Consumer products industry outlook
Volume 6, Winter 2021
In the early part of the year, most consumer products companies will feel a hangover from the pandemic-induced recession of 2020. However, as the economy begins to accelerate in the second half of the year, significant opportunity exists across the entire consumer ecosystem. From retail and restaurant to food and beverage and apparel sectors, those middle market businesses that remain nimble and optimize their digital strategy to follow changing consumer habits, forecast opportunities, and drive marketing and sales will emerge from the recession well positioned to capitalize on pent up consumer demand and stronger economic conditions.
Key takeaways from the Winter 2021 consumer products industry outlook
- The entire consumer products ecosystem is increasingly dependent upon the ability to access and interpret consumer data.
- E-commerce will continue to increase and evolve as experiential online retail.
- Expect restaurants to focus on top-line sales to stabilize operations as they emerge from hibernation.
- The food and beverage M&A landscape will include add-on acquisitions that provide additional market share or entrance into new segments.
- Consumer attitudes are now prioritizing practicality, comfort and value over fashion.
Retail’s New Year’s resolution
As we finally turn the calendar to 2021, the retail industry faces its most important New Year’s resolution in recent history. Retail e-commerce sales spiked during the COVID-19 pandemic, climbing to greater than 30% growth in 2021. While the overall pace of online sales growth will slow in 2021, e-commerce’s overall share of retail sales will be significantly greater in the year ahead and beyond, reaching levels that many in the industry didn’t forecast until 2023 or later. The New Year’s resolution for every retailer should be to adjust their strategy and operating models to position themselves for success in the post-pandemic consumer ecosystem.
Evolution of digital retail
In addition to the simple increase in online sales, the consumer ecosystem will also see the evolution of digital retail away from simple commerce to experiential online retail. The concept of experiential retail that has been focused on brick and mortar to date will find its way into the digital strategies of retailers in the U.S. in the next six to 12 months. The technologies that enable virtual experiences such as livestreaming and augmented reality are becoming cheaper and easier for retailers to adopt. According to a study by Bain & Company, Chinese consumers expected their use of livestreaming or short video to increase by more than 25% in 2020. These concepts are already more widely used and well received by consumers in Asia, which has been at the forefront of digital retail.
Margin compression continues
The post-pandemic shopping patterns of consumers will be critical to retailers because of the adaptations necessary to capture sales through different channels. There’s also a secondary relevance to changing retail channels: Sales through nontraditional brick and mortar have proven to be much more costly, having a significant impact on margins.
Beyond the direct costs associated with picking, packing and shipping, sales through new channels may require a new marketing strategy, which could come at the cost of incremental investment. The adaptations made by retailers thus far during the pandemic have been to keep lights on and drive sales, but the focus in 2021 will turn to profitability. The importance of this focus was highlighted by Doug McMillon, Walmart’s president and CEO, on the retailer’s Q3 2021 earnings call in December.
McMillon stressed that “the ability to leverage cost to pick efficiently, obviously getting things into one box, as much as possible, getting shipping efficiencies, all those kinds of things are going to generate sustainable businesses as it relates to e-commerce as a channel over time.” Many middle market retailers have not been built to accomplish scale and efficiency as it relates to these critical activities that help to protect profitability through digital channels.
The rich get richer
Prior to the pandemic, the housing market in the United States was strong. However, after the immediate short-term shock created by the COVID-19 pandemic, the housing market has taken off and far exceeded pre-pandemic levels. With mortgage rates remaining at historic lows, and optimism likely to improve as the pandemic slows with the rollout of the vaccine, home sales are likely to continue their ascent in the spring of 2021.
More importantly, on a year-over-year percentage basis, new home sales have far outpaced existing home sales. This is particularly relevant in the retail sector, as new homes, usually fueled by first-time home buyers, create significant opportunity for home furnishings and home improvement retailers. With the continued strength in new home sales, these sectors will likely continue to see strong top-line results in the short and intermediate term.
Another sector that benefitted from changing consumer behaviors during the pandemic was the retail food sector. Both grocery and convenience stores saw very strong sales performance, as consumers shifted to preparing and eating more food at home during the pandemic.
While the balance between food at home and food away from home may shift as we move out of the pandemic, there is one COVID-19 trend in the ecosystem that will likely survive. In 2019, online sales represented only approximately 6% of sales, which lagged behind overall retail sales. The growth in online sales in the grocery sector, which had remained relatively steady for years, accelerated significantly beginning in March.
The convenience of at-home delivery and curbside pickup that so many have become accustomed to during the pandemic has removed some of the hesitation that may have existed. In addition to the convenience, consumers realized that many other fears that existed as they relate to purchasing groceries online, such as the inability to choose your own produce, may have been unfounded. As a result, middle market grocers who may not be as far along in their digital transformation journey as big box competitors such as Kroger will focus their operational strategies around adjusting their model to meet the changed preferences of the post-pandemic consumer. According to a survey conducted by Coresight Research in August of 2020, 36.4% of online grocery shoppers don’t expect to change their new habits when the pandemic ends. To that end, we believe that investment in digital transformation will increase dramatically across the entire ecosystem as we get further into 2021, particularly in the middle market.
The poor get poorer—restaurants struggle
After stimulus from the CARES Act and outdoor dining created a bridge for most of the restaurant sector throughout the summer and early fall, the bridge finally ended in the fall of 2020. In our fall 2020 edition of The Real Economy: Industry Outlook, we highlighted a trend in the data that showed diners may be slowly returning to restaurants to dine in and pointed out that making diners comfortable in the winter months would be the next challenge. Unfortunately, the worst case scenario played out, as the virus surged across the United States and the trend began to reverse.
In addition to the worsening pandemic, a failure by Congress to agree on a second stimulus bill and an additional round of PPP until late December, coupled with colder temperatures, has wreaked havoc on the restaurant sector. As 2020 came to a close, many restaurants closed their doors. Some closures were permanent. Others were a temporary closure for the winter months, or what the industry is calling “hibernation,” in yet another creative attempt in the ecosystem to survive the pandemic.
Restaurants on the other side
Despite the vaccine promise, things are not likely to change for the sector in Q1. With the exception of quick serve, which stands to gain from the continued pandemic battle, many restaurants will emerge from hibernation in early spring with hopes that pent up demand will help propel them into recovery. The critical period for most family dining chains will be the spring, as the second half of 2021 will likely see significant improvement as the country moves through the vaccination effort toward herd immunity. During this time, many operators will have to make critical decisions about the future operating model in light of changes in consumer preferences.
In the late first quarter and into the second quarter of 2021, expect restaurants to be focused on driving top-line sales to stabilize operations as they emerge from hibernation.
MIDDLE MARKET INSIGHT
Moving into the second half of 2021, the focus will shift to necessary investments in technology and changes in operating models to improve profitability and thrive in the post pandemic ecosystem.
One of the most significant operational decisions for many in the casual dining space will be deciding whether or not to expand or adopt a large off-premises model. The transition for asset-light, quick-serve restaurants is much easier than it is for some of their casual peers, who have a physical footprint and operating model that is designed to accommodate on-premises dining as the primary sales channel.
The entire consumer ecosystem is becoming increasingly dependent upon the ability to access and interpret data to analyze, predict customer habits, and to drive marketing and sales strategies. In the intermediate to long term, the restaurant sector will also follow suit, regardless of the segment.
Significant opportunity in 2021
While the first half of 2021 will continue to bring challenges for retailers and restaurants alike, the second half of the year presents a very significant opportunity. The RSM economic forecast for the second and third quarter of 2021 suggests significant acceleration of GDP. This growth will be fueled in large part by increased consumer spending as the vaccine becomes more widely available and a combination of a deceleration of the pandemic leading to improvements in the job market and in consumer sentiment.
In order to capitalize on the significant opportunity created by an improving economy and pent up demand throughout the consumer ecosystem, retailers and restaurant operators should focus on three key areas as they refine their channel strategy to react to changed consumer habits that will survive the pandemic.
- Solve the labor equation – The second round of stimulus passed in December extended the unemployment benefit. What it did not do is provide aid to the states. The likely result is further layoffs and cut backs to public services such as transportation. Understanding the labor needs of the business, and then finding qualified employees will be more important than ever.
- Invest in technology – For those that adapted quickly to allow for purchases through new and different channels, it was often done as quickly as possible to allow for survival in a difficult cash flow situation. On a longer-term basis, technology solutions, together with the associated operating models, need to be right-sized to allow for profitability, not just sales generation.
- Optimize supply chain – Technology and operations on the customer-facing side is one piece of the profitability equation. Equally as important is managing the supply chain and refocusing on inventory management and logistics to match up with sales through these new channels.
Consumers’ eating behaviors continue to evolve due to the pandemic. Simple, natural and, now, immunity-boosting ingredients continue to be an important component of their buying decisions. According to Innova Market Insights October 2020 research, six out of 10 global consumers look for food and beverages that support immune health. As many consumers feel that various factors are out of their control when it comes to the pandemic, choosing foods with immunity boosting properties are one way they feel they can make a difference. Larger CPG companies are taking notice of consumers’ ingredient choices and highlighting the benefits in their products such as the probiotics in yogurt and turmeric in herbal teas.
The plant-based movement grew significantly during the pandemic even with closed or minimally operating restaurants. Consumers continue to want sustainable proteins with additional nutrients and have tried these items as they cook at home. Plant-based beverage options, once soy only, are now readily available from a variety of sources such as almond, oat, pea and hemp. Meat alternatives exploded. According to IRI, sales of alternative meat products grew 54% year over year from 2019 to 2020.
Innovation in processing both plant-based and cell-based proteins continues to develop as the need for sustainable food choices grows in importance.
The shift to eating at home has created a focus on overall wellness. The consumer still wants to eat a balanced diet with the occasional indulgence of their favorite treat or take-out entrée that they can’t make at home. Salty snacks and chocolate candies both doubled in growth year over year according to IRI data from 2019 to 2020. We expect cooking at home to continue as it can be less expensive than eating out and has become a habit more than a necessity.
The resiliency of food and beverage manufacturers and distributors was remarkable in 2020. These businesses overcame supply chain disruptions, created omnichannel solutions and reevaluated processes to protect their employees and cut costs. Business decisions that once took several months were often made in days to meet customer demand. Regardless, the companies which could quickly adapt had strong results.
However, 2021 will not be without its challenges, even with the increasing availability of the vaccine. Many middle market food manufacturers and processors are struggling to find labor to meet heightened demand. While unemployment remains high, the labor supply has been disrupted in the pandemic due increased unemployment benefits, health and safety concerns, and family demands. In order to attract talent, businesses have had to offer increased wages and attractive fringe benefits, all putting pressure on their bottom line. Commodity costs and futures are also on the rise as seen below. Finally, with the rise in e-commerce and the subsequent strain on trucking capacity, manufacturers are expecting higher shipping costs.
MIDDLE MARKET INSIGHT
Middle market food and beverage manufacturers will benefit from a tailored digital strategy to optimize costs and operations and keep these rising costs under control.
Mergers and acquisitions
Food and beverage deal activity remained relatively quiet due to disruption from the pandemic. There was an uptick in capital invested in the fourth quarter prompted by stronger balance sheets and potential future capital gains rates.
MIDDLE MARKET INSIGHT
In 2021, it is anticipated that the M&A landscape will be smaller with add-on acquisitions that provide additional market share or entrance into new segments rather than multibillion-dollar, debt-heavy mergers.
For many larger middle market companies, the opportunity to divest nonperforming brands will aid in reducing costs. Much of the activity will also be to better keep up with consumer preferences. For example, McCormick recently purchased Cholula Hot Sauce and FONA International, a natural flavor company to tap into the growing demand for at home cooking and healthier eating.
Delivering more with less in apparel
With encouraging hopes of widespread vaccinations in 2021, apparel companies have reason for optimism after a volatile 2020. However, while there may be certain categories poised for immediate growth, apparel businesses should brace for a slower recovery. Overall apparel sales are expected to trend below pre-crisis levels until sometime in 2022 or 2023; companies should turn their attention to protecting market share and improving profitability to drive more value out of a smaller consumption pie.
Although U.S. consumer spending on clothing and footwear purchases peaked in 2019, the amount consumers have dedicated to apparel and fashion purchases has been on the decline for the last 30 years. Apparel purchases fell to less than 2.5% of total consumer spending in 2020 compared to 5.3% in 2019. With restricted mobility, many consumers’ wardrobes have outsized their lifestyles, indicating that spending on apparel is expected to remain muted even as consumers return, on a limited basis, to restaurants, work and events.
Overall consumer attitudes are now prioritizing practicality, comfort and value over fashion.
Continued COVID-19 outbreaks, delays in the broad rollout of vaccines and new work from home patterns will also slow the recovery to pre-pandemic levels.
Coming out of the 2008 recession, many apparel companies used discounting strategies to capture pent up demand and to grow top-line revenue and market share at the cost of profitability. In the expected slower growth environment, companies in this sector should be focused on maximizing profits on sales. A common factor eroding margin dates back to the 2008 recovery, when apparel companies offered broad selections of SKUs and styles to avoid missing out on trends and cater to broad demographics. Unsold merchandise was sold at heavy discounts through off-price and discount channels. Discounting came to a peak at the onset of the pandemic as apparel companies looked to free up cash flow locked in inventory. However, in the second half of the year, apparel companies were able to right-size inventory levels, bringing total apparel inventory to the lowest level since December 2013. Likewise, inventory-to-sales ratios were brought back in line to pre-pandemic levels for both wholesalers and retailers from their Q2 2020 peaks of 6.1 and 17.7, respectively, despite sales levels that remain depressed.
Inventory discipline is only half the story for profitability as less inventory means less revenue opportunity. Apparel companies should be investing in technology and customer relationship resources to take a demand-focused approach to planning. This is particularly important for middle market apparel companies that may be spreading their bets across smaller product offerings while also protecting market share. Taking a data-driven approach to bring together marketing strategies with product planning will allow companies to invest in hero products and build out complimentary offerings to keep inventory levels manageable and reduce discounting, without missing out on opportunities.
For many companies in the fashion, beauty and home furnishings sectors, e-commerce has gone from a long-term growth strategy to a means of survival during the pandemic. With significantly reduced foot traffic at malls and department stores, which were key sales channels for these sectors prior to the pandemic, smart business owners quickly pivoted to reach customers through digital means. E-commerce is likely to remain crucial as the spread of the coronavirus will continue to keep consumers at home and widespread vaccinations aren’t anticipated until sometime later this year. Companies in these sectors should be investing in e-commerce strategies and tools that will allow them to integrate high-touch human experience through digital channels to continue to compete even in a post-COVID-19 world.
Online marketplaces like Amazon and Wayfair provided the easiest means of getting products to consumers at the start of the pandemic as many companies had already been selling to them, and they had logistics infrastructure to scale quickly that many producers lacked. However, as the pandemic continued, fashion, beauty and home companies that invested in their own e-commerce platforms saw better growth overall. According to data compiled by the U.S. Census Bureau, e-commerce year over year growth through the third quarter of 2020 increased 33.5% and 49.1% for clothing and accessories, and home furnishings, respectively, compared to nonstore retailers (a proxy for purely e-commerce players like Amazon and Wayfair) which only had 27.6%.
Investing in e-commerce platforms allows fashion, beauty and home companies to harvest valuable consumer data while avoiding margin-eroding marketing and logistic fees that come along with selling through third-party online market places. Most importantly, it allows a company to control its online customer experience, a critical aspect for the high-touch nature of the products sold in these sectors.
MIDDLE MARKET INSIGHT
While many companies have embraced digital technologies such as customer service chat bots and product recommendations, those investments that create a personal touch will have the most impact on converting sales and building customer loyalty.
Beauty companies, which long relied on the counter experience, have embraced digital sampling and online application demonstrations. Home furnishing and apparel companies have used augmented reality to preview how apparel may look with complementary products or how pieces work together in a room. Live online shopping assistants are providing a level of customer service customers would hope to see in stores while also increasing conversion rates across all sectors.
As consumer behaviors evolve in a post-pandemic world, these online experiences will continue to play an important role in how consumers interact with brands and make purchasing decisions. Businesses will need to continue to make these investments a priority and tailor them for those new behaviors, including directing consumers back to physical locations for those who prefer that channel.
Sourcing beyond China
From tariff exposure early in the year to supply chain disruption caused by the COVID-19 pandemic, 2020 highlighted the risks associated with the apparel and textile supply chains’ overdependence on China. As the global economy and supply chains rebound, many companies in this sector will still face the same issues they saw at the start of the pandemic.
While the Trump administration has left office, it won’t mean the immediate release of section 301 tariffs placed on many U.S. imports from China. Biden has generally favored free trade, but his administration will likely use the relief of tariffs as part of a larger trade deal focused on intellectual property protections and human rights. Trade talks with China may be a second step for the Biden administration to strengthen ties with other allies in the region or possibly for entering into the Trans-Pacific Partnership. On top of tariffs, labor costs continue to rise in Chinese-apparel producing regions, making other apparel-producing countries more attractive. Finally, as more light is shed on the forced labor of ethnic minorities in the China’s Xinjiang Uighur Autonomous Region (XUAR), apparel and textile companies will need to consider further economic penalties for finished products and materials sourced in that region on top of damage to their own brands’ reputations.
While China remains an important part of the overall apparel supply chain, it’s been surpassed by Vietnam as the largest exporter of cotton apparel to the United States. Companies that have moved on or diversified away from Chinese production stand to benefit from any new trade treaties with other Asian manufacturing economies. Those that moved production to Central America have been able to source and adapt to consumer behaviors quicker without the shipping-container disruptions that have plagued many ports on the West Coast.
Companies that may have moved production should consider corporate social responsibility risks within their supply chain. Many countries that may be attractive alternatives with low labor costs might have labor treatment issues of their own, and cotton grown in the XUAR is being exported to other Asian countries like India and Vietnam. Cotton produced in the region makes up 20% of the global market. With emerging technologies like blockchain improving transparency in sourcing, apparel companies should work with vendors to understand sourcing and verify where possible.
Home furnishings strength
It’s no secret that home furnishings businesses benefited during the pandemic from consumers’ homebound behaviors. As consumers sheltered in place and practiced social distancing, they redirected spending that would have otherwise been earmarked for travel and experiences into their homes, making them more livable and functional. While hope that vaccinations will allow consumers to return to some pre-pandemic behaviors and spend more time away from home, home furnishings will still have tailwinds heading into 2021.
Consumers enter 2021 with strong balance sheets. According to the Bureau of Economic Analysis, U.S. household savings rate was 12.9% at the end of November 2020 exceeding the pre-crisis, five-year average of 7.4%.
In addition to increased savings, new home activity should provide demand for home furnishings products. During the pandemic, many consumers in the professional class migrated to the suburbs, lured by historically low interest rates and telecommuting, lessening the importance of proximity to physical offices. The shift put pressure on existing home inventory which was already low prior to the pandemic. Through November 2020, new home sales exceeded that of the same period in 2019 by 19.2% according to the U.S. Census Bureau. Additionally, of those home sales, an increasing percentage are being sold under construction or built to order, meaning they are unfurnished and aren’t ready to be lived in for months. A flurry of cash-out refinancing activity fuel by those low interest rates helped drive remodeling activity as well. The National Association of Home Builders’ remodeling market index, which tracks both current and future indicators and sentiment among builders, reached all-time highs in Q3 2020 on the strength in calls for bids and work commitments over the next three months and backlogs.
Beauty spurs acquisitions
The beauty sector, which has been resilient during past recessions, found itself hit hard during the COVID-19 recession as consumers sheltered in place. With consumers spending more time at home, they looked to alternative purchases to fill the role of affordable indulgences that cosmetics played in past economic downturns. However, the industry responded by accelerating innovation in areas from customer experience to packaging and ingredients to meet the needs of a beauty and personal care consumer with different priorities. With post-pandemic behavior on the horizon in 2021 and consumer behavior set to shift again, large beauty players will be positioning themselves to right-size their brand portfolios to align with preferences. Many of these large companies right-sized their debt-heavy balance sheets during the pandemic and will look to acquire proven middle market brands to accomplish this.
Merger and acquisition activity already roared back at the end of 2020, led by the venture capital and private equity communities anticipating what the new beauty and personal care landscape will look like and where strategic acquisitions may take place. The fourth quarter of 2020 saw over $2 billion in capital deployed in beauty and personal care companies. Deal activity shows that PE firms and strategic acquirers invested in companies with innovative sales models that bring the personal touch of the beauty counter and salon experience to consumers in their own homes, and those that offered customizable or functional product lines that could be tailored for specific customers or offered health and wellness benefits.
Get data-driven economic insights and outlooks on a variety of middle market industries provided by RSM US LLP senior analysts.