Hungry for a bigger share of a limited spending pie, retailers face a tough choice: Keep prices low to boost sales at the expense of profit margins or get rid of discounted promotions and risk losing market share to rivals.
The holiday season came at the expense of profit. Teen retailer American Eagle Outfitters (AEO), Victoria's Secret parent L Brands (LB) and Signet Jewelers (SIG) are among the many chains that cut quarterly earnings guidance as heavy promotions hurt margins.
High-end department store operator Nordstrom (JWN) last week posted a lower profit for the holiday quarter, primarily due to increased markdowns in response to heightened promotional activity during the holidays. Its gross margin fell 55 basis points.
Analysts estimate retailers' fourth-quarter earnings fell 5.8% vs. a year earlier, or down 5.3% excluding Wal-Mart Stores (WMT), which reported on Feb. 20. The decline would be the worst showing since Q2 2009, at the end of the recession, says Ken Perkins, president of Retail Metrics.
Thomson Reuters had estimated Q4 industry same-store sales rose only 1% including Wal-Mart, compared with a 1.7% increase in 2012. It expected lower comps at Wal-Mart, value department store Kohl's (KSS), Sears Holdings (SHLD), apparel chain Urban Outfitters (URBN), and teen apparel retailers Abercrombie & Fitch (ANF) and Aeropostale (ARO).
Indeed, Wal-Mart's U.S. same-store sales slipped 0.4% in the fourth quarter, while traffic fell 1.7%. It was the fourth consecutive quarter that its comps declined.
At least eight more major retailers will report fourth-quarter results this week.
"The underlying factors driving the promotional cycle will remain in place through much of 2014," Perkins said.
In Q4, Wal-Mart "like many other retailers (was) very aggressive on price," said Perkins. "Margins were certainly adversely affected as they tried to compete on price with Amazon (AMZN) and Best Buy (BBY) and others.
Minimal personal income gains continue to strain consumers, he says, placing pressure on retailers to reduce prices as they vie for shares of a consumer discretionary spending pie that isn't growing.
"CEOs are asking themselves, 'How do I grow in a slow-growth world?'" added Joel Bines, managing director of consulting firm AlixPartners. "The answer is to take share from competitors, and the fastest way is to out-promote them. It's a 'beggar-thy-neighbor' strategy and it's escalating.
That partly explains why the depth and breadth of promotions have stayed deep and wide after the holidays, according to data on 95 large U.S. retailers from retail sales and promotions tracker SaleTally. From Dec. 19 to Jan. 31, 16% of retailers offered storewide promotions vs. 11% last year, says the firm's co-founder Rama Katkar.
The average storewide discount was 30% vs. 27.5% a year earlier.
Adds Sterne Agee analyst Ike Boruchow: "When looking at 176 total promotions across 44 specialty retail concepts, in the month of January nearly 60% of all promotions were larger than last year's comparable offer, while only 13% of promotions were smaller .. . .
Upscale chains with strong brands such as Michael Kors (KORS) and Tiffany & Co. (TIF) are among those that wield enough pricing leverage to stay out of the promotional battleground, experts say.
"The luxury segment has always had and will always have the advantage in this battle," said Bines. "Their consumers by and large have more disposable income than any other segment in the consumer economy.
But for those that jumped on the promotional bandwagon, getting off will be a challenge.
"They have been promoting so much for the past year that consumers are pretty much looking to spend only on items that have been marked down," said Perkins. "Those that (stop) are likely to see sharp declines in traffic and sales because their competitors will be glad to take that traffic even if it is at a lower margin.
Bines concurred: "Once you start feeding your customers aggressive promotional offers in order to drive sales, it becomes a symbiotic relationship where you need them and they need your promotions.
To break that cycle, retailers need a "gangbuster economy," a "remarkably differentiated" product, or must use analytics to "better understand consumer behavior and segment promotional offers," he said.
The rise of Amazon and other online retailers also pressures traditional retailers beyond cyclical promotions. They must compete while carrying brick-and-mortar expenses and must keep fresh their own websites that may cannibalize their own stores.
Perkins added: "Amazon is pressuring everybody's margins ... thus forcing brick-and mortar retailers to act in kind, which obviously impacts margins in a negative way.
J.C. Penney (JCP) was so unsuccessful with Ron Johnson as CEO, it let him go last April after only 17 months. Previously, Johnson had successfully developed Apple's retail stores.
"There is a sense among some investors that the long-term viability of both J.C. Penney and Sears is in question," said Perkins.
Kohl's, Wal-Mart and Target (TGT) are among the chains "exposed" to the margin and competitive pressure, Perkins said.
Most women's specialty apparel chains are "in the same boat," including Chico's FAS (CHS) and Ann (ANN), he added. Clothiers have struggled amid a dearth of new fashions, a spending shift to durable items and away from soft goods, inventory imbalances and weather issues.
The clothing chains "might be OK and be able to avoid drastic markdowns," said Perkins — if they get the fashion right.
He said 2013 "was a lackluster fashion year. But a lot of what I am seeing in the spring fashion cycle looks to be more attractive. "But it remains to be seen whether consumers have the ability to spend.
Brian Sozzi, CEO of Belus Capital Advisors, cites apparel maker Under Armour (UA)and athletic shoe and apparel powerhouse Nike (NKE)as brands with pricing leverage.
"Their products are viewed as adding value to your life," he said. "They're something different you can add to your closets. And when that is created you are able to charge a high price.
Retailers need to make a "collective decision to be much more restrained with inventories," said Michael Niemira, chief economist for the International Council of Shopping Centers.
He cites the apparel segment as among those that seem to have "a bit higher" inventories.
Sozzi agreed that to get off the promotional carousel retailers need to have "very lean inventories in almost every merchandise category so they are out of stock. That creates a sense of urgency.
Overall, he said, the consumer is done "shopping and filling their closets with stuff they don't need.
So they're "analyzing" every purchase as to whether they need it and whether it adds value to their lives.
"Retailers also have to improve their marketing so people know they are getting a lot of value for an item they don't need," Sozzi said. Even online retailers face margin pressure, with Amazon mulling a big hike in Amazon Prime free-shipping membership fees.
"Their cost structure has probably gone up too with shipping costs and all that," Niemira said.