Wednesday, November 22, 2017

Drone Alone: The Changing Face of Retail in Puerto Rico

By on April 14, 2016

In one of the biggest shopping centers in Puerto Rico, at a side hallway that serves as one of the mall’s main entryways, all the retail spaces, except for a bank’s, are closed. At various other points of the mall, one sees even more stores shuttered. A visual inspection through the mall revealed 39 vacant spaces out of about 300. Not too far away in San Juan’s Río Piedras district, an urban center with a once-thriving commercial segment nowadays looks more like a ghost town.

In both instances, as in many others, the store facades only feature white panels or brown paper stuck to glass fronts, with no advertisements boasting of upcoming shops or restaurants slated to take their place. Instead, they stare out blankly at passers-by, serving as reminders of not only Puerto Rico’s dismal economic climate, but also of seismic changes taking place in the retail industry worldwide.

Mall of San Juan

Mall of San Juan

When it comes to Puerto Rico, the decade-long recession—which economists say kicked off in May 2006 with a two-week government shutdown brought on by a budget impasse, and coincided with the phase-out of Section 936 tax incentives—has affected the retail segment to a lesser degree than other economic segments such as construction and real estate, which have seen their business slashed by about half.

Economic figures from the Puerto Rico Trade & Export Co. (CCE by its Spanish acronym), specifically its monthly Retail Sales Report, also known as Infoventas, tell the story of a mostly flat rate of growth for the retail segment. In 2005, retail sales on the island totaled $35.38 billion; with the onset of the recession, that total went down to $34.81 billion for 2006. The following years saw slight deviations in year-end figures that did not go beyond $35.4 billion in sales until 2011. Since 2012, the situation has improved gradually, with annual totals reaching $38.39 billion in 2014.

A look at several retail subsegments reveal patterns of consumer behavior on the island, with average buyers trying to stretch their dollar as much as possible and focusing on necessity goods such as groceries and clothing. Accordingly, the aforementioned areas experienced sales growth on par or higher than the industrywide average. Meanwhile, other subsegments such as electronics, toys and, perhaps unsurprisingly, construction materials, fared far worse, according to the CCE reports.

Another, more recent look at consumer behavior—this time through a May 2015 report by the Puerto Rico Chamber of Food Marketing, Industry & Distribution (MIDA by its Spanish acronym) dubbed Consumer X-Ray—shows that Puerto Rican consumers have reduced monthly grocery expenditures by 14%, to $425 from $492. In another telling finding, the report also found that 38% of respondents have reduced their entertainment outside the home and 47% have cut back on eating out.

Burden on the industry

In all, the retail sector has been able to more or less withstand the economic storm better than most, but this may soon change, as a myriad of factors, among them a steep population decline coupled with an aging population, and a slew of new taxes, are placing a heavy burden on stores and restaurants throughout the island.

In mid-February, the CCE revealed that retail sales reported by local commercial establishments dropped 1.42% year-over-year in 2015. In monetary terms, sales went down by $544.7 million to settle at $37.8 billion. CEE Executive Director Francisco Chévere mostly attributed the drop to the exodus of Puerto Rico residents from the island. “Some 65,000 Puerto Ricans migrated in 2015, an 18.1% increase from the 55,092 who left in 2014,” he said.

Such numbers may be a conservative assessment, compared with other figures. According to a Pew Research Center analysis of U.S. Census Bureau data, 84,000 people left Puerto Rico for the U.S. mainland last year, a 38% increase from 2010, “The island’s population was an estimated 3.47 million in 2015, down 334,000 from 2000—a 9% decline,” the report stated.

plaza las americas

South wing of Plaza Las Américas shopping center, in San Juan’s Hato Rey district

With regard to 2015 retail sales, Adolfo González, president & CEO of Caparra Center Associates (CCA)—which owns and operates San Patricio Plaza and Galería San Patricio shopping centers in Guaynabo, among other retail establishments—gave a more in-depth picture of sales last year, at least concerning the properties that CCA oversees. Along the way, he revealed the growing role that increased government taxation has had on retailers’ bottom line.

“The first half of 2015 was good, with figures showing improvement over the previous year,” González noted. However, on July 1, a hammer blow struck the sector in the form of a hike in the sales & use (IVU by its Spanish acronym) tax to 11.5% from 7%. “We noticed the effects immediately and sales were hit hard,” the CCA exec noted. “The rest of the year was essentially a recovery period, and we ended the year with slightly lower total sales.”

The holiday shopping season, long considered a saving grace for embattled retailers, underwhelmed in 2015, said Arnaldo Oliveras, founder & president of Space Mart Retail & Real Estate Solutions, a shopping-center service provider. According to a survey by the International Council of Shopping Centers, a global shopping center trade association, sales in Puerto Rico during the most recent holiday season went down by around 9%, with the restaurant segment experiencing a slightly smaller decrease.

“Retailers expected just a moderate drop from the previous year, despite the economic situation, but such a drop took plenty by surprise,” Oliveras said.

Closing time

Moreover, a bevy of national retail chains and local stores have closed their Puerto Rico establishments in the past year-and-a-half, resulting in hundreds of jobs being lost. While in the case of national chains, the moves have been partly prompted by changing dynamics in the sector worldwide, a recurring theme among practically all closings has been Puerto Rico’s dismal state of affairs, economy-wise.

Among the most noteworthy in recent months has been that of videogame and electronics retailer GameStop. The chain, which boasts more than 6,400 stores throughout the U.S., Canada, Australia, New Zealand and Europe, closed its 40-plus Puerto Rico stores in March. When the company announced its exit last January, its director of public relations, Joy Mooring, said it was due to “increasing business challenges and growing government restrictions in Puerto Rico.” About 400 employees lost their jobs as a result.

“Puerto Rico is one of the highest selling regions for GameStop,” a manager of a GameStop store in San Juan’s Hato Rey district told online publication Paste Magazine on condition of anonymity. “The new taxes that the government put in place to manage the financial crisis have practically tripled what it costs to bring in new merchandise.”

Plaza_del_Caribe_entrance

Main entrance to Plaza del Caribe Mall, in Ponce

As a result, a person close to the matter told Caribbean Business that the chain was barely breaking even on the island. “There are no national merchants willing to tolerate such a dynamic, especially since in GameStop’s case, they usually had two or even three locations in the same shopping mall,” said the source.

Oddly enough, Puerto Rico Treasury Secretary Juan Zaragoza said shortly after the GameStop announcement that the chain boasted about $500 million in sales throughout its past seven years of operations on the island, a rate of around $90 million annually. Videogame industry observers also pointed out at the time that the model for distributing and selling games has changed radically in recent years due to the onset of downloadable content, for one thing, which has exerted pressure on GameStop’s business model worldwide.

In the realm of local chains, Chiquitín stands out. The kids’ shoe store chain closed its remaining stores in Puerto Rico, one in Plaza Las Américas shopping center and another in Las Catalinas Mall, in Caguas, last January, after 40 years of operation.

When it comes to local retail operations, most that have closed recently have been restaurants. These include several Pizzeria UNO, Quiznos and Fuddruckers locales throughout the island; Old Harbor Brewery in Old San Juan; Greenhouse in San Juan’s Condado district; and Pan Comido and Star Cream, both in Guaynabo.

Another high-profile closing in Puerto Rico has been that of Sports Authority. The sporting goods chain, based in Englewood, Colo., entered the Puerto Rico market a little more than two years ago, opening its first store in Ponce in October 2013 and going on to open two more stores in Carolina and in Plaza Las Américas shopping center in San Juan’s Hato Rey district. In the latter case, Empresas Fonalledas, owners and operators of Plaza, invested several million dollars in expanding the mall to accommodate the 45,000-square-foot Sports Authority outlet, as well as more parking spaces.

Then last March, the company announced it intended to close or sell around 140 of its 463 nationwide locations, including all of its Puerto Rico stores. The decision was made in light of the increasing amount of shopping that is occurring online, Michael E. Foss, CEO of Sports Authority, indicated. “As a result of the changes in consumer buying patterns, Sports Authority determined it needs fewer stores as part of its long-term business model,” he added.

However, according to a local industry player who asked that his name be withheld, it is no coincidence that the chain chose to completely phase-out its presence on the island. “[The company’s upper management] took advantage of the situation,” the source said. “They weren’t generating enough business here and realized the island’s situation was not going to improve in the near future.”

When it comes to the travails the sector is going through, perhaps no chain has been more in the limelight than retail giant Wal-Mart, which operates 48 stores on the island, including Walmart Supercenters, Walmart Discount Stores, Supermercados Amigo, Sam’s Clubs and, until earlier this year, Super Ahorros. As part of a plan to shut down 269 stores worldwide, the company shuttered seven of its Puerto Rico stores in January: three Súper Ahorros supermarkets in Coamo, Villalba and Utuado; and four Amigo supermarkets in Salinas, Río Grande, Carolina and Toa Alta.

The retail chain then found itself engaged in outright war with the local government, specifically after Act 72 was signed last May. The controversial law established an increase in the transfer pricing tax, namely the rate at which corporate property arriving from out of Puerto Rico is taxed, from 2% to 6.5% on entities doing more than $2.75 billion in business on the island. Wal-Mart rapidly took issue with the move, alleging the new tax rate would amount to more than 91% of its net income in Puerto Rico.

The company sued the government in December over Act 72, and a public war of words followed, with Iván Báez, corporate affairs director at Wal-Mart, even saying the company would leave the island if the tax hike were to take effect. Wal-Mart Puerto Rico is the largest private employer on the island, employing some 14,300 residents. During the trial, it was revealed that Act 72 specifically targeted Wal-Mart, as confirmed by Treasury’s Zaragoza during court testimony. U.S. District Court Judge José A. Fusté ultimately ruled in favor of Wal-Mart in late March, deeming that Act 72 violated the U.S. Constitution.

Ongoing challenges

Government taxes have frequently been mentioned as one of the main factors placing a strain on local retail, alongside electricity costs. While the IVU hike to 11.5% last year proved nefarious for countless establishments, the imposition of a 4% business-to-business (B2B) tax has been just as tough.

No wonder, then, that hackles were raised when the government announced it would carry out another tax reform, this time by changing the IVU tax model to a value-added tax system (VAT, or IVA by its Spanish acronym) designed to provide transparency across the board, achieve higher tax compliance, and secure additional revenue to government coffers. Moreover, the change would have also implemented a 10.5% B2B tax. Originally slated to begin April 1, the VAT implementation was postponed for June 1, with a second phase scheduled Aug. 1.

“This just bought two to three months’ time to many retailers,” Oliveras said. “The thing is, this affects small retailers more than anyone else. A lot of them have had to make adjustments to cope with sales and profit losses, as well as increases in operational expenditures. Many have had to change their modus operandi, from reducing their workforce to changing suppliers. Whoever has not adapted by this point will most likely not survive.”

Some local chains have even begun looking beyond the island, a dynamic that prompted Space Mart to open new offices in Brickell, Fla. “It is simply not profitable having a national retail operation on the island, at least not for now,” Oliveras noted. “Look at what happened to Wal-Mart; to draft a law specifically targeting one company, a lot of the retail segment paid close attention to that development, and many are scared to invest further until they see some changes.”

As to the ways in which retail hubs such as shopping centers have been able to adjust, many have had to be creative in terms of giving more leeway to tenants and preventing high vacancies. These are not limited to providing lower rental rates, but extend to lower profit shares and even providing a sort of “test period” for small stores hesitant to try out the waters, various industry players said.

Plaza Carolina

Plaza Carolina

On the other hand, not everything is dire news in the sector. For example, luxury shopping options such as Taubman Centers’ Mall of San Juan and the upcoming retail offerings at Paseo Caribe, in San Juan’s Puerta de Tierra community, show signs of a burgeoning and potentially very profitable subsegment. Moreover, a handful of high-profile stores are scheduled to make their debut on the island soon, chief among them Swedish retail giant H&M. The multinational clothing chain is slated to open a store in the Mall of San Juan and another in Plaza del Sol in Bayamón later this year.

Yet despite the few shining lights on the horizon, the overall feeling industrywide could best be described as uncertain. “Nobody knows what will happen, and stores cannot make projections because the rules are changing from month to month, so to speak,” said Miguel González, vice president of operations at CCA. “Attracting investment from national retailers has become extremely complicated because most see the central government’s fiscal situation as a mirror of the island’s whole economy,” added CCA’s Adolfo González. “Granted, the economy’s weak, but it’s not as bad as the government crisis. The challenge is how to sell Puerto Rico better.”

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