Retailers this summer are preparing for the all-important holiday sales season that will determine if the forecast was accurate. If there’s not enough inventory to sell to an enthusiastic public, a retailer can miss a great opportunity for profits. Buy or produce too much to sell to a lackluster market and a company could be forced to discount to the point of incurring large losses.
Restaurants are in a similar dilemma. They print their prices on their menus and face their respective competitive environments, but it is difficult for them to hedge their protein costs against rising commodity prices. Restaurants also have to decide how much capital to invest in marketing and store renovations. So how do restaurants and other retail stores prepare for the 2011 holiday season?
Greater Economic Forces at Work
Retailers must answer the question carefully. First let’s look at the overall economic picture. People spend more discretionary dollars on retail — such things as eating out, buying clothes, jewelry, home furnishings and new appliances — when they are confident of their economic positions. In order for people to be confident, they not only have to have jobs, but also need to feel that their prospects for better jobs and raises are good.
The economy added just 18,000 jobs in June, the fewest in nine months, according to published reports. The unemployment rate rose to 9.2%, the highest rate this year. This stubbornness upon the part of businesses to hire more employees has persisted since the financial crash of 2008. Corporations are holding $1.9 trillion in cash on their balance sheets, the highest percentage of assets since 1984. Earnings are coming from increased efficiency from technology investment, rather than investing in growth, which means more jobs are not coming down the pike.
Increased corporate cash and caution has led to a deleveraging of corporations. Bank of America/Merrill Lynch economist Michael Hansen said that corporate debt as a percentage of gross domestic product peaked in 2009 at just below 80%. It’s now about 73%. As my colleagues and I work with large companies and talk to other executives, we are not seeing a willingness to change. My prediction is that we’re in a ten-year deleveraging cycle. Eventually this will end and companies will borrow more and start to grow again, but in baseball terms, we’re only in the ninth inning of the first game of a double-header.
Pressure on the Family Dollar
Higher commodity prices are placing more pressure on the individual and family budget than economists and analysts give credit for. Not only are we seeing increased costs for commodities — cotton, copper, gold, silver, corn and other grains — but also the items everyone buys the most are rising, food and gas, all at a time when the actual wage earner is losing ground compared to inflation, or 0.1% from January to May 2011, according to the Department of Commerce.
While the retail federation calls for a 4% increase in sales, gasoline prices continue to hang in the $4 range with no relief in sight. Oil, driven by increasing demand from China, continues to hover around $100 per barrel. Despite the call by some analysts for $80 per barrel oil for the rest of the year, the largest bet on December oil futures on the New York Mercantile Exchange recently was at $120 per barrel. According to the International Monetary Fund, every 10% gain in oil prices will reduce global economic growth by about 0.25 percentage point if sustained for a year.
Bloomberg reported that families are increasingly using credit cards to buy basic necessities such as food and gas. Economist David Rosenberg of Gluskin Sheff & Associates called it a “smoking gun,” that indicates some consumers are resorting to other sources of cash flow just to get by. “People on the margin are putting necessities on their credit cards and this is a trend that’s very consistent with what lower-end retailers have been saying about their paycheck cycles,” Rosenberg said.
What this means to retailers is that by the time the holidays come around, many people won’t have a lot of room left on their credit cards to spend, and even if they do, the economic uncertainties may inhibit them from spending more than last year anyway.
Parents who control family spending are more likely to sacrifice their own discretionary spending rather than deprive their kids, and there’s pressure there too. As schools face tighter budgets, they shift more of the burden for such things as outings, sports and extracurricular activities onto parents. The 2011 Huntington Backpack Index showed the parents’ share of school costs would increase 25% this year, the largest increase since the Huntington Bank began tracking school costs six years ago. And we don’t even need to cite statistics about rising college costs.
In order to cope, retailers are going to have to discount again this year, as they’ve basically trained shoppers to wait for the bargain and discounting is where retailers get hurt. Having worked in the restaurant industry myself, it is obvious the industry has seen changes there too. It used to be uncomfortable for people to present a coupon to a waiter or waitress when ordering. Not anymore. If you pay full price these days, you’re considered gullible.
In light of the two-year low in consumer confidence surveyed in late August, every level of the restaurant industry will start to see consumers reduce the number of trips they make to their favorite eatery. As a result of all these factors, average restaurant checks are going down significantly, which ultimately leads to lower retail sales.
Hopefully this won’t mean that restaurants will change the quality of their product to maintain margins. Customers will catch on over time, and losing customers is something a company cannot afford to do in this economic climate.
Not the Time to Inventory Up
Rather than increase 4% during a year that the economy looks to be growing at a projected 2% for 2011, retail sales are more likely to be flat. There are some signs of strength in luxury sales but it’s the middle class that moves the needle. Corporations hire the middle class, but they are worried about the federal budget deficit and tax policies. And in turn the middle class is pressured and worried about jobs and salaries and commodity costs.
Retailers must manage inventory levels closely. There will have to be a compelling argument for over-ordering inventory for the holiday season. The discounters will continue to thrive. Instead of a turnaround for retail, it will be more of the same in 2011.
Gary Lembo, managing director from CRG Partners’ New York headquarters, has more than 15 years of combined experience in operational and financial restructuring and corporate finance. He has provided turnaround, financial and bankruptcy advisory services to numerous companies. He can be contacted at 212.546.6829 or by e-mail at email@example.com.