The great retail bifurcation Why the retail “apocalypse” is really a renaissance
Conventional wisdom has it that the retail sector is past its heyday. But a closer analysis of the rising income gap in the United States and its effect on consumer spending can bring to the fore a more nuanced picture of the state of the industry, says Kasey Lobaugh.
The idea that people don’t go to stores anymore or that the millennial is ruining retail because they shop from their smartphone or that online is killing brick-and-mortar retail—all of those things I put in this category of conventional wisdom about what’s going on. And with each one of them, when you begin to look at the data behind it, you find out—wait a minute, that doesn’t seem to be right!
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TANYA OTT: How we shop. Where we shop. And why. I’m Tanya Ott and that’s what we’re talking about today on the Press Room.
Tanya Ott: I’m standing at an intersection in Hoover, Alabama, right now. It’s a busy place with people going about their day. But one block to the north, there’s a big box toy retailer that’s going out of business. And just over my right shoulder there’s a strip mall that has several empty shells. One used to be a national appliance chain. It filed for bankruptcy last year and has closed all of its locations. Another was a beauty supply store—a smaller operation—but it also shut down. The mall across the street is home to two iconic department stores that are more than a century old. These ones are still open, but across the country other stores are closing in what some are calling a retail apocalypse. But is it really that bad?
Kasey Lobaugh: Hi. I'm Kasey Lobaugh. I'm Chief Retail Innovation Officer for Deloitte and I spend my time consulting with and helping our largest retail clients think about the evolution of the retail model and the convergence of the digital and physical.
Tanya Ott: I called Kasey because if anyone can tell me what’s going on in retail, it’s him. He started with Deloitte straight out of college, but before that he was just like a lot of us—he worked in retail.
Kasey Lobaugh: I did, funny enough [for] one of the big mass retailers I've had the luck of consulting with at relatively high levels, and I always like to return to the time when I was—let's call it 1986 or 1987—working at the checkout lanes of the same mass retailer. So yeah, I've worked in retail as a checkout clerk, but that was many years ago and I always like to tease that it was when I had to key everything in. There were no bar codes back then.
Tanya Ott: Back in the day, right? When I was a kid—and it sounds to me like you and I might be roughly the same age—but when I was a kid, going to the mall was a really special treat. It was usually with my grandmother and we'd shop for an hour or two and then we'd have lunch and then we'd shop a little bit more. And then when I got older and I was a teenager, the mall was the place where basically we'd escape our parents. We'd run off with our friends to mill around for hours, not really buying much but just kind of hanging out. So, it's really interesting to be looking at this in a retail situation, where we have people shopping online and malls are changing in their resonance, I guess, and brick-and-mortar stores are sort of changing. Why did you want to look at this?
Kasey Lobaugh: It's interesting ... you call out the point, which I always like to point out is sort of the conventional wisdom of the industry. There's this great quote that I think about often and it's from an economist by the name of John Galbraith. And he said, "Conventional wisdom serves to protect us from the painful job of thinking."
Tanya Ott: Okay.
Kasey Lobaugh: I like that because what I've found is that oftentimes we as an industry, and I'm sure this happens in other industries as well, we convince ourselves that we know what's going on. And then we start making these proclamations, and I say "we" because when consulting or when you go to any of the trade shows, you go to the software vendors, [and] we all get wrapped up in the same thing about whatever the conventional wisdom is—here's what's going on and the idea that people don’t go to stores anymore or that the millennial is ruining retail because they shop from their smartphone or that online is killing brick-and-mortar retail. I put all of those in this category of conventional wisdom about what’s going on. And with each of them, when you begin to look at that point and you look at the data behind it, you find out—wait a minute, that doesn’t seem to be right! Because for everything that you can point to say this big online retailer is growing, you can point to an off-price retailer who's had tremendous success in the physical world during the exact same time period. So, you have to ask yourself, okay, I understand the first point, but how can the second point be true if all those things are true?
So, you have to begin to tear it apart and look at it more closely. And that's exactly what we had started to do, to try and look at it more closely, just to challenge the conventional wisdom. So that's really why we decided to look at the topic.
Tanya Ott: What were you looking at specifically? You spent a lot of time going through official data, surveying customers, talking to industry specialists. Who all were you talking to and what were you looking at to figure out what was going on?
Kasey Lobaugh: That's interesting because that question we started with really was—and I'll paraphrase the quote I use often, which is—“what the heck is going on?” That's my paraphrase. Because we know something's happened in retail, but what's really going on? And we spent a year looking at what's really going on and we looked at demographics, we looked at geography, we looked at categories of retail, and we looked at economics. And as we looked at those topics it was the final topic, this idea about changing economics, where when we started to dig deep into that data we had a real aha moment.
Tanya Ott: Lots of things affect how much people buy, including how much money they have to spend, and the last decade's been pretty challenging for a lot of people. We had the collapse of the housing market. We had a severe recession. Give us a snapshot of what you saw in terms of household income and employment and consumer confidence.
Kasey Lobaugh: Sure. And that's where at the macro level you'd look at most of the indicators, if not all the indicators, to say the economy is really healthy. And by the way, when we started to dig into the data—you have to go back now almost two years [or] a year and a half when we started the process—and at the time, the economy was just starting to show signs of some strength. And of course, here we are now where the economy has continued down that path. But we're showing the signs of strength including, if you looked at the US unemployment rate, in 2017 it was down to 4.4 percent; that was after a high in 2012 of 8 percent. Now we've broken the 4 percent mark. We're sub 4 percent now. Then look at the home price index. Same thing: 2007, we go through a period through 2012 where we hit sort of the bottom. 2017, 2018, we've now exceeded the levels we were at prior to the economic downturn in 2008. If you look at consumer confidence, consumer confidence has gone through the roof. Median household incomes have now recovered and they are also now ahead of where they were in 2007. So, across all of those statistics you look at, those all look good.
Even the GDP (gross domestic product), while we've been putting up numbers of 2 or 3 percent, those are relatively strong numbers if you look over the last decade. Of course, the S&P value has skyrocketed. If you look at the households, you find the same thing. Household debt servicing payments have gone down 25 percent from 2009 to 2017, and at the same time the total net worth change in those households has increased by 210 percent. So, across the board you look at it and go, the economy is healthy, but at the same time we were hearing things like, boy we’re in the middle of the retail apocalypse.
Tanya Ott: So how do those two things square?
Kasey Lobaugh: Yeah, it's a scratch-your-head moment. It's like, how can that be, because the consumer is spending. They have the money at the macro level. So, what we decided to do is dig deeper into that because it doesn't square. At the macro level it doesn't square because when you look at the retail industry, what you find is that retail sales have continued to grow every year since 2008. They've dramatically exceeded where they were in 2007 at this point. We surveyed the consumer and what we found was the retail consumer, 44 percent of the consumers were saying, boy, I'm spending more this year than I spent last year. Another 41 percent said I've spent roughly the same. So (more than) 80 percent of the consumers are spending more or the same as they did last year. That's strength.
And then even if we look at by category sales, we see categories like home improvement, beauty, cosmetics, home furnishings all up 3, 4, 5 percent, respectively. So, retail looks strong. The economy looks strong. How can that possibly be the retail apocalypse? And that's the fundamental question that we decided to dig deeper into.
Tanya Ott: What did you find?
Kasey Lobaugh: As we started to dig deeper we looked at generational data to see if maybe that tells us what's going on. We looked at regions, trying to figure out if maybe urban-versus-rural told us something. We looked at gender to say, is there something there? And then finally we looked at economics and, in particular, income levels. And here's really where the big aha moment was. When we looked at all of that data and we started to separate between low-, middle-, and high-income levels, what we discovered was there were dramatic differences that started to appear.
We probably all have heard about this thing called the income gap, where the rich are getting richer and the lower income are the ones that continue to struggle. And I would tell you that's exactly what we found, but as we dug into it in the context of retail, it really magnified for us what's going on. So, for example, if you look at the income gap between 2007 and 2016, the highest income cohort grew 1425 percent more than the lowest income level.
Tanya Ott: Wow!
Kasey Lobaugh: In fact, all the way through 2015, the low-income group was actually negative [growth]. Only in 2016 and 2017 did they go slightly positive. What that means is, over the last decade, while I mentioned earlier that median income levels are now exceeding where we were in 2007, it's actually not true for all income levels. Disproportionately, the growth in income levels have gone to the high-income-level group, and that's really where the big aha starts to take shape.
Now that's just income, by the way. If you looked at the stock market—and of course we know that the stock market has been on an incredible tear over the last couple of years—when you look at who owns stock, that's really where you see the impact of the stock market gain. Ninety-three percent of stocks are owned by the high-income group. Therefore, 93 percent of all of the growth in the stock market, just as one asset classification that's grown, has gone to the high-income level. So not only are they getting the income growth, the asset appreciation that's occurred over the last decade has gone to the high-income level as well.
Tanya Ott: What I'm hearing from you kind of mirrors something that I heard from one of your Deloitte colleagues, Patricia Buckley, who is an economist who looks at wealth inequality, particularly generational wealth inequality, and talks a lot about how younger people—but also people who are at the lower end of the income spectrum—are not being able to participate in the stock market because they may not have a job anymore that has benefits that include a 401k or something else.
Kasey Lobaugh: That's right. It's perfectly in line. The issue, though, just what I've shared with you so far [is], if you dig deeper it only gets worse.
Tanya Ott: Tell me how?
Kasey Lobaugh: For those that study retail, they know that what really matters in retail is what we would call discretionary income. And the way you get to the discretionary income is by taking income levels and then subtracting out nondiscretionary expenses. Nondiscretionary expenses are those things like transportation, housing, food, education, and health care, that you have to pay for before you can begin to spend discretionary dollars. Now first of all, what we find on nondiscretionary expenses is that they have skyrocketed during the same period. So, things like health care are up 62 percent from 2007 to 2016. Education is up 41 percent. Food is up 17 percent. Housing up 12 percent. So as a category, nondiscretionary expenses have skyrocketed. Not only that, but if you look at nondiscretionary [income] as a percentage of income, what you find is disproportionately the low-income level, their income largely goes to these nondiscretionary [costs]. What that means is that their discretionary income has been squeezed at a faster clip than that of the higher-income levels. In fact, when you look at discretionary share of wallet, what you find is the only income level that has grown discretionary income since 2007 is the high-income level. If you're in the low-income level, your discretionary income has actually decreased by 16 percent. If you're in the middle-income level, it's roughly flat. So those two categories alone are 80 percent of the consumers that are either the same or worse off than they were in 2007. We call it sort of a lost decade for many of the consumers.
Meanwhile, the high-income category has actually grown by 4 percent, their discretionary income. They actually have more money to spend despite the fact that nondiscretionary expenses have gone up. So, the only category that's better off is high-income.
Tanya Ott: That's how that gets translated in sort of a broad sense in the retail industry. But are there specific kinds of retailers that might be more sensitive to lower- or lower-middle-income folks having less discretionary income?
Kasey Lobaugh: I talked first about the consumer and how the consumer has been impacted. You're asking a question, which is the right question to ask, which says, does that translate into performance in the retail market? So, what we have done is, we've taken all publicly available, publicly traded US retailers and we tried to plot them out along a value proposition spectrum. So, [to] simplify—on one end is price. So those retailers that are aggressively pursuing low price as their value proposition would be placed farther to the left. For those retailers that are more exclusive, they sell premium products, have premium experiences, or both—the more premier they are, they will be farther to the right. So, we plotted all the retailers along the spectrum, and ultimately when we did they kind of fell into three categories. There were the price-based retailers on one end of the spectrum, the premier retailers on the other, and then in between were what we call the balanced retailers.
Then we said, okay, we're in the midst of the retail apocalypse, right. Let's look at performance of those retailers and for us this is really telling. The first thing we did is we looked at revenue growth and we just said over a five-year period how has revenue growth happened for those cohorts? And what we found is if you're in the price-based retail cohort, your growth has been very good. In fact, that cohort over a five-year period has grown more than 30 percent. If you're in the premier side of things, even better. They're putting up growth upwards of 60 percent. Which of course leaves our balance retailers—those retailers that are not price focused and not premier focused—and they're the ones that essentially have flat growth over that same five-year period.
If you zoom in and look at a one-year period you roughly see the same performance except balanced retailers went negative, down 2 percent over the 2017 period. We then looked at a lot of different ways to look at those—same thing, three cohorts, return on assets, return on equity, PE (price-earnings) ratio—and looked at the three cohorts across just about every way we could look at performance and we'd find roughly the graph would look the same. What we'd find where the price-based retailers [are] doing really well and premier retailers also doing really well, which leaves us with the balanced retailers that, in every case, were underperforming the other two cohorts. In many cases they were flat, sometimes they were negative, but in every single way that we looked at them the balanced retailers were underperforming.
Tanya Ott: What does this mean then? Let's say I'm working in the retail industry and I fall on this balanced category, does it mean that I've got to either decide I'm going to go one way or the other, I'm going to go budget or I'm going to go premier? Where does that leave me?
Kasey Lobaugh: It's really not that simple. And I get this question probably more than anything, which is, if I'm a balanced retailer, what do I have to do?
Tanya Ott: Right.
Kasey Lobaugh: The answer is you have to understand the customer. You have to understand what it is they need, how those needs are changing, and how you best can serve those needs. So, I can't answer the question that says if I'm a balanced retailer what should I do, because one balanced retailer may have different customers than another balanced retailer. The real question is, do you have the ability to understand the needs of the customer? Have you got the mechanisms in place that allow the evolution of your value proposition to go meet the needs of that changing consumer? And by the way, the economics is only one way the consumer is changing. We know that there are other ways that consumers are changing as well. I think what this tells us isn't the answer. What it tells us is what's happened over the last 10 years, and if you've failed to understand the changes in the consumer, you're probably on the losing end of the equation.
There are absolutely examples in the marketplace of premier retailers who have also opened up their price-based version of an offering. There are examples of price-based retailers who have acquired retailers or portions of retailers to add to their own value proposition that would appeal to a more premium customer. Without a doubt those things have happened. Now, those retailers that have failed to act; they're left with the performance [we’ve discussed].
Tanya Ott: What's the final takeaway of this for you? You say it's not exactly a retail apocalypse, but ...
Kasey Lobaugh: It's not a retail apocalypse because we actually see growth in the retail market. It's all a matter of where you look and how you understand where that growth is coming from. I'd also say that what it tells us is the conventional wisdom that purely says online is ruining bricks-and-mortar is actually not true, because much of the growth we see, particularly on the price-based retailers, is all physical. It's brick and mortar. In fact, they are opening a lot of stores. Across the board there are stores being opened, but there's also stores being closed. When we look at store[s] closing and opening, what we find, same performance. The majority of store closings that are occurring in the market are around these balanced retailers that are underperforming the market.
One other interesting aspect I'll share with you is the idea about the millennial. A day doesn’t go by when I don’t read some article that tells me how the millennial is different and how the millennial is ruining retail in one way or another. But the interesting thing is, when we looked at the millennial and when we divided them up by their income cohorts, we found really interesting results. We will all like to imagine the millennial who eats avocado toast and wears yoga pants, but there are millennials who don't fall into that category, who are low-income. Maybe rural or maybe middle America kind of folks that aren't the ones that maybe a lot of people want to imagine. But the low-income millennial is actually more likely to behave like a low-income shopper than they are like their age cohort. The middle-income millennial is more likely to behave like a middle-income shopper than they are like a millennial on average. It's only when you get to the high-income millennials, do they disproportionately and dramatically behave in all the ways we like to imagine millennials behave.
Tanya Ott: When you say, "The way that you would imagine that millennials behave in a retail environment," what does that mean?
Kasey Lobaugh: The conventional wisdom about the millennial is that they shop online, that they don't like to go to stores, that they use their mobile phone disproportionately for shopping sorts of behaviors, that they tend to shop not at the big brands but the small—let's call it fringe—kind of brands, that they spend more on experiences than they do on products. There's a whole collection of those conventional wisdom statements that are out in the marketplace about the millennial. So those are the kinds of things that they talk about when I say they disproportionately behave in those ways.
Tanya Ott: Right.
Kasey Lobaugh: I live in Kansas City. We'll drive over to St. Louis periodically for my son who plays hockey and so I get to go drive right through the middle of Missouri. You know, you'll stop at wherever you stopped to get gas and you can't forget that there's millennials there as well.
Tanya Ott: Yeah, totally. I live in Birmingham, Alabama. And there are plenty of millennials here that are working food service or other positions that don't afford the kind of income that professional positions afford.
Kasey Lobaugh: The millennial is so interesting because we sit around and imagine that they're all working on the Facebook campus and riding scooters to work. But the reality is the millennial is actually worse off today than the same age group would have been 20 years ago. They have no more debt. They're less likely to be pursuing the same level of education. They're less likely to be covered by health care, which is the number one thing that causes people to go into poverty that are not already in poverty. There's a whole bunch of things about millennials that actually tell us whatever we're imagining isn't right.
Tanya Ott: What does that suggest to you about the future, because we do know that millennials have higher debt, that they have less wealth accumulation than people that were their age 20, 25, or 30 years ago. Where does that leave us?
Kasey Lobaugh: What our study really tells us is that value is incredibly important when your pocketbook is being squeezed. And so, what that tells me is that there's still a lot of legs and a lot of opportunity to think about value and to think about the consumer, the evolution of the economy. And by the way, you've got to look at the policies that are being put in place by the administration and ask ourselves are those policies going to accelerate what we discovered in our study or are they going to fix what we've seen in the studies. I'll leave it to listeners to think about, but things like the tax cut and where the benefits of those things accrue have impacts. They have impacts on the consumer and we have to pay attention to this. We like to imagine that the consumer wants same-day delivery of whatever they want [the] same-day delivery of, but what our study says is, there's a whole lot of consumers that just want cheap mac and cheese. And that's the most important thing to them.
Tanya Ott: Kasey Lobaugh … Chief Retail Innovation Officer at Deloitte. His research study is called The great retail bifurcation: Why the retail “apocalypse” is really a renaissance. You can find it at Deloitte.com/insights.
When I was talking with Kasey, I mentioned that interview I did with economist Patricia Buckley. Our conversation about wealth inequality dovetails really well with Kasey’s research. Here’s a little snippet…
Patricia Buckley: It's not a shock that younger people have fewer assets and lower income than older households. But what's striking is that the gap between these younger households and other age groups has been growing.
Tanya Ott: We also talked to a bunch of millennials …
Millennial #1: I had never really thought about owning a house before because I had been a freelance educator and consultant and writer and never really had the financial stability to put down any kind of meaningful down payment. And I always expected that everything else past that would just be too out of my reach.
Millennial #2: Our generation just doesn't have the credit or the finances that our parents did because the housing market has just grown so exponentially.
Millennial #3: The main challenge I ran into when purchasing my home was proving my income. I had one real job that was taxable and the government knew I had this job teaching guitar lessons, and then my other job, which is not a real job, playing music and just receiving like cash.
Tanya Ott: You can hear the full interviews at our website, deloitte.com/insights. Look for the article, “Are we headed for a poorer United States.”
As always, we love to hear what kinds of topics you’re interested in. What do you want to hear more of? What can we help you understand? You can tweet us @deloitteinsight (no S on the end) and I’m at @tanyaott1.
Thanks for listening and have a great day!
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