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Is today’s consumer the new normal?

CONSUMER PRODUCTS INSIGHTS  | 

Despite improving economic data, sales have remained sluggish for many retailers. Changing demographics, more value-conscious consumers and a variety of external factors are challenging retailers to provide more differentiated merchandise and build stronger customer relationships. Director of retail and consumer products advisory services, former industry analyst Jeffrey B. Edelman, evaluates the current environment, detailing difficulties, and discussing projecting sales gains for the sector as a whole, especially the retailers that can connect with consumers from a fashion and value perspective.

Retailer sales have continued to be disappointing: Employment remains on the rise, as does personal income and the savings rate; on the other hand, the number of people unemployed is at a high level and consumer confidence is low. Weather, the strong dollar and the West Coast dock strike were most often mentioned as contributing factors to struggling sales figures, as well as the usual commentary about lack of fashion newness. However, consumer spending on automobiles and other durables has experienced better sales trends.

Demographics could be having a significant impact on spending patterns, as the aging population appears to be more focused on health and related items. On the other hand, millennials have a much different set of spending priorities than their elders.

All of these factors have an impact, but there are some other trends that could be having an even greater effect, deflating the average selling price in contrast to the "trade up" that prevailed over the last decade or so. There appears to have been a cultural shift away from displays of conspicuous consumption; the affluent that have spending power have not been spending the way they had previously. Retail sales, up to this point, have been strongest at both the high and low ends, as consumers moved away from the midpoint ranges.

Retailers, and vendors, enhanced their sales growth and gross margin through upgrading of quality, fashion and differentiated merchandise, and consumers responded very favorably. These lifted the average selling prices across many categories, which was easy to accomplish because of increased imports from China that enabled them to maintain or lower some price points from the outset.

Many stores pared back their price-sensitive brand assortments that were readily available elsewhere in the mall in an effort to generate more full-price selling. Last year, Prada announced it was raising its prices in an effort to maintain its exclusivity. Just recently, Macy's noted it was looking to trade up some of its brands and move out of the mainstream in a number of categories.

Now, we appear to be witnessing a reversal. At the same time, Macy's also announced the opening of a new off-price format, Back Stage, which will debut in the New York area. Kohl's also threw its hat into the ring this month with a new store, Off-Aisle, offering discounts of 70-90 percent on returned merchandise. It will be interesting to see if this format will be successful and profitable, given the additional transportation and operating costs.

Consumers remain focused on value: The value-conscious consumer is having an increased impact on retail sales, and will likely continue to do so going forward. The consumer has increasingly determined the appropriate fashion, quality and price mix for each desired purchase, with percentages varying by product. In addition, this attitude impacts where to purchase, which also generally varies by type of product. The value proposition is enhanced by the consumer's willingness to frequent discount channels more often; that is, remaining focused on the brand, but at a lower price. This raises another issue, as most factory outlets generally carry products that are specially made and usually at lesser quality to make up for the lower price.

We estimate the major off-price chain and factory outlet volume approximates $60 billion, or about two-thirds of the combined volume of the six largest department store companies (Sears and discount stores are excluded due to lack of commonality in the merchandise mix). That market share continues to increase. These are great venues to clear excess inventory and grow market share. To put this into perspective, TJX and Macy's have sales in the area of $28 billion to 29 billion; broadly speaking, they have a similar merchandise assortment, although there are some geographical differences.

The zero-sum game: The domestic apparel, footwear and accessories market, approximating $380 billion in sales, is expected to increase around 2-2.5 percent annually through 2020 to nearly $420 billion. Factory outlet and off-price stores ($60+ billion) could capture one-third of that incremental growth if they were to increase 4 percent per year over that period, based on individual company released statements. The three fast fashion leaders are projected to grow around 11 percent annually from approximately $6 billion, which, if they do, would generate about $4 billion higher volume. Combined, these could account for nearly one-half of industry growth.

E-commerce has enabled many retailers, especially department stores, to maintain share while experiencing small declines on a comparable store basis, although this is a hard figure to quantify because of transfer of store sales. Omnichannel has also been a big equalizer in market share statistics.

Is profitability the biggest loser? The retail landscape will continue to be the survival of the fittest. Importantly, gross margin and profitability for a number of successful retailers have likely peaked, at least for the next few years. The biggest expense pressures will probably be reflected in store operating expenses because of flat to down comparable store sales, higher expenses related to Internet sales, investment spending for new avenues of potential growth, and most importantly, technology spending.

These costs are a moving target in the quest to have the most efficient supply chain and transparency in presentation and delivery to the consumer. So the biggest loser will likely be profitability, accentuated by continued competitive pricing, which can only be offset by creative and differentiated product development.

Winners will likely be those that have more sophisticated marketing and social media programs that allow them to interact with their customers on a direct and timely basis. Knowing what they want and when will be key to generating the next transaction. There needs to be the proper balance of price, fashion and quality, depending on consumer and product. There is no shortage of merchandise or anywhere to buy it, but retailers must work to develop the desired relationship. Service can be an important differentiator in generating incremental sales. It is important to increase labor hours during peak traffic periods, otherwise risking lost sales.

Losers will continue to be those that operate in the same manner as in prior years. Many retailers are addressing more efficient sourcing and logistics. Producers of private label merchandise are probably most at risk as their large customers have become more sophisticated in buying direct.

Jeffrey B. Edelman is director of retail and consumer products advisory services for RSM, and is located in the firm's New York City 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 jeff.edelman@rsmus.com.

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