After a few bumpy years, retail stocks may be coming back into favor with investors, as the survivors are learning how to adapt to a changing marketplace and find new ways to hold their own against (AMZN). A robust economy boosted by the passage of sweeping tax reform legislation that is or will be putting money back in many consumers’ pockets, and high levels of consumer confidence are serving as tailwinds for the sector. Baird spoke recently with Mark Altschwager, Senior Research Analyst covering Softlines, about what he’s seeing. 

Tech Trends Transforming Retail: Technology is transforming the retail industry and has led to tremendous new opportunities for growth, while challenging traditional business models. How are successful retailers adapting to consumers’ increasing demands?

Retail and technology are converging at a rapid pace. Retailers are pivoting away from a focus on “stores versus e-commerce” and toward broader customer-centric strategies. They recognize that the customer’s path to purchase flows across channels and platforms. For instance, a consumer may be inspired by an outfit on Instagram, visit a retailer’s mobile site, cross check the price or availability on Amazon, try on the item in a store, purchase the item in a different color through the store’s extended online inventory, and have the item delivered to their home for free. This is just one of many potential paths to purchase.

Companies are investing in technology that allows them to offer customers a personalized experience throughout their shopping journey. Mobile is the vehicle as everyone is carrying a smartphone, data is the fuel as retailers are capturing a ton of it, and emerging technologies like artificial intelligence will be the engine needed to bring it all together in a seamless way. We think retailers that are building robust loyalty programs, like Ulta Beauty Inc. (ULTA) and Kohl’s Corporation (KSS), will have the customer data and relationships to put them ahead of the curve. To make them more appealing to consumers, a number of retailers like Kohl’s and Nordstrom, Inc. (JWN) are moving toward more flexible rewards programs that accept forms of payment beyond a store credit card. 

Products versus Experiences: In today’s retail environment consumers are increasingly driven more by a desire for experiences than a need for products. What incentives will help draw consumers back to shopping in-store? How are retailers using their online platforms to complement the overall shopping experience? 

Stores still matter – especially as the cost of customer acquisition online rises and consumers demand instant gratification. This is why Amazon saw value in Whole Foods and why digitally-native fashion brands are opening stores. That said, Amazon has changed the game in terms of expectations around convenience and selection – retailers who compete on those items alone are clearly in trouble. The winners will be those that give consumers compelling reasons to visit stores though differentiated products and experiences.

“Experience” doesn’t just mean a coffee shop or restaurant. For fashion and beauty, it means inspiration, discovery, trial and services. We will continue to see the winners invest in these areas. For example, Nordstrom is piloting a “Local” concept with no inventory but an emphasis on stylist and tailoring services; Ulta Beauty Inc. is doubling-down on its beauty services experience; and Coach (Tapestry, Inc., TPR) is accelerating the rollout of Craftsmanship Bars where you can customize your handbag on site.

We’ll also see traditional retailers invest in technology that reduces frictions associated with both online and traditional brick-and-mortar, making the cross-channel shopping experience more convenient and seamless. This includes refinements to service offerings such as buy online/pickup in store, easy online returns, mobile payments, and mobile shopping assistants. Kohl’s has rolled out an innovative pilot program with Amazon to sell Amazon products and accept Amazon returns in its stores as a means of boosting foot traffic to participating locations and while it’s still early, the initial results are promising. Kohl’s also recently announced a partnership with Aldi to make space available in some of its larger stores for the grocer, which meets its goal of downsizing some of its stores while offering a convenient service to customers that they hope will drive traffic. In the end, we will have fewer stores but better stores, as the sector transforms. 

New Store Brands: Some of the retail industry’s biggest players are accelerating the pace at which they bring new exclusive private-label brands to market, increasing competition for national brands. Why will this strategy be important for retailers moving forward?

Private label is nothing new. However, we’re seeing resurgence as retailers recognize that private label plays a key role in both their defense and their offense. Private label is defensive because you can’t “showroom” and compare prices with Amazon or other retailers. The consumer has had all the power on price in recent years – this is a slight shift back in the retailer’s favor. It is offensive because the “exclusive” nature of the products gives consumers a reason to visit your store or online platform, not a competitor. In my view, this is a good thing for all involved; independent brands should worry less about the competitive threat but instead embrace what will ultimately be a healthier industry if retailers aren’t in a “race to zero” on price. In fact, on the fashion front, we’ve seen more national brands proactively exit department stores as excess inventory and intense price competition damaged their brands’ images. This is finally beginning to normalize. 

With the rising importance of private label, we’re seeing fashion retailers invest more in product, marketing and exclusive partnerships to drive excitement behind offerings. An example here is Nordstrom whose current proprietary apparel labels are among its top selling brands and adding new ones is an important part of its future growth strategy. J.C. Penney Company, Inc. (JCP) has also recently unveiled new private label lines and exclusive partnerships, such as launching a lifestyle apparel brand with footwear designer Libby Edelman. While some private label is lower-cost and lower-quality product designed to be an entry-level price point, this is becoming a thing of the past. Consumers today expect high-quality products regardless of whether it is a store-owned or independent brand.