Friday, May 3, 2013

Bifurcation in consumer spending drives retail opportunities

Right before you pull the trigger and launch new strategic initiatives for your business, are you aware of the fact that you are at the point of maximum uncertainty? From that moment on, the results from all your best efforts will become progressively clearer. Failure or success will become evident. Time, after all, is brutally honest about separating right from wrong choices. Looking back and letting time give its verdict is something I find interesting. So, as I came across an old article I wrote back in June 22, 2011 for a trade publication, I thought of sharing it with the readers of this blog. This article should show whether I was able to gain a clear perspective of the market conditions at the time or not. Enjoy!

Article originally published on 06/22/11

Bifurcation in consumer spending drives retail opportunities

What would you say if I told you that you are missing high end sales? Every retailer wants to know where the sales activity is taking place, but the noisy nature of the market makes this search difficult at best. So, I would like to share recent data with the hope of shedding some light on the issue.
But before we get to the core issues, we must address a few key points. It is said that in the short term the stock market is a popularity gauge. Meanwhile, it is also a long-term-value metric. Despite its daily ups and downs, the stock market serves as a great indicator of earnings health over time.
Over time, there are only two ways to get sustainable earnings improvements. A company's bottom line can continue to increase thanks to progressively better pricing power; also referred to as the ability to extract higher margins from the same customer base. Likewise, profits can sustainably improve when a company's consumer population grows.  Next, value investors like Warren Buffet reward companies offering sustainable profit improvements with higher stock valuations over time. Subsequently, the stock market can serve as an illustration of the fundamental changes taking place within an industry or sector.
The sector in focus for this article is retail and the companies being evaluated are Nordstrom, Dollar Tree and Target.  Nordstrom will show the behavior of the affluent consumer while Target represents the middle and Dollar Tree shows the low end. Although Dollar Tree has the smaller foot print in the group, other Dollar stores have mimicked the performance of Dollar Tree, thus making Dollar Tree a valid sample for our evaluation.
The chart below shows the relative stock price performance of these three companies over the last four years. It should be clear that after the recession, a radical changed took place. The group's historical correlation suddenly breaks after the recession with Target failing far behind the pack.
Stock Price Chart of Nordstrom, Target and Dollar Tree

It should be noted that, despite the current feeling of an almost perpetual recession, US retail sales as reported by the Federal Government have already exceeded their pre-recession peak. In fact both Grocery and General Merchandise sectors of the retail report have experienced robust increases in post-recession sales.
US Retail Sales - all sectors
So if sales are good across the US, how could Target fall behind the market as its relative stock valuation seems to suggest; especially when its large scale should make it tightly correlated with the overall market? How can Nordstrom and Dollar Tree be ahead of Target by such a large margin?
The evidence seems to suggest that the mid-price consumer is taking a hard look at the prices they pay and is thus no longer fully supporting their usual product suppliers. For these often referred to as Aspirational Consumers, due to their tendency to spend beyond their income level, the equation has shifted from style towards price.
Meanwhile, the low end consumer is overwhelmed by fuel costs. It has shifted to lower cost and more conveniently located retailers. While Target is usually considered a low cost supplier, Dollar Tree generally reaches further down and has the added benefit of being located closer to lower income areas; saving on transportation costs as a result.
A shift towards lower prices and higher convenience has also helped internet sales, which despite not being represented in this study are reported as having experienced substantial recent growth by the Federal Government's Retail report.
The affluent consumer, on the other hand, continues to buy. With wealth that originates from recent outperformers like corporate profits or investment portfolios, the rich continue to buy from the likes of Tiffany and Nordstrom.
These two scenarios create what has been referred to as the barbell effect; businesses tending to the needs of either the wealthy or the poor are doing well while those focused on the middle are not. Since the fundamental pressures causing the barbell effect promise to stick around for a while longer, what should business owners do?
Many companies have already focused on lower cost products and services. In fact, commoditization seems almost rampant in some product offerings thanks to a departure from all-copper wiring and towards aluminum or even steel cables, for example. In these cases, the retailers are targeting the lower price points rather than the products' performance. While I can't say that I blame them since customers seem to be willing to pay less and less for products, I would like to offer the non intuitive alternative.
Who would have thought that high priced products or services would sell after a recession? This takes us back to reputation building, which is where most businesses started. By focusing on the premium side, owners are sure to further increase the value of their brand equity while also locking in great profits as evidenced by Nordstrom's relative stock value.
Also remember that Nordstrom is far from being a niche supplier. Their size demonstrates that there are plenty of consumers willing to pay more so long as they get superior service and quality. Nordstrom is legendary for their sales-agent tracking metrics and service methodology. Customer satisfaction is the key value behind everything they do; something that seems to be paying off.
Recent conversations with a few installers seem to corroborate Nordstrom's results. Choosing a few good quality premium products and selling to discerning customers who value exceptional service seems to be having great results in their stores. Besides, there is nothing wrong with making Service the focus of a business' value proposition.
Companies that believe that low prices are the only game in town should seriously reconsider their position in light of the evidence presented here. Even when low price alternatives offer great promises, a race to zero may be the last thing a business with long term aspirations may need. The fact is that the premium buyer is still out there and willing to reward businesses who offer quality services and high performance as part of a well rounded package. Set your business apart by catering to these premium consumers. 

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