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Potential retail disruptors in 2015

CONSUMER PRODUCTS INSIGHTS  | 

Positive economic trends have brought optimism to retailers as the holiday season ended on a high note, and momentum carried into 2015. Despite the most promising forecast in years, many hurdles remain and retailers must continue to evolve, adjusting business plans to customer demand to remain successful. Director of retail and consumer products advisory services, former industry analyst Jeffrey B. Edelman, evaluates the reasons behind the recent successes and struggles of some brands, and discusses several strategies that could lead to profitable growth.  

It probably won't be the economy this time: Economic activity remains on an uptrend, and based on latest forecasts, 2015 could be one of the best years for growth in recent memory. Last year ended on a strong note, paced by record automobile sales which likely siphoned discretionary dollars from other areas. Holiday sales closely matched expectations, driven by heavy promotions that took a toll on margins, but left inventory throughout the pipeline fairly clean. The stage should be set for a more manageable business environment; however, there are a number of potential disruptors beyond management's control. This list seems to grow each year.

Liquidation of Sears Holdings is likely to continue: Sears' losses mounted after many quarterly declines in comparable store sales; however, positive cash flow has been bolstered by asset sales and a number of financial maneuvers. Store closings will likely accelerate in an effort to stem the losses, although corporate expense and overhead will have to be adjusted annually to offset the lack of gross profit dollars. At the end of the day, there appears to be little reason for Sears to exist, as other retail venues offer better merchandise selection, service and pricing. There is even less to be said about Kmart as it lacks the breadth of food and consumables that drives traffic.

Most suppliers and factors note the situation is being carefully watched, but all are facing the reality of increased credit risk and declining volume. Store closings will have the most negative impact on C and D shopping malls.

Declining mall traffic may continue: The Internet has siphoned off considerable sales from malls at an increasing rate over the past several years. Bricks and mortar stores have been a large beneficiary of online shopping thanks to their increased omnichannel focus. Many of those, including Macy's and Nordstrom, have been successful in more than offsetting the loss of comparable store volume. Online sales have enabled many retailers to maintain or increase market share; the jury is still out on overall profitability, which is declining at the store level and generally lower for the online business.

The more productive A and B malls (the larger volume and more successful account for about 25 percent of the nation's total) have a better chance of survival because many of their tenants are destination points. It is a different story for the C and D malls, many of which will likely see the ongoing exodus of tenants such as Sears and possibly JCPenney. Many of their stores are just too large and poorly located, and their closings could represent the demise of the rest of the mall, and likely increased margin pressures for remaining stores.

Profitability of online volume trails that of bricks and mortar because of shipping costs and the extra handling involved; returns can add to the cost because of free shipping. One bright spot is stores with successful online presence which can benefit from ease of returns and the likelihood of consumers spending a greater amount through trade up or impulse spending.

Demographics could slow spending growth: The aging population is impacting consumer spending patterns. Interestingly these “mall walkers” generate mall traffic, but the stores are generally closed in the early hours. Priorities of those consumers have changed, such as spending less on apparel and more on health care. This consumer has been increasingly value focused.

At the other end of the spectrum, the younger generation is moving away from the “logo stores” such as Abercrombie & Fitch in favor of many of the fast fashion stores such as H&M, Top Shop and Zara that offer more up-to-date fashion at lower prices. The decline in middle-income households relative to growth in higher-income households suggests marketing programs have to be updated. This could have implications for middle-market retailers such as JCPenney and Kohl's.

More brand consolidation likely: Management teams are analyzing their merchandise mix, looking to cull out the lowest performers in terms of sales and profit per square foot. In the case of Kohl's, among others, there has been increased emphasis on national brands, reducing its selection of poorly performing private brands it had increased only a few years earlier. Other retailers such as Macy's continue to build their successful private brand programs, to some degree at the expense of marginal, secondary national brands.

This should have a ripple effect through the vendor community, as weaker brands' profitability declines due to reduced volume. Of even greater consequence would be the impact on manufacturers of private brands as retailers gain scale to purchase direct more economically. We believe this will become more evident in the new year as retailers will look more actively to offset margin pressure from declining store traffic.

It seems to be a never-ending cycle, as consumers seemed to have gained power over the retailer, who in turn is pushing back further on the supplier.

Logos appear to be losing consumer appeal: Teen retailers had problems last year, reporting significant declines in comparable store sales. Stores such as Abercrombie & Fitch generated large and unprecedented consumer interest in their logo-inspired merchandise until the brand and logo became overexposed and lacking of new and exciting merchandise. The same happened to Coach, which was slow to update its merchandise lineup; its consumer wanted more differentiation than just the logo.

Higher-end luxury brands are experiencing a similar phenomenon, as their sales of core merchandise have weakened over the last six months. Is the consumer tired of sporting the logo or questioning the value proposition relative to other alternatives?

Some brands are sacrificing brand power for short-term gains: At what point does increased distribution through factory outlet stores cause brand saturation earlier than expected? If a product looks the same, the feel might not be identical. A knit shirt after several washings is the acid test between products made for factory outlet or department and specialty stores. The consumer has voted to buy discounted brands, but there is a noticeable quality difference from the original product, and it is probably only a matter of time before that is realized. Sizing, which has always been a strong point for brands because of consistency, is also more unreliable in factory outlets and off-price stores.

Headwinds gaining momentum: Retailers and vendors have been struggling over the past several years and are at a point where many should begin to feel a little wind behind their back. However, a growing number of retailers have noted fast fashion as an increased competitive factor. It is likely that stores such as Forever 21, H&M and Zara, along with other value-focused retailers, including factory outlets and off-price stores, could capture around two-thirds of expected growth of apparel and accessory sales through 2020. This will have an increasingly important impact to both the retail and vendor community.

Technology costs will move higher to remain competitive: Market forces will likely dictate expenditures to a greater extent than in the past. It's all about the consumer, or perhaps more educated consumers. They expect service and transparency, along with low prices. Costs to satisfy that consumer will continue to rise sharply to improve logistics and the overall shopping experience. That is how they want to shop, when (hour of the day) they want to shop, with choice of delivery or store pick-up, convenience and ease of return.

Unfortunately, these technology expenditures become, in some cases, unplanned operational costs, and return on investment is difficult to determine. However, the ultimate cost will be loss of market share if these investments are not made. This would particularly be true with mobile accessibility.

Complacency could be the biggest and most unrecognized problem: Too many retailers and brands seem to take the consumer for granted, which is generally the major cause behind their downfall. They can't continue to do the same thing they did yesterday, as someone else has probably already passed them on the competitive front.

Understanding the targeted consumer is critical for survival and profitable growth. The appropriate value proposition has to be emphasized, and that differs by product within each demographic group. The same shopper could frequent Neiman Marcus, Kohl's, Target and Costco raising the importance of consumer research, which could be the key differentiator this year.

Jeffrey B. Edelman is director of retail and consumer products advisory services for RSM, 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 jeff.edelman@rsmus.com.

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