Amidst all the pain that most of the retail industry has endured during the past few years, the “off-price” sector has been one of the few shining stars.
While most retailers struggle to eke out any top-line growth, the segment’s big four–TJX, Ross, Burlington and Nordstrom Rack–have delivered solid growth. While many retailers are closing stores in droves, the off-price leaders have been opening new outlets at a brisk pace while announcing plans to open hundreds of stores over the next several years. TJX, the parent company of T.J. Maxx, Marshalls, HomeGoods and Sierra Trading Post, added nearly 200 stores this past year alone.
So while it’s easy to blame Amazon for department stores’ troubles, there is ample evidence that it’s been the major share grab on the part of the off-price and outlet sector that’s inflicted a great deal of the pain.
Of course, the bifurcation of retail has been going on for some time. Consumers have been steadily shifting their spending toward more price-oriented brands since the recession. In some cases it has been driven by an economic need to spend less. In other cases by a realization that strong value can be obtained at a lower price, whether that is from a traditional retailer (e.g. Walmart), a leading fast fashion brand (e.g. H&M and Zara), a newer business model (e.g. Gilt and Farfetch) or, of course, Amazon.
Yet there is growing evidence that the segment is beginning to mature and that future results may be quite different from the boom of recent years. In the most recent quarter, TJX saw same-store sales growth slow to 1%. Archrival Ross posted better results but struck a decidedly cautious note. Nordstrom Rack, which has been the star within Nordstrom, has seen its growth slow to below the industry average.
So while one or two quarters do not indicate cause for alarm, there are several reasons why investors might want to beware.
Sluggish apparel growth
Average unit prices for apparel continue to contract, the discounting environment shows no sign of abating and consumers continue to shift their spending away from products to experiences. This means most sales growth must come from stealing share. That’s not likely to come easily.
Competition is always intense in retail, but with the number of new stores that are opening, the rapid growth of online competition and Amazon’s growing and intense focus on apparel and home products (including an almost certain big push into private fashion brands in the next couple of years), sales and margin pressures are certain to become more pronounced.
Here comes e-commerce–and its challenges.
The off-price industry was slow to get into digital commerce. Some of this was for good reason: it’s almost impossible to make money online in apparel with low transaction values and high rates of returns. But given consumer demand, the convergence of channels and pressure from growing competition, none of these brands have a choice but to invest heavily. But as e-commerce becomes an important growth driver, much of that growth will come through diversion of sales from a brand’s own physical stores–and often at a lower profit margin (what I call “the omnichannel migration dilemma”). As e-commerce becomes a more important piece of the overall business, the economics of physical stores will become more challenging, calling into question the reasonableness of the current store opening pace.
Brand dilution and saturation.
The key driver of the off-price business has been offering major brand names at deeply discounted prices. While this is a bit of a con, the consumer is either blissfully ignorant or doesn’t care–at least so far. But as more brands grow through heavily discounted channels the risk of brand dilution goes up. And we’ve already seen several major brands pull back from factory outlet channels and tighten their distribution to wholesale channels where discounting was rampant. As Nordstrom, Neiman Marcus, Saks, Macy’s and Bloomingdales emphasize off-price growth (both physical store openings and online) the brand dilution concern to their “parent brands” looms large.
Overshooting the runway on store growth.
The over-expansion of most major retail chains is plaguing much of the retail industry right now. So far the off-price sector has escaped this fate, largely because the sector has been gaining share. But if growth continues to moderate and a greater share of the business moves to e-commerce, today’s store opening plans seem awfully aspirational. This is not a 2017 issue, and probably not one for 2018 either. But if I were a betting person, I’d wager that in 2019 we will view today’s plans as incredibly optimistic.
While the off-price sector is unlikely to experience the shockwaves of disruption pummeling its retail brethren anytime soon, we should remember that no business is immune from fundamental forces. And no business maintains above average growth forever. Investors would be wise to take a more cautious approach.
A version of this story recently appeared at Forbes, where I am a retail contributor. You can check out more of my posts and follow me here.