Retail Forecast 2006

"Run with the wind, but keep a weather eye open." That's an appropriate prescription for any retailer looking for clear sailing in 2006. On the upside, the nation's economy is expected to continue its fairly healthy growth. That should keep the cash registers ringing. On the downside, consumers are feeling squeezed between stagnant household incomes and the rising costs of gasoline, home heating oil and food. That means merchants will need to reinvigorate their marketing efforts to maintain profitability in an environment of price-conscious shoppers.

"We expect continued strength in the economy in 2006," says Sophia Koropeckyj of Economy.com, an independent research organization based in West Chester, Pa. Gross Domestic Product (GDP) — the most widely used figure for gauging economic health — is expected to increase by 3.7 percent, a figure not much different from the 3.6 percent increase projected for 2005.

Even if the nation's economy remains on its upward track, though, its growth won't match the 4.2 percent rate registered in 2004. "It's clear that we are past the 'post-recession surge' that characterized the robust activity of two years ago," says Koropeckyj. "The economy is moving into a more mature phase of the business cycle."

RETAIL SALES MODERATE

What are the prospects for retailers in particular. Economists believe merchants will tally more sales than ever in 2006, but the increase will not be as great as what was recorded in 2005. "We expect a moderation in the growth of consumer spending," says Scott Hoyt, Economy.com's director of consumer economics. Hoyt believes core retail sales (which exclude auto and gas station sales) will increase 5 percent in 2006, a drop from the 6.8 percent of the previous year and the 7.4 percent of 2004.

The same moderating trend is reflected in projections from the National Retail Federation (NRF), Washington, D.C., where chief economist Rosalind Wells expects "more-modest growth in the overall economy, in consumer spending and in retail sales." Wells believes 2006 retail sales will increase by 4 percent, a figure she characterizes as "not bad, probably about a long-term average." Even so, the figure re.ects a deceleration from the 5.6 percent increase of 2005, and the 7 percent increase of 2004. (The NRF numbers exclude auto, gas station and restaurant sales.)

CONSUMER EXPENSES RISE

Retail sales are decelerating for one primary reason: Consumers have less disposable income. "People are paying more for gasoline, home heating oil, health insurance, food and other goods," says Dr. Deborah Fowler, director of the Center for Retailing, a research and educational resource at the University of South Carolina. "This can only lead to dramatic changes in people's buying patterns that will impact retail sales."

By late 2005 the top-of-mind issue for most retailers was the rapid rise in energy costs. Multiple hurricanes in the Gulf Coast region disrupted oil supplies to underscore what was already written in bold: Consumers were going to be paying more for fuel. By late October merchants were introducing early-bird holiday specials to capture shoppers' money before the arrival of the first big home-heating bills.

Consumers have also been getting pummeled at the service station, a problem made worse by the American appetite for gas-guzzling vehicles. "For over a decade people have been buying big cars," says Jim Dion, president of Dionco, a Chicago-based retail-consulting firm. "Now gasoline prices are taking their toll."

Another factor that will depress disposable income, at least over the longer run, is the gradual rise in interest rates that may slow down house price appreciation and the pace of consumer borrowing.

WAGES STAGNATE

All of these cost increases would not be so bad if households were bringing home more money to pay for them. Yet average household income has remained stagnant for the past five years, according to figures from the U.S.

Census Bureau. This seems paradoxical at first blush, since the nation's unemployment recently dropped to around 5 percent, its best showing in many years. Indeed, it is this very improvement in employment levels that has fueled much of the recent increase in retail sales. "Wage income is the most important factor in consumer budgets and spending decisions," says Hoyt. "And nationally, wage income has reached a four-and-a-half year high thanks to the overall improvement in employment." Another major factor to fairly healthy 2005 revenues, says Hoyt, was the bonus payments and stock options that were the results of robust corporate profits over the past year.

Despite the rise in employment levels, employers have held back from fattening paychecks. One reason is that foreign competition has restrained the ability to raise prices. Another is that employers have been hit with higher costs of doing business. At the same time, more people are settling for positions they might not have taken a year or two ago. "The vast majority of new jobs out there are not high-paying ones," says Dion. "This has contributed to an environment in which many people are working two or three jobs to make ends meet."

The net result of these trends, says Hoyt, is that "while total wage income is growing at a rapid rate, average wage rates and household income are not." This creates a good news/bad news scenario: Sales are up because total national wage income is up. At the same time, retailers are facing considerable pressure to cut prices by shoppers squeezed for disposable cash. These conditions present profitability challenges in an environment where retailers are paying more for their own fuel and other operating expenses.

STRENGTHEN OPERATIONS

So how can retailers prepare for the next 12 months? Here's what our experts say:

• Tighten inventories. "Keep your inventories tight," says Fowler. "I would be very hesitant to overbuy. You want an assortment of merchandise, but you may want to cut back quantity."
• In this effort, computerization can assist. "Technology is a boon to retailers who learn how to use it," says Dion. "It can help many retailers achieve substantial gains in the area of inventory productivity." The trick is to trim inventory without creating stock-outs that send customers to the competition. "Be very careful you don't create a self-fulfilling prophecy," he warns. "Don't create problems by not having enough merchandise when customers come to buy. You can't sell goods from an empty wagon."
• Educate your staff. Upselling will be critical in 2006. Encourage shoppers to make additional purchases that relate to their selected items, and communicate the benefits of purchasing higherquality, higher-priced items. "Ultimately it's how well you educate your staff that makes the difference," says Dion.
• Control payroll. Hire right. In these times smart retailers will hire fewer people but pay more for star individuals who really make a difference to the bottom line. Says Dion: "Retailers are discovering a secret: One good employee is better than three marginal ones. Smart independents are upgrading their staffs by paying fewer people better money."
• Highlight customer service. Maybe it sounds like a tired old bromide, but "give great customer service" may well be the winning battle cry for retailers in 2006. "Customer service has become such an anomaly that now businesses are starting to advertise that they offer it," says Fowler. "That should be a wakeup call to everyone: Do a little more service that encourages the customer to come back. In times of a lackluster economy it's the little things that count, not necessarily the big ones."
  
  Retailers, then, face a challenging business environment as they enter 2006. While sales continue on the same upward trend of the past 12 months, expenses will be rising even faster. More important, cash-strapped shoppers will be eyeing shelves for bargains. Successful retailers will be trimming costs, motivating employees, and giving customers more-personalized attention than ever before.

Tracking Consumer Confidence

Rate expected to rise after taking hurricane hit.

Late in 2005 consumers experienced a crisis in confidence caused by Hurricanes Katrina and Rita and soaring gasoline prices. The Conference Board Consumer Confidence Index plummeted in September to 86.6, down from 105.5 in August (conference-board.org). Similar results were reported by the University of Michigan where the Survey of Consumer Confidence dropped to 76.9 in the September 2005 survey, its lowest level in more than a dozen years (sca.isr.umich.edu).

Despite the plunge, economists expect a rebound in consumer confidence, which has run pretty high in recent times and in fact has proven fairly resilient. "Our studies show that crisis-induced movements in consumer confidence are frequently not mirrored in spending behavior," says Scott Hoyt, Economy.com's director of consumer economics. More important to the maintenance of consumer confidence, says Hoyt, are perceptions of longer-term trends affecting the economy.

—P. P.

Phillip M. Perry is a New York-based writer and consultant.