Top 10 risks and opportunities for 2012
and beyond

Retail and Consumer Products Commentary - January 2012

As the new year commences, Director of Retail and Consumer Products Advisory Services, former industry analyst Jeff Edelman, takes a detailed look at the most critical issues for retailers and vendors and provides advice that could help lead to success in what may otherwise be another challenging year.

Another year of lethargic growth: Consumer spending, largely tied to employment growth, will likely maintain its slow uptrend. Interestingly, corporate profitability has increased sharply over the past two years reflecting rising worker productivity and the ability to pass through higher costs. However, few managers are willing to expand or invest because of uncertainty due to inaction in Washington, D.C. and fear about a further tightening in the regulatory environment. They seem inclined to only add to the workforce if and when there is a more defined upturn in business, rather than bear the burden of higher costs in anticipation of recovery. Thus, it seems likely that 2 percent real GDP growth is a reasonable expectation, followed by a similar increase in employment and consumer spending. Importantly, this does translate into higher retail sales, but a rising tide will not lift all ships. Market share will be an integral part of vendor and retailer sales growth this year.

Shopping malls: an evolving landscape: Mall sales productivity, according to the International Council of Shopping Centers, rose from an annualized monthly rate of $30 per square foot in 1Q03 to $38 in 4Q06, dropping back to $30 in 1Q09 and then approximating $36 in 3Q11. Coincidently, mall vacancy rates dropped slightly to 9.2 percent in 4Q11 from an 11-year peak of 9.4 percent in 3Q11. However, given the number of store closings recently announced, that rate could move up again in upcoming quarters. Importantly, store traffic, number of stores shopped and conversion rates continue to decline largely due to growth of the Internet and increased frequency of more value-priced destinations.

Multichannel is key to survival for many: Online retailing threatens existing store economics, measurement systems and incentives. Bricks and mortar have an advantage over online only with the ability create excitement and the "want" to purchase—Apple is a prime example as well as some luxury retailers. Retailers have always "believed" customers will always be there, which was a wrong assumption. Moreover, they have become less tolerant of a poor shopping experience. Integrating the process and reaching out to the target consumer with a specific product or idea can drive incremental traffic to site or store. The shopping experience is further enhanced with store pick-up for instant gratification or ease of return to the store.

Sears and Kmart can be a game changer: The recent announcement of additional store closings was not a surprise; however, the magnitude of underperformance of the entire chain raises some question, in our view, about their longer-term viability. Lack of management consistency and direction has provided market share opportunity for other retailers with a better strategic vision and reason for the consumer to frequent their venues. Expense reduction and increased technology investment might turn out to be too little too late to recapture their lost customer base. In the meantime, suppliers are likely to remain in a state of flux regarding continuity of business and could be squeezed further. Merchandise liquidation could sustain a promotional environment, not to mention the above mentioned mall vacancy rates.

Enhancing the shopping experience is integral to a retailer's success: However, that becomes more difficult for those that are poorly positioned. Coming back to our point of declining shopping mall productivity; as sales per square foot declines, management will cut expenses to maintain margin, but as service declines, sales drop further. The wheel just keeps going around; defensive action cannot move a strategy to one of strength. To change a store from a liability to an asset requires a different management mindset. There is no shortage of any place to buy anything; however, becoming a destination point can make the difference. A loyal customer can be several times more profitable than a new one; maintaining a strong loyalty program can generate multiple repeat visits.

Differentiation versus price: One can be competitive and survive as long as that strategy is coupled with the ability to be a low-cost provider. However, it becomes difficult to roll back prices when sourcing efficiencies and expense reductions have been exhausted and still maintain profitability. Differentiation, whether it be a point of view, service, selection or a variety of other factors can become a key traffic driver. "Want" rather than "need" is most critical in driving consumer purchase decisions.

Branding can be a key to success: Brands can create and identify communicating "want" solutions to targeted consumers. These could represent consistency in sizing, quality, fashion right, uniqueness and the appropriate price/value relationship. Admittedly, the ratio between price and value differs for each consumer and demographic group; strong brands have been successful directing their message to their target customer. Putting it differently, produce and offer the product you believe your customer wants, rather than what is most cost efficient to offer.

Store consolidation has had an impact on brands: That is likely to continue. Marginal brands and secondary store labels are becoming more irrelevant. Buying power improves as strong retailers increase market share, which is evolving into a more efficient sourcing capability. Furthermore, brand exclusivity, whether licensed or owned, can insure against pressures from competitive pricing. Brand strength can increase store traffic and enhance brand loyalty. The middleman or producer of other merchandise will likely continue to lose market share and suffer ongoing erosion in profitability.

Financial metrics are changing: Online retail has definitely altered the business model, either because of lost volume from the store or through increased costs of multichannel development. Financial managers are beginning to focus on return on investment (ROI) and gross profit dollars per square foot rather than the overall profit margin. The days of driving unit volume at the expense of margin are fading as it has quickly become a losing proposition. However, appropriate merchandise assortment for the targeted consumer, and offering the right price value relationship, can drive higher gross profits per square foot. Multichannel investment is an important contributor to brand equity and Internet volume. Allowing for free shipping and returns, and matching competitive online pricing where applicable, a higher ROI can often be achieved even though the business has a lower gross margin. It is the higher overall return that enables reinvestment for further growth.

Stay ahead of the curve: Winners continue to reinvent themselves within a steadily evolving environment. Plans have to be flexible rather than etched in stone, and they need to be reevaluated constantly as competitive issues and the environment changes. If you are doing the same thing you did yesterday, then someone else has already caught up to you. Leaders can remain ahead of the pack while the distance between followers widens.

Jeff Edelman is Director of Retail and Consumer Products Advisory Services for McGladrey, 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@mcgladrey.com.