Consumer products industry outlook
Consumer remains king amid slowing economic growth
INSIGHT ARTICLE |
Key takeaways from the fall 2019 consumer products industry outlook
- Margin pressures are increasing amid rising labor costs and tariffs.
- Apparel, footwear and home furnishings importers reckon with new round of tariffs.
- Restaurants face increasing labor costs and declining consumer foot traffic.
- Food and beverage companies face historically high transportation and warehousing costs.
- Middle market retailers must take advantage of emerging technologies.
In the face of economic headwinds stemming primarily from the ongoing trade dispute with China, consumer spending has kept the U.S. economy afloat in 2019. This strong spending has been driven by continued growth in employment and wages, albeit at a more modest pace than in 2018. At the same time, labor market strength is creating margin pressures in the consumer ecosystem. The six- to 12-month outlook for consumer products businesses will be heavily dependent upon how these factors evolve from the patterns that have fueled the strong economic growth in recent years.
CONSUMER SPENDING OUTLOOK
Strong wages and low unemployment, coupled with improved consumer sentiment, set the stage for robust consumer spending in 2018. While the employment market has softened slightly in the middle of 2019 and sentiment has become more volatile amid economic uncertainty, strong consumer spending has held up. In fact, in the second quarter of 2019, personal consumption reached its highest level since 2014.
The short-term outlook in the consumer ecosystem is heavily dependent upon the ability of the consumer to continue to spend. And it’s not just the U.S. trade war with China and Brexit that are hitting consumer confidence; other hard data suggests we may be nearing the peak.
Take the financial pressures faced by the millennial and generation z cohorts. As these emerging groups become more significant demographics in the U.S. consumer base, they are also challenged with rising real estate and health care costs, and student debt. In fact, rental costs and student debt have ballooned at a faster pace than personal income during the current economic cycle.
TRADE POLICY IMPACT
There is no more immediate threat to the financial performance of the consumer ecosystem than the current trade standoff. Although the direct impact has been slow to show up in the hard data, the dispute has put more pressure on the consumer ecosystem than at any point in modern history.
U.S. trade policy has been highly erratic and unpredictable over the past 18 months. Seemingly capricious decisions over whether tariffs will, or will not, be imposed have made it difficult for firms throughout the consumer supply chain to plan. This, in turn, has affected operations, like the timing of inventory purchases, as well as financial decisions, like price increases and forecasting cash flow needs.
So firms manage as best they can. Two of the most common practices used to deal with the tariffs have been accelerated purchasing to beat the imposition of tariffs and sourcing products from other countries in Southeast Asia or even Mexico where tariffs are more benign. While neither is a perfect solution, both practices are expected to continue in the near-term.
Already, evidence is starting to reflect these changes in behavior. Based upon bills of lading filed with U.S. customs, purchases of consumer goods pegged for the holiday shopping season peaked sooner than they have historically, indicating an acceleration of purchases in advance of tariffs imposed as of Sept. 1. Purchases will most likely spike again later in the fall as consumer companies try to bring inventory into the country before additional tariffs effective Dec. 15.
MIDDLE MARKET INSIGHT: Middle market consumer products companies often do not have the same negotiating and pricing power that big-box stores enjoy. As a result, tariffs can have a disproportionate impact on their operational and financial performance.
Shifts in companies’ supply practices will continue, with the impact showing up in hard data toward the end of 2019 and into 2020. Even if an agreement is reached between the United States and China, the effects will persist well beyond an agreement date. As a result, firms in the consumer ecosystem should have both shortand long-term financial and operating plans heading through the second half of 2019.
FASHION, BEAUTY AND HOME FURNISHINGS
The fashion, beauty and home furnishings sectors were not affected as significantly as other consumer products by the first three tariff lists. That won’t be the case with List 4, which includes approximately $28 billion in apparel items. Overall, the list covers about $51 billion worth of goods, including footwear and home textiles, according to the American Apparel & Footwear Association.
The increased costs could put significant margin pressure on companies throughout the supply chain. With previous tariff lists, RSM clients have suggested that a 10% tariff can be spread throughout the supply chain to mitigate impact. But the apparel and footwear sectors are already subject to tariffs, and List 4 will impose tariffs at a higher rate of 15%, rather than the previously announced 10%. The new rate could put additional stress on costs, resulting in the need to pass those costs through to consumers more quickly. In an industry that includes many discretionary items, customers will be more sensitive to price increases. Higher prices, coupled with the uncertainty surrounding the economy at home and abroad, may eventually dampen sentiment.
In addition, today’s consumer has shown a penchant for discounts. According to the National Retail Federation, the majority of shoppers were looking for discounts and sales before they made purchases during the backto-school season beginning in August.
The discount-hunter mentality is most likely not isolated to one shopping season. If apparel retailers need to offer discounts to be competitive, that leaves less room for profit and diminished pricing power further down in the supply chain. This trend could have a significant impact on middle market companies, especially those in the middle of the supply chain. Typically, these companies have less purchasing and pricing power throughout the ecosystem, which could lead to a disproportionate share of the overall financial impact.
In the first half of 2019, restaurants benefited from a strong consumer buoyed from the benefits of tax reform, strong wages and general confidence in the economy. According to Black Box Intelligence, total industry sales were up close to 4% in the first quarter of 2019, compared to a year earlier, and certain segments, such as fine dining and fast casual, grew more than 7% over the same period.
Despite the strong overall industry sales, the restaurant sector has suffered a recent decline in same-store sales and overall traffic as the industry transforms to cater to today’s convenience-driven consumer. In the second half of the year, tax reform benefits are now in the rearview mirror and economic uncertainty surrounding the protracted U.S. trade war with China will most likely hurt consumer sentiment if an agreement is not reached in the near-term. As a result, downward trends could continue.
A continued focus in the ecosystem in the near term will be to manage increasing costs. Increases in minimum wage in many states means higher costs for operators. The impact doesn’t stop with those employees making minimum wage. As wages for entry level workers increase, managers and more senior employees seek increases as well. The result is a compounded effect on overall labor costs.
FOOD AND BEVERAGE
Food and beverage sales have been strong in 2019, with year-over-year growth close to 5%. Similar to other sectors throughout the consumer ecosystem, margin pressures will be the focus in the near-term due to inflation. While inflation has been benign at a macroeconomic level, the sector faces rising labor costs and historically high transportation and warehousing costs. According to the Bureau of Labor Statistics, the Employment Cost Index for Transportation and Warehousing rose 16% in the last five years.
Food and beverage companies may be able to offset higher costs with price increases. However, with prices expected to rise across other consumer goods as a result of tariffs, pricing requires a careful balance. Many brands will likely attempt to charge higher prices by capitalizing on growing demand for organic, sustainable and healthy foods. Larger front-runners such as Beyond Meat and Impossible Foods will have an advantage over middle market competitors because of their ability to leverage economies of scale.
The introduction of cannabis-infused foods and beverages represents another notable trend in the food and beverage ecosystem that could help drive sales. Many larger food manufacturers have already invested in marketing strategies to introduce their customer base to these products and boost demand ahead of full Food and Drug Administration approval.
One of the strongest categories for retail early in 2019 has been non-store sales—which is predominantly digitally native firms—which was up more than 14% year-over-year through August. In a world where consumer preferences are constantly evolving and shoppers are using many different channels to find the right product at the right price, the role of traditional brick-and-mortar stores has evolved. Traditional retailers are shrinking their physical square footage and increasing investment in digital strategies to attract and retain customers. At the same time, brands that have historically operated only online are opening physical locations to accommodate consumer expectations for a multichannel experience.
Despite strong growth, online sales may be decelerating. Beginning in mid-2018, sales began slowing to the 12%-15% growth range from a high of more than 17% in the fourth quarter of 2017, according to data from FTI Consulting. While e-commerce is expected to remain strong, its recent slowdown may be a sign that the sales channel has hit a natural inflection point as online sales have been more widely adopted.
MIDDLE MARKET INSIGHT To distinguish themselves in the online space, middle market retailers should look to take advantage of emerging technologies to create unique and innovative experiences for their consumers as the lines between e-commerce and traditional brick-and-mortar retailing continue to blur.
Whether or not retail sales remain strong through the critical holiday shopping season depends in large part on how consumers react to trade policy and other geopolitical pressures such as Brexit. These issues are likely to affect consumer confidence, levels of spending and the timing of purchases.
Even if tariff-related price increases don’t make their way through the supply chain to retail shoppers in time for this holiday season, consumers will likely accelerate their purchases to avoid what might be perceived as higher prices at the register later in the calendar year. As a result, retail sales will most likely remain strong through the early part of the fourth quarter. December, as is often the case, will be a make-orbreak month for many retailers, and perhaps the economy as a whole.
Throughout the consumer ecosystem, labor will be front and center in coming months as retailers staff up for the holiday season. Higher wages and benefit costs may hurt profits. But in the end, businesses have little choice. Despite creative attempts to attract and retain talent through other means, retailers will have to pay the higher wages and offer more attractive benefits to achieve a positive customer experience and sales growth.