Retail Sales: Temporary Surge or Continued Recovery?

Fourth-quarter financials in 2017 demonstrate once again that retailers walk a tightrope when it comes to driving sales and maintaining gross margins. In spite of healthy sales increases in the fourth quarter, many retail executives felt the impact of a dynamic business environment that challenged retail companies on numerous fronts: new technology, evolving consumer preferences, digitalization, new competitors, etc. Attracting new customers and keeping them “in the fold” is never a fait accompli. Executives must continue to manage both short- and long-term strategies across all their operations to maintain financial flexibility and remain relevant with consumers.

Retailers enjoyed robust Q4 and holiday sales, welcome results after several challenging years and talk of a “retail apocalypse.” However, do strong 2017 holiday sales indicate the beginning of a retail resurgence? With promising year-to-date 2018 sales, we might just be experiencing a resurgence. In fact, retail sales have increased 4 percent or more since July 2017. But we question: Are the sales increases actually driving increased profitability?

Q4 2017: Promotions Reigned Supreme

Based on a BRG survey of over 100 retail executives, we expected heavy promotional activity for the fourth quarter of 2017. To gauge the impact of the heavy promotions, we examined the financial results of 77 large and midsized public U.S. retailers across 18 retail channels. We found that while total sales increased 5.5 percent and gross margin dollars increased 3.3 percent, gross margin rate declined by 55 basis points. High promotional activity had its expected impact, especially on the bottom line.

According to our analysis, this group of 77 retailers made 4.5 percent less in overall EBITDA dollars in Q4 2017 than in Q4 2016, despite the significant sales increase. Most of the EBITDA decline came in the grocery, home furnishings, jewelry and mass merchandise sectors. In addition to gross margin softness due to promotional activity, retailers continue to face higher costs to serve in the highly competitive retail environment. The higher cost to serve comes from increased transportation costs, wage pressures in a tighter labor market, and greater cost of complexity from delivering omnichannel initiatives and other efforts to grow the business.

Looking Ahead

Some retailers are bucking the current trends and finding ways to profitably serve their customers in the challenging omnichannel environment, but many are struggling to increase profitability. If these retailers don't find ways to compete profitably in this period of upward trending sales, how will they perform in more challenging environments without making some critical changes in the way they operate?

It's interesting to assess history and learn lessons from past performance, but unless retailers build on these learnings to achieve profitable sales, history will repeat itself and the odds for survival will continue to diminish. As retailers prepare for the most important months of the 2018 sales calendar, we offer six actionable best practices we’ve seen at retailers that appear to have solved the riddle:

1. Understand your customers’ journeys. Listen to and understand shoppers through robust consumer research and insights. Greater insights lead to more informed planning, which in turn improves product assortment, reduces markdowns, and drives profitable long-term customer relationships with the brand.
2. Leverage analytics to improve pricing and reduce margin erosion. The approach to pricing and promotions must be highly structured and strategic. It's critical to understand incremental contribution margin generated from specific promotions and determine which promotions truly drive incremental traffic.
3. Increase store labor efficiency. Now is the time to re-examine store labor planning. Remove unnecessary tasks, simplify communications, review hours of operation, and shift labor to customer-facing activities at peak times of the day and days of the week.
4. Optimize inventory allocation capabilities to avoid markdowns. Today’s competitive omnichannel environment dictates that retailers strategically allocate inventory to avoid moving products to clearance. Alignment of sizes, colors, price points, multi-item purchase quantities and ethnic preferences is critical.
5. Improve e-commerce fulfillment costs. Retailers must undertake a careful examination of free shipping thresholds, take full advantage of certain efficiency levers such as zone skipping, and ensure that all unusual package size accessorial charges are understood and are part of the total customer value proposition.
6. Reduce corporate SG&A costs. Start with a clean sheet of paper and conduct zero-based budgeting. Develop the organization around what the business needs are of your customer today and tomorrow.

Despite recent green shoots, retail remains a stressed industry. Companies in all retail categories have undergone a wave of disruption, and over the last few years some have fallen short in addressing challenges. Those that remain will face more tests, but opportunities exist for those that can piece together the puzzle. It will require a strategic and coordinated effort across the operation, as well as flexibility in addressing both short- and long-term challenges, especially in the six areas noted above.

Keith Jelinek is the managing director, retail and consumer practice, Berkeley Research Group (BRG), a leading global strategic advisory and expert consulting firm.