Bricks and Clicks: Baird explores the ongoing evolution of the retail industry

As the familiar saying goes, “the customer is always right” – and in 2014, it’s clear that the typical consumer expects more than ever from retailers. A shorter holiday shopping season, deep discounts and unusually severe weather led to a disappointing close to 2013 for many retailers. The first earnings season of 2014 did little to improve the landscape, as many well-established names reported disappointing sales. Even long-established retailers are struggling to find a sustainable balance between brick-and-mortar stores and the rise of online shopping.

In the second quarter of 2014, a group of Baird’s Senior Equity Research Analysts convened to discuss recent trends in the Retail industry and the shift from traditional retail to e-commerce, resulting in the following Q&A.

Several long-established retailers lowered their already bearish earnings estimates during the most recent earnings season. “Blame the weather!” was a common refrain as many retailers and media outlets sought an explanation for disappointing sales figures. With spring upon us, should we expect to see a surge in consumer spending?

Mark Altschwager, Senior Research Analyst
Weather was clearly a headwind for apparel retailers in the last quarter of 2013 and first few months of the new year. Consumers had less interest in visiting their local mall to purchase lightweight spring clothing amid the “polar vortex.” But as the ground thaws, I would expect consumer’s wallets to follow suit as some pent-up demand fuels spending. Longer-term, sustained employment and income gains will be needed to drive growth in apparel sales. 

Peter Benedict, Senior Research Analyst
Near-term consumer spending could also be encouraged by better job and wage prospects, higher home and asset values, and the cycling of last year’s drag from higher taxes. The harsh winter also set the stage for strong seasonal demand in certain subsectors. Take home improvement retailers, for example. Many consumers have weather-related property damage to tend to, and they will seek out products and building materials to complete important projects in their homes.

Colin Sebastian, Senior Research Analyst
On the other hand, e-commerce is not quite as vulnerable to disruptions like major weather events or macro-retail trends. E-commerce growth rates are fairly steady. The underlying driver for this expansion is the industrywide shift from traditional brick-and-mortar stores to online shopping. We estimate that e-commerce represents just under 10% of all retail sales, leaving a significant runway for growth as the industry continues to evolve.

Consumers are doing more and more of their shopping online. According to comScore, consumers spent more than $42 billion online during the 2013 holiday season, a 10% increase over 2012 levels. Are traditional brick-and-mortar retailers successfully adapting to consumers’ shifting preferences? Who is successfully navigating this change?

Colin Sebastian
In the past, we’ve seen traditional retailers approach the online space as a mere extension of their physical stores. Very few devoted a significant amount of resources to building a competitive website or online retail strategy. In today’s market, many retailers are finally taking e-commerce much more seriously. However, traditional retailers face competitive headwinds from online-only retailers, particularly Amazon. It is still very challenging for traditional retailers to think and act like technology companies, and this continues to give Amazon a significant competitive advantage.

Peter Benedict
Brick-and-mortar retailers simply must embrace the online shopping trend. In our view, the shift toward online/mobile commerce is firmly in place and will only strengthen over time. Companies that have made significant investments in online retail and distribution are at the forefront of this trend. Williams-Sonoma is one of the best positioned companies to handle the shift from traditional retail to online commerce. Half of its business is now in the direct-to-consumer division.

Even big-box players like Walmart and Home Depot are successfully evolving their businesses to embrace the new reality of multichannel retail. Approximately 50% of orders placed on are picked up in a store, and roughly one-third of orders are either picked up in or fulfilled by one of their physical stores. The era of traditional brick-and-mortar-only retail chains as we know them is largely over.

In addition to the shift from traditional to online commerce, retailers are also experiencing a shift in demographics among consumers. Millennials have vastly different consumer attitudes and preferences from their baby boomer – and even Generation X – counterparts. Are retailers successfully adjusting their strategies to attract and retain this new generation of consumers?

Mark Altschwager
The apparel sector is a great example of these shifting demographic trends. There is a very intense level of competition to win the consumer's dollar in today's market. Apparel retailers not only must compete with each other by offering compelling products that fit the latest fashion trends, they must also navigate millennials’ unique spending habits. Millennials are spending more money on tech-related purchases like phones and video games, leaving less money for clothes. This is why good value and effective marketing are so important. Marketing and consumer engagement efforts are changing. More of those dollars are being allocated to Facebook, Twitter, Instagram and Pinterest campaigns to get their brand in front of their target customer.

The most successful apparel retailers are also making investments in mobile commerce platforms to cater to the shopping habits of millennial consumers and capture market share. Gap, Kohl’s, Nordstrom and Urban Outfitters are several companies that have made smart investments in this area.

Card data breaches have featured prominently in the news over the past few months. Have these highly publicized incidents impacted consumers’ attitudes or spending habits?

Colin Sebastian
Recent data theft incidents have prompted consumers to seek out and explore new ways to make their transactions more secure and convenient. The idea of a “digital wallet” that securely stores payment information and passwords is more appealing to consumers in wake of Target’s card data breach late last year. While the mobile payments trend has been fairly slow to evolve, we expect the pace to pick up as consumers seek new ways to do business with their favorite retailers. Companies such as PayPal and Square are developing mobile payment services that capitalize on consumers’ increasing comfort with and preference for making purchases on smartphones and other mobile devices.