Insight

Retail viewpoint: back to school—boom or bust?

August 2017

July core retail sales posted a 0.6% month-over-month increase1 – the biggest increase since January. Retail sales for June and May were also revised higher.2 Amazon held its annual Prime Day last month, which helped boost sales of so-called nonstore retailers by 1.3% last month, the largest increase since December.3 Sales also rose 1.2% at auto dealers, 1.2% at home and garden centers, and even 1% at department stores that have been losing ground to internet rivals.4 Steady hiring, the lowest unemployment rate in 16 years, and (slowly) rising incomes have all buoyed consumer spending, which increased at a 2.8% annualized rate in the second quarter and helped push GDP growth to 2.6%.1

With September just around the corner, we’re deep into the much-anticipated back-to-school (BTS) shopping season. The raging BTS debate between the National Retail Federation (NRF) and the New York Post have left many wondering where to place their bets this year.

Over the past few years, BTS sales have grown 3-4%. But the NRF expects bullish double digit growth this BTS season. Why? Because of increasing consumer confidence, higher college enrollment, and a growing trend of college students moving out of homes and into dorms and off-campus housing. The NRF also cited a third-party survey whose respondents said they were willing to spend more this year.

The Post cast doubt on that prediction (to put it lightly). The Post cited store closures, bankruptcies, sluggish mall traffic, and tumbling sales and said the NRF’s glowing outlook had them "wondering if a new crystal ball is in order."

So, who should we believe? Based on the macroeconomics—which we’ll discuss in more depth later—it’s unlikely that a broad swath of consumers will increase their spending by as much as the NRF predicts. US consumers changed after the 2008 financial crisis; they face new priorities and tradeoffs when considering how to maximize their dollars. Yes, there are pockets of people who will spend more, but the focus on value and necessities will probably limit topline growth.

The most important thing retailers can do this season is face the market appropriately stocked and priced—or risk losing possible gains. We see bright spots and soft spots from both the consumer and retailer’s points of view and think retailers that made hard choices, went on inventory diets, right-sized businesses, and realigned offerings will take advantage of this BTS season.

Let’s start with the consumer’s perspective…

With unemployment down to 4.3%, the US has returned to pre-crisis levels, even when factoring in underemployment.6 Some might even argue that the nation’s economy is in a much better place for retail than it was before the crisis. Low interest rates have kept consumer savings only around 100 basis points above pre-crisis levels, which led to greater personal consumption. Additionally, $15 billion in credit card balances came off households in Q1, freeing up credit. Taken together with high consumer confidence, that should be enough to fuel a strong BTS season, right?

Not necessarily. Certain economic trends inside households across the US can’t be ignored. First of all, household debt has exceeded 2008 levels by $50 billion—straining budgets (figure 1). That’s on top of price inflation, which last year’s raise and bonus probably didn’t cover. While wealthier friends nabbed designer handbags or upgraded their cars, average middle class consumers continued shopping for necessities but traded out of Whole Foods and opted for a staycation this summer.7

As for the retailer’s perspective…

Consumer confidence is up, but it’s still not high across the board. Any increases in spending don’t seem to be making their way to retailers. Companies are forced to run promotions constantly, and either match last year’s deals or get even more aggressive to move products off shelves. This of course drives margins down and can often outweigh any potential gain on the sales lift upside. Simple math shows that the advantage of selling closer to full margin can greatly outweigh selling more at lower margin.

Let’s take for example a $100 pair of sneakers typically selling today at 30% down from full price.

Retailer A:

  • $100 at 30% off at cost of goods sold (COGS) of $45 = $70
  • Sell price -$45 COGS = $25 unit margin
  • $25 unit margin x 1,000 units = $25,000 total margin

Imagine that another retailer is selling the same pair of sneakers. But because of forecast inaccuracies and bad buying habits, the retailer has to sell it at an overall discount of 40%.

Retailer B:

  • $100 at 40% off at COGS of $45 = $60
  • Sell price -$45 COGS = $15 unit margin
  • $15 unit margin x 1,000 units = $15,000 total margin

Retailer B’s $10,000 shortfall is a 60% reduction in margin on the same number of sneakers picked, packed, shipped, displayed, and priced. The $15 per unit requires an additional +667 unit (+66.7%) sales increase in sales to match. So in the end, Retailer A only showed $70,000 of revenue ($70 x 1,000 units) against Retailer B’s $100,020 ($60 x 1,667 units).

Retailer A did a lot less work … and earned the same amount. Meanwhile, Retailer B’s extra sales are not fully incremental either, likely replacing other products that could have made it into the basket, like a new backpack or pair of jeans. Clearly, promo-mania has exacerbated an already difficult problem.

This no doubt sounds like Retail 101 to many. But when we combine this simple example with today’s inventory trends, it serves as an important reminder (figure 2). Retail inventories are up, but the segments most heavily tied to BTS sales are drastically down from last year. Some retailers managed to reduce their overall promotional and clearance discounts hinting towards fewer worries of promos to push aged inventory. However, despite continuing challenges, reductions, and closures, clothing and accessory stores are keeping inventory levels close—probably too close—to BTS last year and the year before. The chances are high that many retailers in this segment will still have to rely on promotions to clear out inventory and to match comparable sales numbers from prior years. So far, it looks like just that many are pushing discounts equal to or greater than last year.

We hope NRF’s cash-heavy and need-specific consumers materialize and give retailers a strong boost. But the current economics point to a BTS consumer who’s budget-conscious. Given that the bulk of BTS purchases are necessities (and they compete with food and fuel for budget dollars), consumers from almost all walks of life will be looking for the best deals—especially since there’s no Trapper Keeper (or other single hot BTS item) on the market this year. Although the sheer volume of shoppers in this market this season may lead to some higher revenues, the opportunity for margin expansion is limited at best.

As the BTS season winds down, we will soon see who did their homework over the summer by clearing old inventory, reworking buying decisions, and right-sizing store footprints to put themselves on the honor roll this fall.

Data pack

For our complete data pack of retailer and macroeconomic data including many of the key economic indicators discussed above please contact retail@alixpartners.com.

1    Seasonally adjusted July retail sales exclude motor vehicles, gas, food services, and drinking places.
2    Seasonally adjusted June and May retail sales exclude motor vehicles, gas, food services, and drinking places.
3    http://www.marketwatch.com/story/us-retail-sales-soar-in-july-to-7-month-high-2017-08-15
4    Ibid
5    https://www.reuters.com/article/us-usa-economy-retail-idUSKCN1AV1BZ
6    data.bls.gov/timeseries/LNS14000000
7    https://www.clevelandfed.org/newsroom-and-events/publications/economic-commentary/2014-economic-commentaries/ec-201418-income-inequality-and-income-class-consumption-patterns.aspx

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