As Retail Sales Are Expected To Rise, Online Sellers Could Be The Big Winners

| About: Consumer Discretionary (XLY)

By Tom West, Director of Equity Research

Consumer spending is expected to rise this holiday season, but the benefits won't be evenly spread. Mainstream retailers, under pressure from Amazon and off-price stores, are shifting risk to brands.

U.S. retailers are fast approaching the most important part of their year - starting with Black Friday and Cyber Monday and then rolling on to the rest of the holiday season. It's always a critical period, but the stakes are arguably even higher this year after a disappointing performance in 2015. If projections pan out, this year could be a much better one.

Retailers are taking on less risk this year

Last year retailers underperformed because of the unseasonably warm weather in November and December - it was 72 degrees on Christmas Eve in New York City, a full 32 degrees higher than the historical average. The warm weather across much of the country led to underwhelming foot traffic at malls and particularly weak demand for cold weather clothing. This resulted in retailers being left with excess inventory - well into 2016 - that they were forced to discount in order to clear.

This year retailers have reacted by being far more conservative with their inventories - a key part of their efforts to shift more business risk onto brands. With lower inventories, retailers won't be left as exposed if sales disappoint once again this holiday season. This strategy puts more pressure on brands to provide extra inventory if and when sales are strong - brands, in effect, are being forced to carry more of the risk (and cost) of matching consumer demand or are faced with leaving potential revenue on the table.

If forecasts are an indication, retailers should be in better shape

Despite the conservative approach, this year could turn out to be better for retailers. The National Retail Federation forecasts that consumer spending will rise by 3.6% this holiday season, well above the 10-year average of 2.5% and slightly ahead of the seven-year average of 3.4%, since the economic recovery began in 2009. Consumer confidence surveys are also heading in the right direction, with higher levels in 2015 and 2016 than in the previous four years.

Click to enlarge

The Index of Consumer Sentiment
Source: University of Michigan Consumer Sentiment Index as of October 2016

Online sellers are poised to dominate

Growing consumer appetites are welcome news for apparel retailers in the short term, but pressure from online competition continues unabated. Amazon is taking an increasingly larger share of consumer spending, notably in the apparel sector, where it is predicted to become the market leader next year, surpassing Wal-Mart (NYSE:WMT) and Macy's (NYSE:M). As part of Amazon's push into fashion, the online retail giant has revamped merchandise display on its website and has launched a fashion advertising campaign in the U.S. and Europe.

Brick-and-mortar retailers continue to feel pressure from the change in Americans' buying habits and the move online. Macy's, for example, has announced plans to shut 100 stores or about 15% of its storefronts by early 2017, as store-level profitability has suffered and the justification to keep these stores open has become more difficult. Traditional retailers are being forced to continue to invest in their own e-commerce initiatives or face the hard fact that they could lose an online sale to a competitor. The purchase of Jet.com (Private:JET) by Wal-Mart Stores for $3 billion in August highlights the high cost a traditional retailer is willing to pay to position itself to effectively compete in the evolving and challenging environment.

There are some bright spots in the brick-and-mortar world, though. Off-price retailers like T.J. Maxx (NYSE:TJX), Burlington Stores (NYSE:BURL) and Ross Stores (NASDAQ:ROST) are doing well despite generally not having a big online presence. Consumers like their value proposition as well as the treasure hunt aspect to shopping in a place where you can't be sure what you might find.

There has been an expectation that brands themselves would more easily navigate the shift in consumer shopping habits. The reasoning was that strong demand for a brand such as Nike (NYSE:NKE) could drive a consumer to make a Nike purchase, whether in store, online or directly from the brand. But it is increasingly apparent that brands face their own set of challenges, such as navigating the changing environment of store closures, retailer bankruptcies (such as Sports Authority) and inventory conservatism by traditional retailers.

Here too, Amazon (NASDAQ:AMZN) is disrupting the traditional relationship brands have had with department stores. Stores traditionally negotiate upfront prices for goods with brands and, if a particular item doesn't sell as well as hoped, go back to the brand to ask for a markdown allowance to help offset the loss in profitability of having to sell the goods at a lower price. Amazon is different in that it pushes hard on pricing upfront but does not go back to its partners for any markdowns, even if sales disappoint.

Online pricing is a critical area for brands. Many retailers have policies of matching competitors' pricing, and in an online retail environment, price discovery is a much easier process for consumers. With the amount of price-matching that goes on in the industry, it means that if lower prices appear on Amazon - often the first place consumers search - low prices quickly reverberate across the industry. The situation is complicated by the fact that there are often multiple sellers of items on Amazon - from Amazon itself to the brands or other independent vendors. To try and control the retail and pricing landscape a little, many brands are choosing to work more closely with Amazon, providing the e-commerce giant with their products and even putting employees into Amazon offices to ensure the relationship runs smoothly.

Bottom line

Whatever happens this holiday season, the main trends in the retail industry are likely to continue. The "Amazonification" of retail is here to stay. The trick for brands and retailers alike is to ensure that they are able to adapt and move in line with consumers' changing habits.

© 2016 Columbia Management Investment Advisers, LLC. All rights reserved.

With respect to mutual funds and Tri-Continental Corporation, investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. To learn more about this and other important information about each fund, download a free prospectus. The prospectus should be read carefully before investing.

Investors should consider the investment objectives, risks, charges, and expenses of Columbia Seligman Premium Technology Growth Fund carefully before investing. To obtain the Fund's most recent periodic reports and other regulatory filings, contact your financial advisor or
download reports here
. These reports and other filings can also be found on the Securities and Exchange Commission's EDGAR Database. You should read these reports and other filings carefully before investing.

The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that any forecasts are accurate.

Columbia Funds and Columbia Acorn Funds are distributed by Columbia Management Investment Distributors, Inc., member
FINRA. Columbia Funds are managed by Columbia Management Investment Advisers, LLC and Columbia Acorn Funds are managed by Columbia Wanger Asset Management, LLC, a subsidiary of Columbia Management Investment Advisers, LLC.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

NOT FDIC INSURED · No Bank Guarantee · May Lose Value

Disclosure: None