Ho, ho, hold the applause

By Jeffrey B. Edelman

All things considered, Q3 trends mirrored those of Q2, with slow consumer spending growth reflecting the slow growth in employment and income, relatively stronger sales of housing-related merchandise and ongoing penetration of e-commerce. Weak store traffic continued; those stores that are innovative and differentiated with a strong Omni-channel presence were able to increase market share.

Dynamics began to shift in September: Fashion influences positively impacted the whole sector, particularly in the better women”™s and men”™s areas later in the month, strengthening in October. Nevertheless, most of the volume reflected increased promotional activity; many retailers experienced declining gross margins that ranged 30-50 basis points on average.

Omni-channel continued to be an important contributor to top line growth: Q3 success was marked by differentiation and customer targeting. Using social networks and multimedia techniques allowed retailers to connect with consumers in a targeted, meaningful way. As consumers perform more online research in advance of shopping, smart retailers can connect with customers in a way that influences their purchasing decisions. Nordstrom noted its best customer sales came from those that were “best connected,” generally spending three to four times more than other purchases.

Macy”™s posts gains, while others struggle: Comparable store sales were relatively flat for many of the reporting retailers. Macy”™s was one of the stronger reports, with a 3.5 percent comparable store sales increase, largely driven by its online volume.

At the opposite end of the spectrum, Kohl”™s came in with a small decline (1.6 percent) in its comparable store sales, as it had not yet fully implemented changes to its desired brand mix.

Value led the parade: TJX was one of the winners, with its 5 percent comparable store sales gain. It might be more correct to say perceived value was an important consideration, rather than just low prices. Impulse purchases and the “want rather than need” merchandise were central to consumer purchases within the value sector. TJX benefited from excess branded vendor merchandise, which seemed to overshadow the price/value merchandise offerings by many department stores in the quarter.

Holiday sales are likely to post the weakest gain in several years: Holiday sales projections are down this year, perhaps +2.0-2.5 percent, compared to around 3.5 percent last year. The big issue remains slow employment growth and weak consumer confidence. The hiring rate will not likely improve over the near term because of the uncertain macroeconomic backdrop. A shorter selling season promises to be a difficult headwind as there are 25 days between Thanksgiving and Christmas versus 32 last year. However, online shopping will be the big winner, with sales expected to increase at a double-digit rate.

The calendar shift, with 52 weeks this year versus 53 in 2012, will distort reported sales for December and the quarter as a whole, appearing to be much weaker on a comparable basis.

Heavy promotions started earlier this year: Retailers that opened Thanksgiving evening got a jump start on most others; accordingly, 8 p.m. openings are becoming the norm. In addition, Hanukkah began on Thanksgiving. We could see that some of that purchasing was also pulled earlier; a much larger percentage of volume may occur earlier at lower margins this year as retailers looked to capture a share of consumer”™s wallets sooner.

Consumers remain value focused: Off-price retailers and factory outlet stores are likely to show the best sales increases, similar to recent quarters. Retailers need to offer the right price/value relationship for the target consumer. Consumers are sensitive to price changes, but will not sacrifice quality in many cases. The growth in the factory outlets has proven that there is a segment of the consumer who will sacrifice the latest fashion for wearing a brand at a lower price.

The aftermath: This increased promotion, on top of not achieving projected sales growth, will negatively impact the gross margins of every retailer. They will likely have too much inventory at the end of the season. Suppliers to retail will presumably face returns in addition to higher charge backs and requests for increased markdown allowances from retailers. A number of suppliers also run the risk of cancellation or decrease in orders for resort or spring 2014. The impact of the pre-Thanksgiving storms are unknown, but they will likely hinder sales figures.

With weak holiday sales, more retailers and companies supplying them will be financially challenged, have a harder time getting sufficient financing, and become more vulnerable to takeover by strategic and financial acquirers. We will likely see more consolidation at the supplier and retailer level. The bigger retailers will get stronger and the buying power will shift to the retailers, putting more pressure on the suppliers to differentiate or keep prices low to survive.

Jeffrey B. Edelman is director of retail and consumer products advisory services for McGladrey in the firm”™s New York City office. He can be reached at (212) 372-1225 or jeff.edelman@mcgladrey.com.