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Moody’s: US Department Stores Squeezed in Shift to Off-Price Retail

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The same discounting departments stores are using to beg customers to buy has only served to soften their already weakening relevance in retail today.

Consumers have put value, convenience and price transparency above most in their decisions to buy and increased markdowns have discouraged them from paying full price for products.

That discounting, according to Moody’s Investors Service, has been the retail sector’s “Achilles Heel.”

In a retail report out Monday, Moody’s said department stores are also feeling the sting of the shift to off-price retail and e-commerce, which have both served to drag on mall traffic.

“The US consumers’ growing fixation on value—where they now routinely demand easy access to a broad spectrum of goods at the most competitive prices—has been triggering a fundamental realignment in the way retailers across the industry are accelerating efforts to compete more effectively,” the report noted. “Department stores, which have been among the hardest-hit in the retail industry, have relatively slow supply chains that can quickly suffer inventory backlogs when consumer demand suddenly shifts—an issue we regard as their ‘Achilles Heel.’”

What’s more, this year a strong dollar led to lower international tourist spending, mall traffic was weak and unseasonal weather didn’t help out at all.

“Bottom line, it’s been a tough year for the department store sector, which we now expect will post an 11 percent decline in operating income for 2016, following a year of declining sales,” Moody’s said.

Off-price, however, hasn’t seemed to suffer thanks to its more nimble ways.

Market share in sales for the off-price sector should grow to 10 percent of apparel sales by 2018, up from 8.8% last year as same store sales gain more traction.

“This reduces the risk of miscalculating fashion trends and getting stuck with unwanted inventory—a more chronic problem for department stores, which are becoming more focused on reconfiguring their supply chains to reduce initial order commitments and improve their ability to reorder based on demand,” according to Moody’s.

Consumers want product so close to season that designers have started offering see-now, buy-now options where goods essentially walk straight off the runways and into stores. Buyers have also grown increasingly less interested in color and fabric trends for the season ahead—they want to know what consumers want to buy and wear now.

That shift has come in part due to fast fashion, another retail arm chasing department stores into changing their ways, and many of those department stores have started reducing their development cycles and trying to offer new product more often.

“The goal is to better flex their business model and increase full price selling,” Moody’s explained. “However, we believe their efforts are only in the early stages and that they have already made significant changes to their sourcing or product in order to compete more competitively.”

Online is the greatest new growth channel

The move to more online and mobile retail has fueled demand for price transparency as consumers often browse to price compare before purchasing. It’s also driven shoppers out of stores.

“Online penetration for the industry continues to rise as sales at its physical locations decline,” Moody’s said. At Nordstrom, for example, e-commerce penetration has risen nearly 20 percent for its full-line business, and at Neiman Marcus as high as 25 percent.

The entire retail sector will need to continue investing in upgrading platforms and offerings as online apparel continues to increase market share, according to Moody’s.

How to get the brick-and-mortar footprint right

“We believe department stores have a competitive advantage in their physical stores over other online players when they can efficiently integrate existing floor space with their online offerings,” Moody’s said.

The goal will be to maximize the use of square footage, and many department stores have a long way to go in ditching excess locations and better using space to increase sales per store. Some retailers will have to cut back on stores that have a higher alternative value (like from subleasing or the sale of an owned property) or look into smaller store formats where square footage productivity could be increased.

“The off-price model—which depends on physical store locations—underscores how consumers are willing to visit stores if the right value equation exists,” Moody’s said. “While that’s good news for department stores, they still face the difficult task of providing products that motivate the customer to choose their store in the first place. They need to provide products unique to their store and to make sure they’re pricing goods competitively in this new period of greater price transparency and online options.”

Department stores are better positioned for 2017

Now that many department stores have scaled back on inventories to better match up with current decreased mall traffic and demand, they are better positioned going into the holiday season and 2017, according to Moody’s.

What needs to happen next is that they learn to create an “aura” of scarcity for consumers—much like Zara has done so well—and get them to feel the need to buy now for fear that the product may be gone later.

“To create the scarcity ‘aura,’ however, means limiting product overhang. Retailers will need to reduce inventory positions and create fresher product presentations so customers feel compelled to buy earlier in the cycle,” according to Moody’s.

Despite all the dismal accounts of department stores, Moody’s said the sector is moving in the right direction as many are putting new approaches in place and offering more merchandise that’s exclusive or limited.

“Companies that control brands will be able to adapt more easily because this will help them gain exposure to multiple channels as the customer shifts their shopping patterns,” Moody’s added. Brands like Nike and Under Armour have been able to diversify the outlets they distribute to and can reach more customers while reducing their dependence on any one channel for growth.

Retailers will also be looking to reduce their dependence on apparel by “deweatherizing” their stores. J.C. Penney’s latest introduction of appliances to 500 of its locations and its increased focus on the home category will help the retailer do just that.

“We believe such efforts will help performance start stabilizing in 2017, at which point we expect operating income to grow 4.6% as sales trough and margins improve from better inventory management,” Moody’s said. “Stores may also benefit to the extent more normalized weather patterns are experienced relative to last year.”

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