Mattress Firm's Expansion Left It With Too Many Stores Too Close Together. Can It Survive The Correction?

As retailers close en masse across the country, Mattress Firm has expanded aggressively, with 1,500 new stores since 2010. The retailer's fraud allegations against the men making its real estate decisions have raised new questions about the company's aggressive growth.

Retailers have been shuttering locations by the hundreds across the country, but mattress stores, and Mattress Firm in particular, have aggressively grown. As retailer bankruptcies like Blockbuster and RadioShack have piled up, Mattress Firm has often been willing to fill their vacant storefronts. As a result, the company's locations appear in dense clusters all across America.

The clustered locations have come under new scrutiny in the wake of a lawsuit Mattress Firm filed in Harris County, Texas, against two of its former real estate executives, its outside broker and a group of developers. In the suit, Mattress Firm alleges Colliers International Vice President Alexander Deitch and two of the retailer's former in-house real estate executives, Bruce Levy and Ryan Vinson, were responsible for about 1,500 new stores during their time leading Mattress Firm's real estate efforts, as well as hundreds more lease renewals.

“It's quite obvious [Mattress Firm] expanded too quickly," said Transwestern Director of Research Stuart Showers, also based in Houston. "They pushed very hard for growth, so it made it easy to cover [the alleged fraud] up. A lot of these locations don't make much sense. They're deals just to get a deal done."

In its hometown of Houston, Mattress Firm operates three stores at Interstate 45 and West Road, all on the northwest corner of the intersection. In Montrose, Mattress Firm operates five locations in roughly one square mile, two of which are right next door to each other.

Mattress Firm CEO Ken Murphy, said for the company’s best markets, Mattress Firm aims to have one store for about every 50,000 people. In Schereville, Indiana — population 28,000 — Mattress Firm has five stores less than a block apart. Mattress Firm operates another six stores on a one-mile stretch in Naperville, Indiana. Five more operate within a mile of each other in Spokane, Washington.

In Atlanta, on Moreland Avenue, two Mattress Firms operate across the street from each other with identical hours. Mattress Firm has four locations within two blocks of Boise Town Square in Idaho. The list goes on.

“If you see a Mattress Firm, there’s likely another close by,” NAI Partners Retail Senior Vice President Jason Gaines said.

Mattress Firm claims Levy, Vinson, Deitch and a group of developers conspired to push Mattress Firm into more, and more expensive, locations as it grew to operate its current portfolio of more than 3,500 stores.

Mattress Firm alleges the cohort was responsible for leases signed for above-market prices, then conspired to sell the properties where the company's new locations opened for substantial profits. It claims Deitch and Levy secretly owned stakes with the developers that owned some of the properties, and used their control of Mattress Firm's real estate decisions to profit personally from the sales.

Mattress Firm’s internal investigation uncovered the alleged fraudulent activities, it said, and it fired the two executives last year.

Drawing the line between fraud and aggressive expansion is at the heart of Mattress Firm’s lawsuit. The lawsuit claims one portion of the scheme alone — a $50K broker fee per lease — could have cost the retailer at least $40M in excess payments. That accounts for roughly 800 locations.

In a statement from the company's lawyer, Mattress Firm said the decision to work with Levy, Vinson and Deitch was a result of Mattress Firm’s overall growth strategy, which was part of its vision to build the first truly national mattress retailer.

“We invest in real estate in highly trafficked intersections and shopping centers in key markets to maintain visibility,” Mattress Firm Senior Vice President of Communications Sunni Goodman said. “Additionally, acquisitions have added to our real estate portfolio. This sometimes results in having Mattress Firm locations in close proximity.”

Coinciding with its rapid expansion, Mattress Firm has been gobbling up competitors like Back To Bed, Bedding Experts and Sleepy’s, which it purchased for $780M. The acquisitions compounded Mattress Firm's clusters. 

Why Mattress Stores Are So Prevalent

“The mattress business is uniquely tempted to open up more locations,” Gaines said.

Mattress Firm does not own the mattresses it sells in its stores; it functions similarly to a car dealership with a commission-based sales manager and a 30-day revolving credit inventory. Mattress Firm is only paying for rent, utilities and a basic presentation showroom build-out, Gaines said. Mattress stores do not have the liability of other retailers because of their business model.

In addition to low costs, mattress stores typically have high margins. Brad Thomas, an equity research analyst for KeyBanc Capital Markets, told Planet Money that retail profits are steep for a mattress because manufacturing costs are low. Thomas estimates that a $1K mattress costs around $250 to make.

University of Chicago professor of marketing Jean-Pierre Dubé thinks the mattress business shares a great deal of competitive similarities with car dealerships. The concept behind the strategy is called location theory, an integral part of spatial economics. When a dealership or retailer moves to capture more market share, its competitors will move in kind.

The two competing retailers will move again and again until they both find the optimal location, where they both capture the most market share, often practically on top of each other. Clustered locations also benefit from agglomeration. Firms cluster locations to leverage scale economics. Clustering locations allows stores to share inputs, customer bases and a labor pool, reducing the cost of doing business.

Or, Dubé said, there could have been no economic theory governing the decisions at all.

“Another argument is that [Mattress Firm] grew too rapidly and had no idea what they were doing,” Dubé said. “It’s an element of bad planning.”

Contraction Is Coming 

Mattress Firm is reviewing its real estate footprint intent on trimming stores, but it has not yet decided how many or which stores to shut down, according to the company's first-quarter financial report. Most closures will come as store leases end, Murphy said.

“It’s not surprising to see this type of regret from retailers who expand too quickly,” Dubé said. “In the mattress industry, it’s less clear. When you’re only doing one deal, you can do due diligence. When you’re doing hundreds of deals, it becomes much more difficult.”

As a landlord, Florida-based ComNet Realty President Harry Zucker has worked with plenty of mattress stores. When Mattress Firm built a new stand-alone location across the street from an already-open Mattress Firm store he owned, he figured the company would not renew its lease. He was wrong.

“It would only make sense if they built something across the street that they would leave, but in the end, they stayed,” Zucker said. “Who knows what goes through their heads?”

Even Mattress Firm employees are struggling to understand the strategy.

“I chuckle when you say 'strategy,'” Mattress Firm Store Manager Devonte Hill said.

Hill manages a store in Houston that is less than a quarter-mile from two others. He has felt the effects of his particular cluster. He said often customers will shop Mattress Firm locations that are close to each other looking for the best price, putting downward pressure on the commissions of sales people looking to meet their numbers.

“We have to make the sale, this is how we feed our kids,” Hill said. “The inter-store competition causes extra stress.”

Going Forward

Questions continue to mount for Mattress Firm. Last week, the CEO of Mattress Firm’s parent company, Steinhoff International Holdings, resigned amid accounting irregularities, sending the company’s stock into a downward spiral. PwC has been appointed to probe the matter. Steinhoff’s stock slumped as much as 72% in one day in Frankfurt, Germany, wiping out more than $8.3B in value.

The storm of e-commerce disruption might be catching up with Mattress Firm. The company’s last public filing, before it was bought out, showed earnings slipped from a $14M loss in 2012 to a $111M loss in 2016, despite revenue growing from $704M to $2.5B in that same period. The drop signals a growing disconnect between revenue and profits as the company tries to compete in an increasingly competitive market.

Companies like Casper and Tuft & Needle are leading a new generation of mattress makers skipping brick-and-mortar locations altogether to sell their mattresses online. Online sales now account for 10% of mattress sales, but that number is quickly growing, according to Furniture Today Executive Editor David Perry.

Mattress Firm is following suit, hoping to leverage its abundant locations by offering what e-commerce brands cannot; try-before-you-buy and returns. They have plenty of locations to leverage, for now.

“There’s no question there’s been some brilliance to what Mattress Firm has done in terms of cornering the market,” Showers said. "Now it's a question of how they're going to weather the fallout."

Jarred Schenke contributed to this report.