Consumer products industry outlook
INSIGHT ARTICLE |
As consumer products companies emerge from the cloud of COVID-19, many businesses continue to address existential challenges from declining foot traffic and decreased sales to supply chain disruptions and margin pressures. Companies that embrace innovation and digital strategies, evaluate consumer preferences and leverage multi-channels to connect with their customers will look to survive and perhaps thrive in 2021.
Key takeaways from the fall 2020 consumer products industry outlook
- Retail bankruptcies will continue, but this strategy could address debt burden and provide access to growth capital.
- The fallout from a decline in traffic coupled with significant margin pressures will likely mean significant reorganization in the restaurant sector.
- Digital commerce remains imperative for consumer products sectors.
- Rapid shifts in consumer preferences provide further fuel for mergers and acquisitions in the beauty industry.
- Innovation is key for food and beverage companies regarding products, packaging and safety measures.
- Across the entire consumer products industry, digital transformation continues to be an important strategic effort.
Many headlines have highlighted the return of retail sales to pre-COVID-19 levels, but the reality, especially in the middle market, is that there is great variation by sector. Restaurants, factory outlets and many mall-based retailers are still nowhere near their pre-pandemic sales figures, while some sectors such as furniture and home furnishings, and sporting goods, have seen a significant recovery in the summer months. The outlook heading into the holiday season and the winter months for many sectors will depend heavily upon an effective virus treatment as well as the timeline for a vaccine.
In most of the U.S., restaurants have survived, albeit with severely depressed margins, by expanding their outdoor seating to attract diners who are not yet comfortable dining indoors. Consumers have also ventured to brick and mortar retail locations, either to shop in stores that have been retrofitted for COVID-19 safety, or to pick up items they ordered online. The summer weather, coupled with outdoor activities for kids, had American consumers leaving the house more frequently than they likely will once the snowy winter months arrive.
Retail bankruptcies to continue, but it’s not all bad
This holiday season, finding a parking space at the nearest shopping mall will not be a problem. The bankruptcies and store closures thus far in 2020 have been heavily skewed toward mall-based retailers. The impact of these closures goes beyond the stores themselves as many of the closures, such as Neiman Marcus and J.C. Penney, were mall anchors. These store closures negatively affect overall foot traffic in the malls, and consequently, other mall retailers. As a result, retail bankruptcies will continue in the fourth quarter and early in 2021.
MIDDLE MARKET INSIGHT
While some of the bankruptcies in 2020 saw stores closing their doors for good, bankruptcy restructurings can be an opportunity for retailers to emerge and thrive in the longer term.
There are two major challenges that many retailers face that can be addressed through a successful restructuring.
Prior to the digital era, growth in retail meant opening new brick and mortar locations. Consequently, many middle market retailers have carried significant debt on their balance sheets. It’s common practice in the retail ecosystem for maturing debt to be refinanced to avoid balloon payments in an industry where cash flow is critical. Bankruptcy restructuring can give retailers the opportunity to adjust their leverage model and right size their balance sheets to emerge with a focus on optimizing their operating model to succeed through the digital evolution.
It’s no secret that the retail operating model has been changing for some time now, and the COVID-19 pandemic has accelerated the shift to multichannel retail. Many traditional retailers, especially those in the middle market, have operating models, technology and physical footprints that are not optimized for the rapid changes to the way consumers shop and purchase in today’s retail ecosystem. According to the recent RSM Digital Transformation Survey, some of the largest barriers are access to capital (see debt burden, previously) and contractual obligations. A successful bankruptcy restructuring can help give retailers debt relief, access to growth capital and an opportunity to terminate long-term leases that may be in undesirable locations or that do not meet the ideal footprint for a multichannel operating model.
Increased digital sales exacerbate last-mile pain
Entering Q4 and the holiday season, surveys from Coresight Research and others continue to suggest that consumer behavior adopted during the pandemic will continue. Retailers that invested in infrastructure to support the virtual customer experience will benefit the most in the upcoming holiday season as customer loyalty will be tested as consumers purchase and return more online.
Companies leveraging UPS, FedEx, and the United States Postal Service for last-mile delivery may see an increase in fees as carriers deal with increased volumes and cost increases and look to recoup costs from larger shippers. One method that some companies are employing to combat this fee is to offer customers a discount for picking up in, or outside of, stores. During the pandemic, consumer adoption of buy online pick-up in store (BOPIS) and curbside pickup has increased and should be considered by all retailers. In many cases, the changes to operations required to adopt these popular channels can be accomplished in a matter of weeks.
Diners slowly returning?
The summer months saw more and more restaurants re-opening after state-imposed restrictions forced many to close early in the pandemic. By the end of the second quarter, restaurants were allowed to operate in nearly all states, and in many cases, at or near full capacity. While overall traffic is still nowhere near pre-COVID-19 levels, many operators have been able to take advantage of improvised outdoor space to capitalize on pent-up demand from consumers eager to dine out after months of eating at home.
Assuming new case statistics remain stable and no additional restrictions are put in place, the restaurant sector will face its next challenge once the winter months approach: making customers comfortable dining indoors. There’s some evidence that suggests that diners are becoming increasingly more comfortable.
The percent of overall seated diners compared to 2019 has fluctuated in the United States from month to month throughout the summer. However, those restaurants that never re-opened, as well as the fact that restaurants opened at different times based upon state restrictions, distorts the pattern in the data. A better indication of the trend is the number of seated diners compared to 2019 for only those restaurants that are open in 2020, that were also open during the same time in 2019. This data demonstrates a slight upward trend for dine-in. For most of the United States there’s still time for outdoor dining well into the fall. Like many other sectors, the restaurant sector will be greatly affected by how we’re able to manage new coronavirus cases and, more importantly, how those numbers affect the comfort level of Americans to dine indoors.
Margin pressures intensify
In the summer edition of The Real Economy: Industry Outlook, we forecasted the significant negative impact to margins resulting from the need for restaurants to reorganize physical space, explore options for outdoor dining and increase the frequency of cleaning efforts. The second quarter results demonstrated that this new operating model is simply not sustainable for the restaurant sector.
COVID-19 fallout creates opportunity
The fallout from a decline in traffic coupled with significant margin pressures will likely mean a significant reorganization in the restaurant sector. Many restaurants that have closed may not reopen, and some that have reopened may still close for good. The result is that many markets that were previously over-seated may have capacity for growth, creating opportunity for those that survive and for those looking to invest in new locations or concepts.
MIDDLE MARKET INSIGHT
Fine dining aside, the key to future success will be creating an asset-light operating model that caters to the consumers’ insistence for on-demand food.
Thus far, despite the challenges faced by the sector, restaurant industry valuations have remained high within the S&P Supercomposite Restaurant Index. The successful operators within the index driving these strong valuations tend to have one thing in common: a strong digital platform and an operating model that supports off-premises dining. For privately held, middle market restaurants, the same is true. Those with that same combination will support stronger valuations. For those without, investors will price in the impact of the current recession and the cost associated with changing unit locations and layouts as well as the required technology investment and the increased complexity to managing the labor equation in the post-COVID-19 environment.
For apparel companies, digital commerce has gone from a growing sales channel to a means of survival during the pandemic. The closure of department stores and other physical retail businesses—historically relied on to display, promote and sell products—forced fashion, beauty and home furnishings companies to adopt digital channels. Digital commerce continues to be imperative. According to Coresight Research’s weekly COVID-19 survey, consumers continue to indicate they are buying more apparel online despite spending less in the category overall.
The accelerated shift toward e-commerce has been a windfall for marketplace giants like Amazon Fashion and Wayfair, with established footprints in the sector. They remain an important channel for many middle market fashion and home companies. However, those companies that have invested in their own direct-to-consumer online sales models have avoided margin eroding fees charged by the marketplaces. They’ve also benefited from controlling the end-to-end customer experience while gleaning valuable customer data and improving gross margins. In fact, e-commerce growth increased significantly during the second quarter overall and fashion, beauty and home branded companies outpaced that of nonstore retailers, commonly used as a proxy for e-commerce only. Those businesses that had preexisting direct-to-consumer platforms, or were able to pivot early on in the pandemic, saw success.
MIDDLE MARKET INSIGHT
The online arena for fashion, beauty and home purchases is growing increasingly crowded, though. For companies to stay ahead, they need to continue to leverage insight from consumer data to make strategic decisions around merchandising, pricing and promotions.
Adopting innovative technologies like augmented and virtual reality can help companies in the sector create unique, value-added customer experiences to stand out in a crowded field. As physical retailers reopen, it will become even more important to make sure the right inventory is in front of the right customers at a competitive price, whether online or in store.
Skinny inventory model
Companies in the apparel sector are taking a lean approach to inventory levels heading into a critical holiday shopping season. According to U.S. Census Bureau data, during the onset of the pandemic apparel wholesalers and retailers saw inventory to sales ratios balloon to 6.0 and 18.9, respectively, as stores shuttered and consumers pulled back discretionary spending. Measures such as heavy discounting and selling through off-price channels have allowed some companies to manage inventory levels into the third quarter, while others are sitting on inventory waiting for next season. Looking forward, apparel businesses are mitigating their exposure even as the holiday season approaches. Through September, apparel imports are down 12% from the previous year while overall imports for other discretionary categories are up over 20%. The trend could signal a permanent change as apparel companies weigh the cost of carrying inventory and the potential lost sales and erosion of consumer experience from selling out of popular products too soon. Middle market apparel companies should look for digital tools that will allow them to better understand promotional effectiveness and leverage sell-through data to help them make merchandising decisions and to keep up with rapidly changing consumer preferences.
Apparel companies moving on from China
Apparel companies continue to look for alternatives to producing in China. In recent years, apparel importers have had to deal with loose intellectual property laws, rising Chinese factory wages, punitive tariffs, supply chain disruptions from the onset of the coronavirus pandemic, and most recently, a potential ban on products using cotton made in the Xinjiang region in response to alleged forced labor and other human rights violations. It’s estimated that the western Chinese autonomous region produces 80% of the country’s cotton and 22% of the global market. Uncertainty surrounding the ban will only further slow imports coming from China as apparel companies seek alternative sourcing to achieve the same cost effectiveness in production without the risk.
Apparel companies may find geopolitical turmoil even as they move supply chains to new locations. Many south and Southeast Asian countries are still recovering from the impact of COVID-19 and source raw materials such as cotton from China. Moving production closer to the end consumer is an attractive option that allows companies to cut down lead times and develop on-demand supply chains. However, as U.S. companies look to leverage closer-to-home alternatives, production capacity in places such as Central America and the Caribbean basin is still limited and carries higher labor costs. Apparel business leaders will need to weigh risks, costs of production and potential benefits of nimble supply chains when making sourcing decisions; they should also look for technology solutions to reduce the labor inputs and increase efficiency and effectiveness.
Changing consumer preferences fuel beauty mergers and acquisitions
While beauty sales have recovered sooner than other discretionary spending categories, the recovery has largely been affected by significant shifts in consumer behavior. The beauty industry has been relatively immune to past recessions, as consumers saw cosmetics as affordable splurges. The COVID-19 environment saw consumers spending less on color cosmetics and fragrances as they sheltered in place and scaled back going to public places like work, restaurants and events. The pullback was somewhat offset by growth in skincare, haircare and wellness categories as preferences shifted toward personal care. Beauty brands have also found success with DIY products as consumers are reluctant to go back to hair and nail salons and beauty counters, even as those businesses slowly reopen.
Rapid shifts in consumer preferences provide further fuel for mergers and acquisitions in the beauty industry. The big beauty players historically relied on mergers and acquisitions to optimize product offerings and round out brand portfolios. Those efforts will only increase as a new consumer landscape takes shape. These debt heavy conglomerates could look to divest low growth categories to free up capital to deploy on acquisitions of emerging brands. Lower multiples and deal sizes due to COVID-19-related distress or independent brands looking for capital to scale quickly should also contribute to accelerated deal activity in the beauty sector.
Whether consumers are shopping brick and mortar or online, their choices have been diminished. It is clear that food companies made strides in SKU rationalization to cut costs and improve efficiencies because of the pandemic. In order for companies to sustain sales growth, innovation is key. One way to increase consumer loyalty is through unique offerings. More consumers are preparing meals at home and according to the food industry association, FMI, roughly 39% plan on continuing to purchase food from restaurants less often because they believe it is healthier and cheaper. Sean Jafar, senior manager of syndicated research at Dataessential, suggests the main driver for manufacturers suppling the food service sector to gain market share is by satisfying cravings for foods that consumers have difficulty making at home.
MIDDLE MARKET INSIGHT
While the pandemic had shoppers return to the center of the store, innovation will also be what keeps them coming back.
Increased innovation in ready-made meals and frozen food items all with a focus on healthier ingredients and convenience are a good strategy to attract consumers who are much more concerned with the pandemic than with the economy. Furthermore, food safety is also ripe for innovation. Package innovation for shelf stability and freshness has been a trend even before the pandemic as consumers are clamoring for innovation in serving sizes and safe packaging. Single serve items that are safely wrapped offer consumers the sense of safety in what they are eating; the less their food has been handled, the safer they feel.
Safety and sustainability
Consumers still demand safe, sustainable products at a value-driven price. The U.S. Food and Drug Administration continually monitors and updates the nutrition facts label requirements based on nutrition research and scientific findings. They also continue to improve labeling requirements to make it easier for consumers to understand what is in their food, including clearer information on serving size, calories, fat and sugar. U.S. government regulations continue to shift the focus of food safety from reaction to prevention. Producers and manufacturers will need to continue to train employees and modernize facilities to prevent and respond to contamination outbreaks.
This summer the FDA launched another food initiative called the “New Era of Smarter Food Safety” to aid in compliance of the Food Safety Modernization Act. In their blueprint they outline four categories or “core elements” that they will endeavor to achieve in the next decade. The first is technology-enabled traceability so consumers can be protected from contaminated products and improve speed of identifying the source. The second core element is smarter tools and approaches for prevention and outbreak. In the FDA’s FAQs they comment, “The FDA is looking to enhance and strengthen root cause analyses and predictive analytics” in the hopes of modifying practices to avoid identified risks. The third core element falls under new business models and retail food modernization. As e-commerce and advanced innovations in food production and delivery evolve, the FDA is working to make sure food continues to be safe. Finally, they are working to generate a food safety culture. As we have seen, especially in protein and other food manufacturing facilities, containing the COVID-19 virus outbreak proved difficult. This fourth core element aims to improve not only safety of the food but the people who work in the facilities. Digital transformation will be key in keeping up not only with consumer demands, but also making it through the federal regulatory landscape.
There has been a great deal of discussion about consumers switching to online shopping from traditional brick and mortar because of the pandemic. As mentioned earlier and further supported by Coresight data, grocery purchases online have slowed, but remained in a consistent trend of an average of 30% to 40% of people surveyed reporting they will continue to purchase groceries online.
Middle market food and beverage manufacturers and distributors should continue to invest in e-commerce to sustain long-term growth. E-commerce as a term encapsulates a variety of important functions. Investing in the right technology to reach customers via omnichannel, quickly react to changing customer preferences, control inventory and optimize supply chains will be critical if companies want to stay competitive and be ready for any other unplanned disruptions. Larger consumer packaged food companies have been better able to handle supply chain disruptions as they have more sophisticated tools to handle inventory, thus making it difficult for smaller and midsized companies to compete. As the pandemic continues, we expect to see smaller bolt-on acquisitions that increase share in an existing category, expand a geographic footprint or increase sales in other categories.
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