market for the first time, existing stores often decide a renovation is a competitive necessity. If the existing store is aging, the retailer’s desire to renovate in the face of new competition is even stronger.

“Ninety-nine times out of 100 the impetus to remodel is going to be competition,” says Andrew Swedenborg, executive vice president for business development at King Retail Solutions, a consultancy in Eugene, Ore., that guided Robért Fresh Markets on its rebranding and remodeling. “A good remodel is great marketing for a store in and of itself. It causes excitement in a community, gets a grocery store noticed and elevates the store above its local competition in the eyes of the customers.”

While competitive pressure often drives a renovation, a corporate directive also can spur it. Walgreen Co.’s Duane Reade, a New York-based pharmacy chain that also sells groceries, is remodeling all of its 254 stores as part of the company’s rebranding effort. “We are repositioning our entire brand identity in a comprehensive manner across the board,” says Scott McCulloch, senior director of merchandising. “The entire chain has taken on a new identity and every store will be remodeled by early 2014.”

Remodeling a location usually costs less than building one from the ground up, yet in some circumstances a new store might be the better long-term investment, experts say. “If a store is doing excessive sales per square foot, and they’re getting a bottleneck at the front end, they may need to move to a larger location or expand,” Livingston says.

On average, grocery retailers generate $10 in weekly sales per square foot of space, Livingston says. If a store is generating $5 to $6 per square foot per week, the retailer needs to renovate or close the location. If the store is generating $20 per square foot per week, the retailer should consider expanding or building a larger store, he says.

Competition wasn’t the main factor spurring Marc Robért to renovate Robért Fresh Markets in New Orleans in 2005: Hurricane Katrina forced his hand by destroying all five of his locations. The gut renovations have generated positive returns for stores in neighborhoods that have recovered from the storm, Robért says. The last three projects Robért Fresh Markets launched—two renovations and one new store—cost $6 million each. Robért says he is comfortable with the return on investments for all three, though he declines to be specific.

How is ROI Measured?

When weighing a renovation, determine how the return on investment will be measured. Accurate measurements allow the store to focus subsequent remodels on those areas that pay off the most.

A typical ROI calculation is a ratio of increased sales to the amount of investment. For example, if a renovation cost $1 million, and the store earned $200,000 more in the year following the renovation, the ROI is 20 percent. That’s a highly simplistic view of ROI, however, and ignores the impact on sales of variables other than the renovation, such as competition, weather and population patterns.

A more accurate measurement compares a remodeled store’s performance to that of similar “control” stores that were not remodeled, says Anthony Bruce, chief executive officer at Applied Predictive Technologies (APT), a Washington D.C.-based firm that helps businesses measure the impact of capital investments, such as store remodels, with software called Test & Learn. “Consider a remodel program where the retailer repaints some stores, expands some stores and adds new checkout lanes to others,” Bruce says. “Test & Learn can distill the winning combination of remodel elements and recommend actions for every other store in the chain.”

Not every grocery retailer uses such a sophisticated system, of course, but more are considering the impact of not renovating when making their decisions. “We often advise clients to consider what they stand to lose if they don’t remodel rather than [focus] on a specific desired ROI,” Swedenborg says.

Which Elements Pay Off?

Researching customer needs in advance of a remodel can pay off. “We did a lot of research,” Robért says. “We conducted focus groups to learn what was important to our customers.”

For example, the company’s research suggested customers like to socialize in stores. “There’s a Mayberry aspect of the community. People want to meet their friends and chat at the store,” Robért says. So when the company built a new Lakeview, La., store, it included a comfortable sit-down area for shoppers to eat prepared foods. It also added sushi, prime beef and other value-added items prepared by in-store chefs after the research indicated many customers have young families and want more convenient prepared foods.

Many stores have boosted profits by adding prepared food departments. The deli area can be a draw for customers if it is stocked well with lunch trays, breakfast items and other to-go items, says Dan Phillips, a project manager for Phillips Enterprises Inc., a retail renovation consultancy in Bellevue, Wash.

What Renovations Don’t Pay Off?

Phillips advises against adding store features that inefficiently tie up staff. “For example, one large store in our area installed a roasted nut service pod in the middle of the store. Now that pod needs to be manned continuously. Even if it’s slow, that person can’t leave to stock shelves or something.”

The floral department might make the store smell good, but it often doesn’t generate much cash relative to the space it occupies. “It’s never a moneymaker,” Phillips says.

Renovations will not fix underlying problems, Livingston advises. For example, a chain invested in new decor and other cosmetic improvements, but it didn’t change its prices or improve low employee morale. “There’s a saying, ‘You can’t put lipstick on a pig.’ Well, remodel dollars are wasted if you don’t take care of the underlying problems,” Livingston says.

How Long Does it Last?

Competitors can determine a renovation’s lifespan. In areas with little competition, a renovation will remain fresh for much longer than in areas where competitors are frequently updating their looks. Metropolitan Market in downtown Seattle tends to remodel every three years, Phillips says. “Stores out from the city will do a minor remodel every five years and a full remodel every 10 years,” he says.

The quality of the renovation helps determine its lifespan, too. “A good design can last 10 years or more; a trendy design will last 10 minutes,” Swedenborg quips. “On average, though, a store’s design remains fresh for about five to seven years following a remodel.”

Tax Implications

Retailers considering renovations should pay close attention to new Internal Revenue Service (IRS) regulations affecting the way renovation costs are treated, says Rob Levin, managing director in the Corporate Strategic Federal Tax Services Group of Grant Thornton LLP in Atlanta. “The new rules help taxpayers determine if their renovation costs should be deducted as an expense or capitalized,” Levin says. “The old regulations were ambiguous, and the taxpayer could make a subjective judgment about that.”

The new regulations stipulate that taxpayers consider their property in parts rather than as a whole. For example, under the old regulations, if a grocery store replaced one of three HVAC systems, it could probably deduct that expense in a single year with the understanding that the new HVAC did not materially affect the life of the building as a whole. Under the new regulations, the retailer would have to capitalize the purchase instead because the new HVAC would materially affect the life of the HVAC system.

If a renovation expense is deemed deductible, the retailer can take the full tax benefit of that work in the year it occurred. If it needs to be capitalized, the tax benefit will be spread out over the estimated life of the improvement. Another change allows companies to immediately deduct the remaining unamortized value of a component being replaced. For example, if a retailer is replacing a roof and the existing roof is not fully amortized, the remaining amortization can be taken as soon as the new roof is installed.

While the new tax regulations might change the return on investment in a given year, it is just one of many factors retailers should weigh as they consider renovating. The bottom line for most retailers is this: If enough customers spend enough new money in the renovated store, the renovation will be deemed successful.

Ed Avis is a freelance writer and editor in Chicago. He has written for Crain’s Chicago Business, the Chicago Tribune, Specialty Coffee Retailer, Tea Magazine, and many other consumer and trade publications.
 


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