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Follow the Leader: Off-Price Gets Crowded

Off-price is on fire. And with little else sparking consumer interest these days, it’s no wonder that more and more value outposts are cropping up everywhere.

In April, Moody’s called out this sector as one of the few bright spots at retail, along with dollar stores, home improvement and automotive. In fact, the ratings service expects this segment to represent 10 percent of apparel sales by 2018, up from 8.8% in 2015.

And like moths to a flame, retailers are opening off-price concepts as quickly as possible. TigerTrade, a wholesale platform for off-price transactions, reports the number of off-price stores increased by 12 percent in 2016. And as traditional mall-based stores continue to crash and burn, the original off-price chains like Ross and TJ Maxx are seeing increased competition from department stores hoping to heat up lukewarm sales performance.

In fact, it’s hard to find a full-line department store that isn’t at least dabbling in the space. In addition to Saks Off 5th, Nordstrom Rack and Macy’s Backstage, Stage Stores, which acquired 50 Gordman’s locations from bankruptcy, plans to transform them into off-price destinations by the holidays. Just two months before it entered bankruptcy protection, Sears Canada introduced The Cut @ Sears concept inside Sears locations in April, citing that “off-price retail is a hot trend across Canada.” Bloomingdale’s has 17 outlets, Lord & Taylor has a single The Find location and Kohl’s has four Off/Aisle stores.

Click to see how department stores’ off-price aspirations stack up against the originals in this space:

Click to see full size.

A look at the latest numbers makes it easy to see why off-price is garnering so much attention. In its latest earnings call, Nordstrom enumerated the reasons why its planning to top off its 221 Rack locations with 15 more this year. The retailer said off-price accounts for 30 percent of the company’s sales. It also attracts the most new customers and it funnels a third of Rack consumers to the full-line stores. Further, the company’s 2.7% net sales increase to $3.3 billion in the first quarter was achieved because off-price (which includes Rack and Hautelook) increased by 8.7% compared to the 1.7% decline for the full-line business.

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Macy’s attributes Backstage with increasing mainline sales. At its recent investor meeting, the company said Macy’s locations with the off-price concept inside are seeing a 4.6 to 6.4 point increase. Further, 26 percent off Backstage shoppers also shop the full-line assortment.

In the same quarter, Ross achieved a 7 percent increase in sales to $3.3 billion and Burlington saw a 5 percent increase to $1.3 billion. TJX sales increased by 3 percent to $7.8 billion, and CEO and president Ernie Herrman said the company is gaining market share across all of its nameplates: TJ Maxx, Marshall’s, Home Goods and Sierra Trading Post.

Moody’s vice president Christina Boni highlighted buying as the key to off-price success. “Unlike department stores, the off-price incumbents continue to achieve impressive results thanks to their ability to purchase high volumes of disparate goods closer to the time they’re likely to be purchased,” she said.

The challenges

Experts wonder if the newer off-price stores will have the supply chain agility and inventory management necessary to compete in this space.

David Jamieson, executive vice president and COO of Kimco Realty, which manages more than 500 open-air shopping centers, said that TJX, which is the heavyweight when it comes to the fight for off-price dollars, has honed its formula over years. “They have an extensive supply chain that goes to how they buy and manage inventory in stores to create scarcity and drive that inherent demand, so you’re not sure what and where you’ll find it.”

Ross is also expert at creating that treasure hunt mentality, Jamieson said. The assortment is so alluring, the chain is now opening stores in its better markets in close proximity to one another in what it dubs a “double down” model. “They diversify the merchandise just enough so people move from store to store each day,” he explained, adding it’s strategies like this that make him wonder if the new off-price chains have what it takes to survive. “It takes a long time of trial and error to develop that treasure hunt concept.”

Not only do the new stores jumping on the off-price bandwagon not have the experience, they could also fall prey to a pitfall that took another beloved store down. Filene’s Basement, the off-price division of Filene’s department store in Boston that closed in early 2012, ultimately became a victim of its own success.

Ken Morris, a founder and partner at Boston Retail Partners, worked for Filene’s in the 80s before moving onto May Company and Lord & Taylor. Initially, he said, the department store’s off-price arm was a subterranean treasure trove, where shoppers could expect to find items from the full-line assortment on deep discounts. Think fur coats from the mainline assortment that cost thousands of dollars marked down handsomely.

But it wasn’t just the deals that drew customers in, it was the markdown model. “Filene’s Basement was a bargain hunter’s mecca. They had automatic markdowns every 15 days, which kept people coming back all the time. People knew the cadence,” Morris said. “It’s all about the product mix and creating excitement. I’m amazed that [other retailers] haven’t used the automatic markdown component.”

Over time however, the Filene’s Basement model got watered down, and turned shoppers off.

“Filene’s Basement expanded and went to manufacturing product for the Basement, which ends up not being clearance, and they were getting full-line department store prices for product and you can’t fool people for too long like that,” Morris said.

It’s a cautionary tale for today’s off-price retailers, especially the department stores trying to pivot into this arena. Jamieson said inexpensive goods without the magic won’t yield the same enviable foot traffic. “It’s not just about price. It’s the value proposition that makes a difference,” he said. “When you see other retailers that are trying to compete just on price, it’s not the same model.”

But that scenario is inevitable, according to retail veteran Jan Roger Kniffen. In a recent interview with Sourcing Journal, he expressed doubt about the continued growth of this sector. “The pace cannot continue… We are reaching the point where off-price will just mean ‘low price,'” he said. “There isn’t enough overruns and excess goods on the face of the earth to supply all of these off-price players.”

Already, approximately 85 percent of TJX product is cut for the retailer.

Opportunities ahead

Assuming these newer off-price stores execute on product and price, the upside could be substantial given the meltdown in the full-price sector. Financial services firm Wedbush expects off-price to pick up $1 billion in sales just on the Macy’s and J.C. Penney store closures that have been announced thus far.

The more than 4,000 doors that are scheduled to close in the U.S. adds up to huge potential, Jamieson agreed. “With the stress in the regular consumer sector, those dollars will be redistributed somewhere,” he said.

And TJX is getting ready to absorb department store’s loss. TJX, which operated more than 3,800 stores across nameplates and borders in 2016, told investors it sees “significant opportunity” for expanding its store base by 50 percent to 5,600 over time. And that’s just for current store concepts in current markets.

“It used to be that [off-price performance was] tied to the economy. When things were good, these guys didn’t do so well,” Morris said. “But that’s no longer the case. Everyone is looking for a bargain now no matter their economic circumstance.”

Even the “haves” are hunting for bargains. In its first quarter earnings call, Burlington reported that while low income shoppers are heading elsewhere, higher end shoppers are seeking them out. “We’re growing customers that make over $75,000 a year and actually last year make over $100,000 a year,” said CFO/Principal Marc Katz. The company attributes this to a focus on better and best product and customer experience.

It’s a mindset that Morris said will spread to other countries, and when it does, those off-price players that have made investments there will win big. TigerTrade estimates that the global market for off-price is $280 billion, of which the U.S. only represents $90 billion.

While conquering Europe is already on the agenda for some of these retailers, China and India hold the biggest promise. “As the middle class grows in these countries,” Morris said, “they’re going to want to stretch their dollars like everyone else.”