Has profitability peaked?
CONSUMER PRODUCTS INSIGHTS |
Even though economic indicators have steadily improved, increasing profitability has been a struggle for many retailers. Customer demands have changed, and the costs of staying competitive are increasing pressure on the bottom line and causing many companies to revisit growth goals. McGladrey director, consumer products industry, former industry analyst Jeffrey B. Edelman, evaluates the factors that will continue to pressure profitability, and the strategies retailers can implement to offset these challenges.
It should feel better than this: Economic headwinds have been diminishing over the past several quarters. Employment growth and real income continue to grow slowly; however, it appears as if consumer spending is shifting away from traditional consumer products at this point in the economic cycle. Additionally, sales appear to be deflated, reflecting channel mix and preferences of the value-focused shopper.
These topics have been touched upon in previous commentaries; a more critical issue at this point is whether past levels of profitability and goals can be achieved. A 3 percent economic growth target is more realistic than 4 percent used previously. In addition, industry top-line growth is proving difficult to achieve, while at the same time there are increasing margin pressures that will likely continue to prevail. A number of public companies are categorizing expenses as investment for future growth, which sounds better.
Adjusting to slower sales targets: Most retailer sales continue to trail expectations, leading to the current high level in promotional activity. E-commerce has been a contributing factor in pulling sales from bricks and mortar, although the latter has also been benefiting from online sales. E-commerce has become a significant game changer that could be additive to sales, and help maintain market share.
Many have also addressed their store base with an eye on culling low volume locations, especially those with leases due for renewal shortly. Others have been more focused on eliminating marginal product categories. It would appear as if many retailers and vendors effectively addressed controllable issues to improve the quality of sales.
There are many uncontrollable costs required to remain competitive that will continue to pressure profitability. These include:
- Higher wage costs: Wage costs and related benefits have been ongoing issues. A number of companies have been able to offset some of the expenses through more effective scheduling, but there is a limit as to how far they can go. Perhaps a more effective route would be enhanced employee training geared to increased product knowledge and service levels that will hopefully increase the number and size of transactions.
- Consolidation, store closings and openings: One would have thought there would be a net decrease in store space through consolidation and closing of C and D malls. However, store openings appear to be sustained at an unrestrained pace; witness the growth of off price and factory outlet stores, fast fashion stores, and more recently, efforts of Internet sellers looking to build a bricks and mortar presence. Thus, costs for a traditional retailer to maintain market share, including omnichannel efforts could outpace potential efficiencies from anticipated incremental volume.
- Controlling investment to drive growth difficult to contain. Many retailers and vendors are scrambling to update technology as fast as possible to stay even, or hopefully, ahead of competitors. Unfortunately, these investments are difficult to budget within a certain time frame as the job needs to be completed as soon as possible to maintain and grow market share.
Marketing costs appear to be open-ended as sellers want to communicate with their target customers. This assumes they know their most loyal and profitable customers. Free shipping is now standard in most cases, but those costs will be increasing nearly 5 percent in January.
- The Wal-Mart factor: Wal-Mart has consistently focused on what it called the profitability wheel. That is lower prices drive volume and generate efficiencies that drive market share and profitability. Its management recently unveiled a new strategy to invigorate its employees and store base in an effort to regain lost market share.
The company has been one of the most difficult for vendors to deal with because of ever increasing demands for lower costs. Now there is a new wrinkle, charging warehousing costs for merchandise in their distribution centers and extending payment cycles. Brands selling to department stores have faced the issue of markdown allowances for many years, a situation that continues to worsen. These events could push more consumer products companies into increased efforts towards self-distribution through their respective websites.
However, some opportunities exist to potentially offset some of the previously mentioned costs, including:
- Potentially significant sourcing and supply chain savings: Managers should attempt to shorten cycle time wherever possible, which could keep inventory better in balance and with a better fashion content. A number of fast fashion retailers have excelled in this area, enabling them to bring in fresh merchandise more often. Fashion newness, therefore, should generate increased store traffic and repeat visits. Sourcing from a more cost-efficient country may not be the most profitable depending on quality, availability of raw materials and labor, logistics and turnaround time.
- Providing value, although it can be a tricky equation: Value can potentially differ by consumer group and product, with each carrying a different relationship on price, service and fashion. Low price is often mentioned as a deal closer; however, there appears to be increased interest on ease of transaction and return.
This could be as simple as a very informative website and delivery schedule if ordered on line. Online ordering and in-store pickup could be even more effective strategies to translate into increased purchases. This is particularly the case with returns, as some retailers note a much higher net transaction value when items are returned to the store.
- Converting a casual customer into a loyal customer: Loyal customers can often be four times as profitable. A well-targeted information gathering and marketing program can elevate a brand's site or retail store or site to the top choice to start looking to purchase. This can be compounded by a loyalty program that could further strengthen the customer relationship. Understanding your shoppers and their preferences should lead a more personalized retail experience. Optimize digital programs to improve viability as a purchase destination.
It's all about the customer: It is imperative for any seller to know their customer, what they want, when they want it, and provide ease of return. Success is measured by creating the want to purchase, rather than the need to buy or replenish. There is no shortage of what to buy, where to buy it, or how to buy it. There is however, a premium on the experience. Good ones generate repeat business, bad ones are just remembered. That experience can be enhanced through ongoing in-store and website innovations.
Jeffrey B. Edelman is director of consumer products industry services for McGladrey, and is located in the firm's New York office. He routinely advises senior management of companies operating in the consumer and retail sectors on strategic, sourcing, financial, marketing and distribution issues. He also works closely with internal teams on matters such as new business development, transactional advisory, including due diligence and tax. Jeff can be reached at 212.372.1225, or via email at firstname.lastname@example.org.