2012 Retail Industry Perspective
We would like to offer our thoughts on the current retail environment, what 2012 holds, and the capabilities that will drive your company's future success.
The U.S. economy wobbled in 2011. The year started on a high note after a strong holiday season in 2010. But then disturbing macroeconomic factors—stubbornly high unemployment, rising inflation, government debt crises in Europe and the U.S., and stock market volatility—raised fears of a double-dip recession and caused consumer confidence to sink again.
The impact of these events varied according to consumer income levels. Our annual consumer survey found that spending was most constrained among low-income shoppers, who continued to feel recessionary pressures. As one might expect, shoppers at the higher end felt less squeezed. This was reflected in performance: Retailers such as Wal-Mart, Target, and Kohl's struggled with same-store sales growth, while Saks, Nordstrom, and Neiman Marcus recorded same-store sales growth of 8 to 12 percent, and high-end luxury retailers, such as Louis Vuitton and Hermès, again enjoyed double-digit growth.
Though more optimistic than in the past few years, the National Retail Federation is forecasting a "mild" holiday season with same-store sales growth of 2.8 percent. Stock market losses, which tend to more acutely affect wealthier customer segments, have caused luxury retailers to reduce their predictions for holiday sales. Moreover, higher-income consumers who are still buying are shifting to online channels, which will lead to lower traffic, revenue, and profits in bricks-and-mortar stores. As a result, all retailers will have to continue to be aggressive in seeking opportunities for top-line growth, while maintaining the strength of the bottom line by driving operational efficiencies.
We believe that capabilities in four areas will be important to your efforts:
The ability to manage new formats, optimize the existing footprint, and strengthen capabilities in the growing online channel will be critical for retailers going forward.
Retailers continue the long-term task of exploring store formats that will enable them to penetrate new geographies and consumer segments. Wal-Mart is innovating in formats with mixed results: The retailer recently closed down its Marketside pilot (smaller-format grocery stores) and is now experimenting with Wal-Mart Express, a scaled-down version of its core format designed for space-constrained urban markets and low-population rural markets. Rite Aid has partnered with Save-a-Lot to combine pharmacy capabilities and low-income assortments in certain geographies. As formats proliferate, retailers will need to pay special attention to integrating them, to properly serve target customers and exploit white spaces in the market.
Other retailers are reinventing what they do inside the box in order to enhance their appeal. For example, Walgreen is adding fresh food to many stores, upgrading its beauty offerings in select locations, and redesigning its pharmacies to improve the customer experience (by making it easier to interact with pharmacists, for instance).
Retailers are also reevaluating their footprints, given the new realities of consumer demand and the rising use of online channels. Best Buy and Gap announced the closure of up to 20 percent of their stores, and some retailers, including Sears and Target, are renting excess space to other retailers.
The growth in online channels is and will remain the big story in retail, with some categories, such as electronics and books, more affected in the near term than others. To capitalize on this trend, retailers will need to go beyond the basics, such as easily navigable websites and liberal return policies, and develop new capabilities that enable them to innovate and gain competitive advantage. For instance, Safeway is developing its digital shopper marketing capability and is currently rolling out the "Just for U" personalized deal generator, which taps customer purchase histories from its loyalty card program to deliver digital coupons.
In an era of frugal consumers, developing the capabilities required to place the right product in the right store at the right price is essential to fuel top-line growth and profitability. Furthermore, customers are demanding a more "curated" selection; they want the right styles, prices, and experience all in one format.
To get the most out of their stores, retailers will also need to tailor them to better reflect local tastes and preferences. This localization effort leads to a better shopping experience, increasing traffic, revenues, and loyalty.
To achieve this, retailers will have to accurately answer a set of tough questions: How many and which SKUs in each category should each store carry? How should product assortment in each store differ by region and by the unique demographics and characteristics of the trade area? How much space should be dedicated to one category or product versus others? What should be the base price of SKUs in a given category? How should they be promoted, and when? There are a vast number of choices.
Localizing each store and getting the merchandising right is a herculean task with no apparent shortcuts. Many retailers will need to upgrade their merchandising capability holistically by integrating systems (store trait database; point-of-sale systems; pricing systems), analytic engines (demand analytics; price elasticity; promotion returns; store clustering), processes (basic assortment planning; promotions; campaign tracking and performance measurement), organization (business alignment around the right "center of gravity"; clear and well-defined roles, responsibilities, and decision rights), and people (analytic talent). The returns for undertaking this effort can be dramatic: We've seen retailers improve their top line by 2 to 3 percent over the base case for their sector.
Right now, while the economic outlook is still sluggish, effective promotions are critical, especially in the fiercely competitive and spending-constrained lower- to middle-income market. These frugal consumers are highly sensitive to pricing and frequently use coupons. Leading retailers are investing in shopper marketing and loyalty programs, acquiring and analyzing consumer data, and better tailoring their promotions to their customers. They are partnering with manufacturers to design, tailor, and refine promotional events. And many are developing the measurement and analytic capability needed to better evaluate the performance of their promotions.
All of a retailer's efforts are ultimately directed to providing a shopping experience capable of attracting and retaining customers. A compelling shopping experience is also a highly effective differentiator that confers competitive advantage. Witness the continued success of the experience-focused retailers, such as Zappos.com and REI.
In developing compelling experiences, retailers must understand the varying expectations that arise in different formats and retail settings, as well as among the different customer segments across those formats. Further, retailers must calculate the cost of providing a specific customer experience (including the implementation cost and the ongoing operational cost) and weigh it against the targeted returns.
Customer experience is driven by multiple levers: the layout and the look and feel of the store; product assortment, pricing, and stocking; and interaction with employees. The first two drivers can be fairly easily copied, but high-quality service is hard to replicate and can be a true competitive advantage. Retailers must leverage both formal and informal levers to help employees deliver the desired customer experience. Formal levers define employee roles and behaviors, develop employee characteristics and skills, create performance measures and incentives, and establish store processes. Informal levers include the leadership behaviors needed to individually motivate employees, such as immediate and public recognition, constructive coaching, and staff empowerment. For example, Publix, the regional grocer known for its customer service, hires employees to meet its service standard and "trains them on all the little details," ties incentives directly to store performance, and publicly recognizes employees who receive compliments from customers. Ritz-Carlton makes customer satisfaction every employee's responsibility and provides them with discretionary funds to resolve service issues.
Forward-looking retailers are focused on social media, which is likely to become the next generation of e-commerce engines and a powerful new sales channel. In a 2010 survey by Booz & Company, 27 percent of consumers said they would purchase goods through social networking sites, and 10 percent said such transactions would likely be incremental to their regular shopping.
The sales volume in social media is still small, but we expect it to grow to US$30 billion by 2015, nearly half of which will be in the United States. Almost all sizable retailers are already using social media, such as Facebook and Twitter, to connect with customers. Some have already started to build a commercial presence in the new channel. For instance, 1-800-Flowers has a fully functioning store on Facebook.
Though the long-term revenue prospects in social media are appealing, the direct revenue it generates will be only a small fraction of sales for many retailers in the near term. However, to prepare for the future, retailers should be thinking about capabilities they will need to commercialize social media. They should be monitoring the social conversation around their brands and using social media as a channel for building customer intimacy, understanding, and loyalty. Further, they should be considering how to make the leap from getting customers to "like" them on Facebook to getting them to make repeated purchases. (For more detail, see "The Coming Wave of 'Social Apponomics'")
The specific capabilities that retailers develop to address these four areas—format, merchandising, experience, and social media—will differ among companies. Not every capability is suitable for every retailer; your company must carefully consider how its way to play differentiates it from its competitors, and how it can take best advantage of its unique strengths. In doing so, you can identify your company's best growth opportunities and begin to capture the premium that accrues from strategic coherence.
In the past, our year-end missives have prompted executives to call or write us with their own thoughts and comments. We hope this one sparks a dialogue with you about the challenges you face in the coming year, the distinctive capabilities needed to meet those challenges, and how we can help you make your company more prosperous in 2012.
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