Insights and Resources
Consumer products industry outlook
INSIGHT ARTICLE |
Authored by RSM US LLP
Key takeaways from the summer 2020 consumer products industry outlook
- Embracing digital transformation is more important now than ever, but consumer products companies should implement a robust and strategic digital road map in
order to thrive post-COVID-19.
- Supply chain recovery will continue to be a challenge due to complex geopolitical interdependency and shifting consumer behaviors. Reopening doesn’t mean recovery, and many consumer products companies will continue to struggle with profitability.
- Center-of-store food and beverage brands will see opportunities as consumers search for shelf staples and healthy food trends.
- With an anticipated scale back in traditional brick-and-mortar retail traffic, digital direct-to-consumer channels will play an important part in shaping the future
for consumer products companies, especially in the apparel, beauty and home furnishings sectors.
In a matter of months, the coronavirus and ensuing government responses deteriorated consumer spending, a critical component of economic growth in the United States. Fueled by a strong labor market and rising wages, household consumption was a resilient driver of U.S. economic growth despite headwinds presented by slumping manufacturing and geopolitical turmoil throughout 2019 and heading into 2020. With restaurants and retailers shuttered and consumers sheltering in place while facing depression-like levels of unemployment and uncertainty, spending quickly eroded in the second quarter. Despite this erosion, consumer spending will be a critical part of the recovery. An important focal point of the existing stimulus has been getting cash in the hands of consumers and will continue to be a key factor in policy decisions going forward.
While household consumption is expected to increase in the third quarter, behaviors developed during the height of the pandemic will likely reshape how consumers are spending. Before the pandemic, experiential and leisure purchases were taking a growing share of discretionary spending. However, awareness of social distancing could significantly alter that trend as consumers trade restaurant purchases for grocery purchases and travel budgets are reallocated to home improvements. Shifts in such behaviors will be critical to business leaders as they guide their organizations through the survival period and emerge with new short-, intermediate- and long-term plans to thrive in the continuously evolving consumer ecosystem.
COVID-19 accelerates digital evolution
One of the undisputed consequences of the COVID-19 pandemic has been an exponential increase in retail sales through non-brick-and-mortar channels. Evidence is mounting that this trend will not be short term in nature. Digital evolution is far from a new concept in the consumer ecosystem. To date, this movement has been led by big-box retailers with sufficient capital to invest in innovation and change. According to the RSM Digital Transformation Survey conducted in late 2019, middle market retailers, on the other hand, have struggled getting out of the starting blocks.
One of the primary responses for why retailers have struggled was that it is difficult for middle market retailers to determine where to make investments and how to measure their return on those investments. The acceleration of the move away from brick-and-mortar and to other shopping channels during the coronavirus pandemic will forever change this narrative. Retailers can no longer view their adaptation to these changing shopping patterns as an investment with a return. Of course, this evolution requires changes to physical space and technology that will need capital investment; however, these changes must be viewed as a necessary cost of doing business as a retailer.
One of the short-term challenges that many retailers face as they emerge from long periods with brick-and-mortar closures is adapting technology and infrastructure to fulfil more orders through delivery and in-store pickup. As retailers reopened across the country in May and June, those that previously did not offer in-store pickup or delivery have been forced to do so. Those that did offer these are seeing increased volumes.
MIDDLE MARKET INSIGHT: The stress created by the sudden and sharp drop in sales has not left most middle market retailers in a position to have the cash required to make significant systems upgrades in the short term. However, many will find that their current technology licenses include significant unused functionality that can be leveraged to help.
The stress created by the sudden and sharp drop in sales has not left most middle market retailers in a position to have the cash required to make significant systems upgrades in the short term. However, many will find that their current technology licenses include significant unused functionality that can be leveraged to help. Longer term, a robust digital strategy will need to be developed and deployed to allow retailers to thrive when the immediate fallout from the pandemic passes.
Supply chain and consumer preference disruption
Starting in China, the coronavirus pandemic has worked its way across the globe, sparing very few links in the complex and geographically diverse consumer supply chain. The different timelines and the severity of how each part of the world has been affected make it very difficult for supply chains to recover in a linear fashion. Consumer preferences have also been affected by the economic fallout that most households have experienced. Consistent with other historical recessions, consumers are moving back toward value and staple items.
These changes to the consumer landscape represent an opportunity for middle market retailers. Middle market retailers have the ability to be more nimble than their big-box counterparts that are used to buying large, shipping containersize quantities from a concentrated group of suppliers. As we emerge from the recession, retailers will scrutinize product offerings and carry smaller quantities of more products until they can identify and capitalize on short-term trends. Many middle market retailers have already demonstrated this by sourcing and selling personal protective equipment during the height of the pandemic, despite not carrying these items on a regular basis.
While their smaller size may allow them to be nimble to help with shortterm adjustments, it will eventually represent a challenge for middle market retailers as many lack the ability to scale. As a result, longer-term models will contemplate outsourcing fulfillment activities. In April 2020, a Bloomberg Intelligence publication reported that UPS estimated 58% of small and midsize companies would outsource fulfillment in the next five years.
The short-term retail outlook is very hard to forecast, primarily because of the uncertainty surrounding a potential second wave of the coronavirus pandemic. Since the Memorial Day weekend, cases have been rising in two-thirds of the states, with states across the South and Southwest now forming the epicenter of infection. Early indications from the health community also indicate that the virus may be seasonal, similar to the flu. However, things may be different than they were in early 2020. Better hygiene and social distancing habits, advancements in treatment protocols, as well as better testing and tracing initiatives across the country could allow for a less severe impact the second
time around. The pattern of spread may also mimic the first wave, in which certain geographic areas were spared, while others were affected. The resulting economic impact will follow this pattern and different parts of the country will face very different outlooks depending upon the severity of a second wave, or a complete lack thereof. Retailers will have to pay close attention to these patterns as they reopen and plan their operations in the third quarter and into the holiday season.
Businesses should focus investment and promotion, in the near term, on areas that allow the most opportunity to thrive, such as online sales channels and “buy online, pick up in-store” offers, and away from those with higher risk of being affected by an outbreak, such as traditional brick-and-mortar stores. These investments will pay dividends longer term as well, regardless of whether or not there is a second wave.
While social distancing may help us reduce the severity of a second wave, it poses a significant challenge to the retail ecosystem. Significant changes to physical retail space are necessary to allow consumers to feel safe shopping at brick-and-mortar locations. These costs, together with depressed sales, have created dismal profitability in the second quarter and will continue to pressure profitability in the third quarter and likely through the holiday season.
The costs associated with effectively reopening are inevitable, so retailers will turn their focus to driving sales as the consumer ecosystem moves out of survival mode and emerges into recovery mode. The digital trend that preceded the pandemic has been accelerated by the required changes to consumer shopping patterns during the first and second quarters of 2020. A continuous survey by Coresight Research that spans March through May 2020 suggests that more than 60% of consumers will continue their new shopping habits that developed during the pandemic. This means that the most successful retailers will have to expand sales and increase profitability through non-brick-and-mortar channels, including social media.
While it’s no surprise that middle market retailers were hard hit by fallout from the COVID-19 pandemic, proprietary RSM data underscores this vulnerability.
Some 44% of U.S. retailers lost domestic revenue because of the pandemic, while nearly half experienced disruptions to U.S. operations or production, according to a special industry oversampling included in the proprietary second quarter RSM US Middle Market Business Index , a quarterly measurement of middle market business sentiment.
The oversampling—fielded April 8 to April 23, 2020—included 416 executives in four industries, including 109 in retail. An oversampling adds people to a particular survey category to improve the data’s reliability.
One key data point highlighted a potential opportunity for retailers: Some 80% of the retail respondents said they did not have a formal business continuity plan that outlines the procedures and instructions to be followed if an unanticipated event such as a pandemic interrupts their normal business operations. Even worse, of those who did have a formal plan, 50% were only somewhat familiar, or not at all familiar, with that plan. That was higher than the other industries polled.
There is a clear need for better planning. This is a lesson middle market retailers can learn from as the country begins to reopen. If the United States experiences an ongoing resurgence of rolling outbreaks, or worse, a second wave that is equivalent or more severe than the first, retailers should be prepared. There is no way to completely eliminate the economic fallout, but being prepared can make the difference between closing doors permanently and emerging on the other side.
COVID-19 reduced traffic in the first quarter and into the second quarter of 2020. Unsurprisingly, some store sales were down sharply in the last week of March. The impact was felt across all restaurant sectors. However, quickserves and fast casuals that are asset light and are better suited for an increase in delivery and take out have fared and will continue to fare much better than the casual and fine dining sectors.
Domino’s Pizza is a great example of a restaurant that has been able to succeed, thus far, during the pandemic as a result of its existing digital platform, which includes one of the best mobile apps in the industry, and an established delivery model. Other operators with a similar infrastructure heading into the pandemic have also been able to do very well.
The cost of reopening
In early to mid-May, restaurants around the country slowly began to reopen.However, states issued very strict guidelines that restaurants must follow in order to minimize the risk associated with a second outbreak. In nearly all states, these guidelines include social distancing within the restaurant, which in many cases results in a significant reduction of the overall restaurant capacity. In addition, lingering fears will make customers wary about returning to a dine-in setting. Many operators will be unable to sustain operations if forced to operate at less than 100% capacity. A combination of good weather and pentup demand could create an opportunity for those with access to outdoor space to manage some of the capacity lost inside the restaurant.
The cost of reopening doesn’t stop with the lost revenue from reduced traffic. Restaurants need to reorganize their physical space, explore options for outdoor dining space, increase the frequency of cleaning efforts and implement contactless payment methods. For those that did not offer it previously, significant investment may be required to accommodate pickup and delivery. In some cases, this may even mean a completely new operating model that includes the use of ghost or dark kitchens, concepts that were on the rise before the pandemic.
It will also be very difficult to properly manage the labor equation in uncertain times. All of this is before considering the reduced margins and additional packaging costs associated with an increase in delivery and takeout.
Finally, fixed costs, most notably rent commitments, were not made under the assumption that units would operate at significantly reduced capacity. In order to survive on lower average unit volume, operators will need to renegotiate with landlords and other stakeholders to match fixed costs to the lower volumes. This is a critical component of any plan for most operators to emerge from the pandemic.
In short, profitability is going to be very difficult in the second half of 2020. Less profitable locations will be closed, and those better suited to the changes required by the new normal will become top-performing units. Early reactions to a “COVID surcharge” in states like California have been negative and likely will not persist. However, menu prices are likely to increase across the country in an effort to combat rising costs, following the trend already seen in grocery store prices.
MIDDLE MARKET INSIGHT: Middle market restaurants that have strong unit-level management to navigate these headwinds have the best opportunity to succeed and return to profitability on the other side.
Restaurant owners will look to find ways to manage cash flows and survive the reopening period on pent-up demand and cost increases, with hopes of returning to profitability if and when a vaccine is found, or we reach herd immunity. Middle market restaurants that have strong unit-level management to navigate these headwinds have the best opportunity to succeed and return to profitability on the other side.
As we begin a global economic recession, food and beverage is projected to be the only consumer products sector to have growth in 2020, according to market research firm Euromonitor. This unprecedented time of record unemployment and pandemic conditions will shape consumer spending and put pressure on food manufacturers and distributors already operating on thin margins. Supply and demand disruption and rising operating and transportation costs will translate into higher prices. As companies continue to manage through the crisis and plan for the road ahead, it will take resilience, innovation and transparency to succeed.
Heading back to center
The pandemic caused consumers to head to the center of the grocery store to stock up on shelf staples like canned and frozen foods. As shelter-inplace rules were announced, there was great uncertainty and shoppers were concerned about everything from contagion to food shortages. Stocking up was something they could control during an uncontrollable situation. Shopping the center of the store could last for a few reasons.
When shoppers turned to e-commerce for their groceries, many websites featured recipes using canned and frozen foods. Consumers are discovering healthy recipes using items such as rice, beans and tuna. They also opted for frozen fruits and vegetables when fresh alternatives were not available. According to a survey from the American Frozen Food Institute, frozen food purchases increased 70% since March 2020.. The center aisles also offer healthy and quick scratch-cooking ingredients that meet consumer preferences for both healthy and convenient meals. Finally, the center of the store often offers value with store branded items for the costconscious consumer. Center-of-store brands should focus on retaining this new connection with the consumer and develop digital strategies to stay top of mind, whether the consumer shops brick-and-mortar or online.
Food and immunity
“Let food be thy medicine and medicine be thy food.” – Hippocrates
During the pandemic, we have seen the healthy food trend evolve. Consumers eat healthy to lose weight, increase energy and sleep better. Now they are looking for ingredients that boost immunity and prevent illness. Shelter-in-place orders and reduced discretionary income caused more people to cook from home, finding it easier to eat healthy. As unemployment grows, so does the loss of medical benefits and consumers are motivated to stay healthy and avoid expensive trips to the doctor.
Consumers continue to consider plant-based products as healthy; however, it may be difficult for some manufacturers to pivot. Many smallerplant-based manufacturers focus primarily on restaurants and may not have a retail distribution channel in place. Many consumers may choose to eat plant-based proteins considering potential future meat shortages and higher prices. To be successful, manufacturers will need to get control of their supply chains and distribution channels, and use predictive analytics to be prepared for potential future disruptions.
As consumers were stockpiling groceries, food manufacturers of all types were running multiple shifts to keep up with demand. Food processors have strict guidelines to keep food safe; however, the pandemic shone an unfavorable light on the meat and poultry processing industry. In early April 2020, the U.S. Centers for Disease Control and Prevention was alerted to several cases of plant workers testing positive for COVID-19. After a monthlong investigation, the CDC found 4,913 cases of COVID-19 and 20 deaths reported from 115 plants in 19 states.
There were several factors that contributed to the quick spread of the virus both from structural and operational constraints to social and economic challenges. The CDC recommended changes such as increased sanitation in high-touch areas, physical distance barriers and face coverings, as well as employee education and improved medical leave benefits. While many plants temporarily closed to address the problem, an executive order was issued to keep the plants open. This encouraged another round of panic buying, causing consumers to see higher prices and limited selection.
Regardless, in a survey performed by Datassential in early May, 69% of U.S. consumers identified themselves as meat eaters. These consumers were also asked about whether a spread of the virus among meat processing facilities would prevent them from future meat purchases. Of the one thousand people surveyed, 39% were concerned but would still buy meat; another 37% were not concerned at all. While these are positive signs for the meat and poultry industry, meat and poultry processors still need to be aware of pricing. The pandemic has made consumers more resourceful and flexible due to the economic downturn and rise in unemployment. While they may not stop eating meat, they most likely will limit their consumption to save money.
Businesses in the fashion, beauty and home furnishing sectors have been particularly susceptible to the disruptions brought about by the COVID-19 pandemic due to complicated global supply chains and dependence on consumer discretionary spending. While the leaders of these organizations had to adapt to challenges brought about by both supply and demand shocks during the most critical times of the pandemic, adapting their businesses to be resilient to these types of changes will be critical to their recovery and longterm success.
Supply chain disruption
Nearshoring, moving the production of goods closer to consumer-dense markets in the United States and Western Europe, has been an enticing concept to fashion and home furnishings businesses. The cost of uprooting established supply chains and vendor relationships combined with an increased cost of labor have prohibited many companies from making such a change. However, recent geopolitical turmoils combined with the impact of COVID-19 on antiquated supply chain practices are changing the equation on this topic.
Even before the shutdown of Chinese factories in response to the COVID-19 pandemic sent a supply shock into the apparel and home furnishing supply chains, businesses in these sectors were evaluating their dependence on Chinese production. Over the course of the past decade, factories in Southern and Southeast Asia emerged as less expensive alternatives to China and the introduction of section 301 tariffs on U.S. imports from China to the United States provided further incentives for companies to abandon China. Through May 2020, U.S. furniture imports from China decreased to 43% of total imports of this type from an average of 66% the previous five years. Home furnishing businesses had greater incentives to shift production as their products’ inclusion on List 3 subjected them to higher tariffs earlier than many apparel imports. However, apparel products destined for the United States were also beginning to shift toward countries such as Vietnam, Bangladesh and Indonesia.
As demand rebounds, companies may find partners in these countries unwilling or unable to return to legacy production patterns. Many Asian textile producers were left with the cost of holding inventory as wholesale and retail partners in the United States delayed or canceled orders outright.
The pandemic has made consumers more resourceful and flexible due to the economic downturn and rise in unemployment. While they may not stop eating meat, they most likely will limit their consumption to save money.
These producers will likely be unwilling to make themselves vulnerable to this type of inventory exposure risk in the future and will require more commitment from importers . Additionally, many textile and apparel producing countries outside of China are operating near poverty levels. Factory shutdowns may mean that critical infrastructure may not be maintained and those countries’ resources may be allocated elsewhere as a result of the pandemic. Moreover, factories in these countries with poor working conditions such as lack of ventilation will draw further criticism as consumers continue to become more conscious.
The flexibility and reduced import costs provided by nearshoring production may be more attractive given these limitations on factory capacity and stricter payment terms from legacy Asian partners. Apparel leaders have already acknowledged that the notoriously long lead times that have plagued the sector are ill-suited to adapt to unpredictable consumer behaviors and discretionary spending expected in the aftermath of the coronavirus and ensuing recession. In response, the traditional fashion calendar has been abandoned by many organizations, and digital solutions around sampling and production have allowed companies to accelerate the design process. The further adoption of technology and automation in the production process will also reduce the dependency on the costly labor associated with geographically significant locations.
Inventory: The 800-pound gorilla in the warehouse
The abrupt fallout of demand left apparel brands holding on to unprecedented levels of inventory. Retail partners responded to closures of stores and liquidity issues by postponing, reducing and even canceling many orders. Historically, apparel retailers and wholesalers have maintained inventory-to-sales ratios somewhere below 2.5; however, in April 2020, these escalated to 18.9 and 6.0, respectively. This left companies in this sector with difficult decisions on how to sell through inventory to avoid added costs of holding it, as well as to deal with liquidity issues of their own.
Companies with generic labels and styles have the option of holding on to inventory and reducing future orders as inventory trickles into sales channels. While this strategy won’t free up cash immediately, organizations will benefit from fewer and smaller orders until built-up inventory sells through. Other available options include steep discounting through traditional retail channels as well as selling to off-price retailers. Fashion brands relied heavily on steep product discounts for liquidity and driving sales through the 2008 recession and recovery. While this strategy provides the benefit of immediate liquidity, it could come at the cost of long-term brand erosion. Premium and luxury brands
will need to consider discounting strategies, like voucher offers, to attract consumers but also promote brand loyalty and value.
Rethinking the direct-to-consumer playbook
With an anticipated scale back in traditional brick-and-mortar retail traffic, digital direct-to-consumer channels will play an important role in shaping the future of apparel and home furnishings. Before the pandemic, companies in these sectors attracted private equity, venture capital and public investment with the promise of disrupting narrow consumer categories, scaling quickly and taking market share from brands controlled by conglomerates. These companies pumped funds into customer acquisition costs to promote awareness and recognition, with the goal of growing top-line sales with less emphasis on profitability. Recent high-profile IPOs have called into question investors’ perception of this business model’s ability to maintain top-line growth without an unsustainable marketing spend. The stock price of Casper Sleep Inc., the most recent direct-to-consumer company to go public, has floundered below its IPO price, which had already been revised downward. Casper is only a recent example that the payoff for a high-growth consumer brand may not be as lucrative as technology-driven peers without a proven path toward profitability.
While doubt looms over the idea of a big IPO payday, venture capital and private equity investment multiples will likely also soften. Middle market businesses in this space should rethink how funds from capital raises should be allocated. As the direct-to-consumer space has gotten more crowded and mass consumer businesses are increasing digital spending dollars, the traditional marketing direct-to-consumer playbook has become more expensive to follow. Companies should focus on the return on individual marketing investments from a profitability standpoint to prove growth can be perpetuated in a sustainable fashion. Alternative exit strategies should also be considered. A strategic acquirer may see more value in folding a direct-to-consumer platform into a preexisting business model that investors in public markets might not.
Beauty and personal care consumption has been historically steady even through recessionary periods. While the unique nature of the current recession and the shifts in consumer behavior have tested the resiliency of this sector, the short- and long-term impact will likely shift performance of specific categories rather than result in a pullback in overall sector growth. With consumers confined to homes, nesting purchases have allowed personal care and skin care categories to outperform facial cosmetics and fragrances during March, April and May. As states across the country ease restrictions and consumers return to workplaces, events and restaurants, personal and skin care routines will allow those categories to maintain their strength even as others rebound. This could drive mergers and acquisitions as big beauty players could look to round out their product offerings in high-growth categories by purchasing independent brands looking for liquidity and capital but don't have the digital resources to reach their consumers in the new lowtouch marketplace.
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This article was written by Karen Galivan, Christopher Shaker, Peter Cadigan and originally appeared on 2020-07-20.
2020 RSM US LLP. All rights reserved.
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