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Consumer prices: Down the slippery slope

INSIGHT ARTICLE  | 

What’s on the horizon for consumer products pricing in a rigorously cost-conscious marketplace?

The race to the bottom
While most consumer products companies are focused on improving profitability this year, there is increased risk for many in this cost-competitive environment. Last year’s winners were largely within the value sector, particularly off-price retailers. This year will likely reflect a narrowing of the pricing gap with traditional retailers. We noted in our March commentary, Kohl’s and Macy’s both announced strategies of sharper pricing; since then, there have been more companies singing a similar tune. Many are using Walmart and Amazon as benchmarks and will be more closely attuned to online price comparison. The ability to keep up with frequent price changes is difficult. Consumers can search and buy faster than other sellers can match. Target, keen to stay relevant in the fray, said it would sacrifice full-year margins to keep its prices competitive. We could be looking at a deep black hole in terms of price reductions as retailers race to address a demanding marketplace.

Price reductions spread
Supermarket operator Kroger reported a surprise decline in holiday-quarter same-store sales as competition in the grocery industry intensified amid falling food prices and anticipation of increased pressure from German discount grocery chain, Aldi. Walmart, not to be outdone, indicated it is running a price-comparison test in approximately 1,200 U.S. stores as it looks to close its pricing gap with such rivals as Aldi and Kroger.

In related news, Costco recently announced its intention to raise its membership fees around midyear. This will be phased in over the next year or so. Of note, Costco has typically raised its membership fees every five to six years as an offset to its competitive pricing. Its management recently indicated it believed it was facing stiffer competition in the pricing of a number of visible products and categories, implying this move could have more significance than in the past. Additionally, Costco’s promotional program will be tweaked to emphasize sharper pricing on fewer items. The retailer’s membership fees approximated 72 percent of its operating income last year, its operating margin was around 3 percent and gross margin was 11 percent. This successful formula has maintained steady increases in membership and renewal rates.

Consumers continue to focus more on price than fashion
Value-conscious consumers are placing different emphasis on fashion, quality and price today than in previous years; a trend apparently poised to continue. There are different considerations that are determining where to make purchases. Omnichannel is only part of the answer, although it does exert downward pressure on prices. The value proposition was enhanced by the consumers’ willingness to frequent discount channels more often; that is, remaining focused on the brand but at a lower price. Many brands have introduced a lower price point in some categories to attract that value customer.

Off-price retail has become even more relevant
TJX continues to raise the bar for the industry. We estimate factory outlets and off-price retailers combined sales approached $70 billion last year, nearly approximating that of the six largest department store companies, in part due to the latter’s store closing programs. Additionally, TJX will be expanding further into home-related categories as well as international markets.

One has always questioned the availability of fashion-right merchandise in off-price stores; however, given industry consolidation and increased buying clout, these strong retailers continue to gain market share. Their sales increased roughly 40 percent between 2011 and 2016. Many brands create specific merchandise for these outlets that are not necessarily identical to the products sold through department stores. Additionally, other brands have been resurrected and sold exclusively through these outlets, offering more of a perceived value. This segment has become even more saturated given growth by department stores such as Saks, Nordstrom, Neiman Marcus and Bloomingdales.

Unknown variable
The major variable, and likely unknown for months, will be the impact of import taxes as reform policies like the proposed border adjustment tax have yet to be realized. History suggests these and other costs will not likely be passed through to consumers immediately, but rather a phase-in that could ultimately impact profitability through the supply chain.

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