By Phil Wahba and Dhanya Skariachan
MARTINSBURG, West Virginia (Reuters) - The brave new world for U.S. retailers can be found in small cities like Martinsburg, West Virginia.
That's where department store chain Macy's Inc recently opened a facility the size of 43 football fields - big enough to stock 1 million pairs of shoes - just to fulfill orders made online.
The $150 million building, its third one dedicated primarily to supporting macys.com, has already been handling 60,000 orders on a busy day this holiday season. Macy's expects that figure to triple in two years.
"The customer is increasingly voting that she wants to shop both ways," said RB Harrison, Macy's executive vice president in charge of integrating e-commerce and store operations.
From Macy's to Home Depot Inc and Best Buy Co Inc, retail executives are racing to speed up order delivery and improve inventory management, which if done well, can help profit margins.
Many chains are also hiring staff, or even buying firms in Silicon Valley, to get the edge in technology.
"Today, tomorrow and going forward, you are comparing the experience in our store to the experience of sitting in your living room, in the comfort of your home, ordering something on your laptop, your smart phone or your iPad," Home Depot Chief Executive Frank Blake told Reuters.
"Your willingness to put up with rude associates, dirty stores and out of stocks is just going to go down and down and down. Our bar on performance in our stores is going to go up and up and up," he said.
To be sure, online sales to date account for just 7 percent of retail sales, according to Forrester Research. But the firm expects online sales growth to rise 45 percent to $327 billion and account for 9 percent of overall sales by 2016.
Retailers are realizing they must respond to that kind of growth.
"When I was meeting with brick-and-mortar retailers 24 months ago they weren't thinking about online," said Carlo Bronzini Vender, a senior partner at New York-based investment bank Sonenshine Partners who helped advise Drugstore.com when it was bought by Walgreen Co in 2011. "Now people are being more proactive about it."
Even if some retailers like Macy's are less exposed to the threat from e-commerce's 800-pound gorilla Amazon.com Inc than a company like electronics chain Best Buy Inc, they are all under enormous pressure to offer faster delivery times, better service and an array of products.
Already armed with 40 e-commerce fulfillment facilities, Amazon is set to open another 7 centers next year.
And by next year, Amazon could offer cost-efficient same-day shipping to every customer in the 10 largest U.S. cities, according to RBC Capital Markets.
This year, Saks Inc, Dillard's Inc and Kohl's Corp are among retailers that opened the biggest online fulfillment centers they have ever had.
And those without much of an online presence are moving quickly to get one. For example, T.J. Maxx parent TJX Cos Inc, which sells designer clothing and home goods at discounted prices, said on Friday it bought off-price Internet retailer Sierra Trading Post for about $200 million.
Most national retailers have largely stopped opening new stores as same-store sales growth has slowed compared to online.
But the stores can be a major weapon for companies like Macy's and Home Depot as they fight Amazon.
Since this summer, 292 of Macy's 800 stores have been doing double-duty as mini-fulfillment centers that assemble, pack and ship online orders, up from 23 stores a year ago. It plans to add this function to 200 more stores next year.
Nordstrom Inc has been doing this for years, giving it a big lead over other department stores.
At Macy's, already 10 percent of orders placed online have been dispatched through stores this holiday season.
"It's a natural extension for us because of our ability to leverage the 800 stores' inventory," said Harrison of Macy's. He noted that the cost for equipping a store for e-commerce is relatively small, requiring a small space in the docking area for tables, scales, and room to pack boxes.
Saks is testing "ship-from-store" and expects to roll it out next fall. Wal-Mart Stores Inc and Kohl's are also testing it.
"Fulfilling online orders from the store is the most important thing that will change physical retailers over the next five years," said Matt Nemer, an e-commerce analyst at Wells Fargo.
The strategy is aimed squarely at boosting profit margins.
Saks CEO Stephen Sadove envisions a scenario in which a pair of shoes sitting unsold at his Saks Fifth Avenue flagship could be used to fill an online order and sold at full price, instead of ending up being sold at a discount, hurting profit.
Macy's computers have complex algorithms that scour companywide inventory, factor in distance and shipping costs to come up with an optimal way to assemble and ship an order.
Despite higher shipping costs, Macy's shipments are often split between locations if a computer determines that the benefit to margins from selling an item that a store doesn't need or has too much of outweighs the extra expenses.
Stores are also serving as pick-up spots for online orders, and many retailers are finding this a boon. Wal-Mart says customers spend about $60 in a store when they pick up items ordered online.
In November, Best Buy decided to assign additional employees to deal with in-store pick-ups since 40 percent of bestbuy.com orders are now picked up.
DANGER OF MISSTEPS
Even Amazon sees the benefits of a physical presence. Staples Inc said last month it will install "Amazon Lockers" at its stores, allowing customers to have packages sent to Staples stores to avoid delivery hassles.
The biggest reason many retailers are only now offering 'ship-from store' and in-store pick-up is that the traditionally managed store and e-commerce inventory had been handled separately.
That is changing rapidly. Saks is spending about $40 million this year to update its computer systems in part to integrate databases. Industry experts say Nordstrom's e-commerce lead over department store rivals stems in large part to technology investments it made years ago.
But there are risks.
Computer systems and staff have to be ready or else retailers can face disaster, said Forrester Research analyst Sucharita Mulpuru. The use of stores is pointless if, for example, an inventory system gives the stockroom person collecting an order incorrect information about where a coat is located, leading to wasted time.
There is also a big risk of an item in store being "shopworn," or unsuitable to be sold.
"It's smart to fulfill from stores if you can figure out a way to get your operations right," Mulpuru said, noting the potential for human error is another concern. Such problems are limited at fulfillment centers because the systems are highly automated.
Executives agree. Harrison said stores are not meant to replace fulfillment centers, with their much greater breadth and quantity of products, but are there to supplement them.
"It's always going to be more efficient to ship from a fulfillment center," Saks' Sadove told Reuters. "You're never going to be perfect in 'ship-from-store'."
SILICON VALLEY APPEAL
To support its e-commerce strategy, retailers are aggressively hiring in Silicon Valley. Nordstrom took on more than 400 new employees with software engineering and website development experience, including Kirk Beardsley, an e-commerce executive from Microsoft Corp who had been a director of business development at Amazon for over seven years.
Retailers hope to take this even further by analyzing online data. Macy's executive Harrison said data collected this holiday season will help prepare for the next steps in its online push.
Last year, Wal-Mart acquired California-based start-up Kosmix, which developed technology to filter data from social media networks. As a result, Wal-Mart's San Bruno, California-based e-commerce offices now house more than 1,000 staff.
Getting hold of the technology to back up these efforts is driving acquisitions. They are frequently small ones, driven by retailers' attempts to master the online sales process, rather than immediately boost sales.
Home Depot, which bought tech start-up Redbeacon earlier this year, is looking to acquire or partner with more companies in the Valley, according to CEO Blake.
Redbeacon, founded by a trio of Google Inc veterans, matches homeowners with the best contractors for jobs such as cleaning and home repair. That kind of innovation will send shock waves through the sector, Blake said.
"I think there is going to be as much change over the next 10 years in retail as in the last 50 years. So if you're prioritizing where you put your best people, your best resources and all the rest, for us it's on inter-connective retail," said Blake.
(Additional reporting by Jessica Wohl, Olivia Oran, Sarah McBride, Alistair Barr, Brad Dorfman; Writing by Edward Tobin; Editing by Martin Howell and Jeffrey Benkoe)