Retail's Next Wave: The Niche

Former Staples CEO and VC expert Tom Stemberg talks about why big chains are facing increasing competition from well-funded concept retailers

The Thanksgiving turkey has been reduced to bones, and the holiday shopping season is underway. The retail industry as a whole is projected to post a holiday-season sales increase of 5%, to $457 billion, over last year, according to the National Retail Federation.

While retail managers and salespeople scramble to get merchandise onto shelves and lure shoppers, Tom Stemberg, partner at venture-capital firm Highland Capital Partners in Lexington, Mass., and founder and former CEO of office-supply chain Staples, is looking to 2007 and beyond to identify the next wave in retailing—a sector that is attracting more than its share of attention from venture-capital and private-equity firms.

He recently spoke with Business Week correspondent Louise Lee. Edited excerpts of their conversation follow.

What do you see happening in the private-equity world with regard to the retail business?

The tremendous amount of private equity around large-scale retail companies has been a trend that I suspect will continue. There's a huge amount of capital pursuing companies. We have a lot of large funds out there such as Blackhawk, Apollo, Cerberus. A lot of companies have gone private in the last year, including Burlington Coat Factory, Michael's Arts & Crafts, Linens & Things, and Petco. The private environment is a healthier one in which to right yourself without quarterly scrutiny.

What retailers in particular do you think may go private next year?

I'm loath to speculate on names. But there are a number that analysts have on their lists that will draw attention. They will all be fair game.

What makes the strong retailers stand out today?

They're perpetually focused on the customer. Staples (SPLS) is going beyond price and focusing on making it easier for the customer to shop. Best Buy (BBY), with its Geek Squad, is very focused on enhancing the customer's ability to use its products. That'll be successful. PetSmart (PETM) is focused on pet owners, not just the products. The pet-hotel concept, for instance, will be a winning concept.

What kind of retailer is most likely to be launched today?

Overall, the interest and activity is on smaller niche players. As far as new category-killers go, most categories have already been killed. There's more interest in concepts that go after particular niches. LuluLemon Athletica goes after the women's exercise market. Zumiez sells surfing and [snow-] boarding products. Another that just had its initial public offering is Bare Escentuals (BARE), which sells natural cosmetics. And we've invested in Blue Tulip, a retailer that has gifts targeted for certain occasions. It's for the time-stressed consumer who has a specialized need.

Why should new retailers focus on a particular niche?

Big categories have been killed. But more importantly, society is increasingly fragmented, so there's more activity serving those segments. Retailers are responding to the segmenting of society.

Why are we seeing more new retail concepts sprouting up now?

There wasn't a lot of capital deployed in retail startups in the last 10 years. Many people assumed that shopping would all be done over the Net. But people still want to touch and feel things.

Where does that leave the big general-merchandise discounters? Does their mere size help them? Wal-Mart, for one, said on Nov. 27 that sales for the month are expected to decline from a year ago.

Size does not appear to be the advantage it once was. When you're big, there's a lot of people who shoot at you, from unions to communities that don't want you. The value of size has diminished over time.

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