What to Watch: Caught in the Middle

The squeeze is getting tighter.

For middle-income and working-class families — those inordinately impacted by inflation, higher costs on essentials like food and heating, and rising interest rates — money for discretionaries such as apparel and accessories is drying up. And that’s going to make 2023 a tougher year than 2022 for many retailers. Middle-income Americans are shopping cautiously and “strategically” anticipating a difficult financial road ahead.

More from WWD

Feeling the most pressure will be mainstream department stores such as J.C. Penney, Macy’s, Kohl’s, Von Maur, Belk and Dillard’s, and fashion specialty chains such as Gap, Old Navy and H&M, They’re likely to lose those shoppers trading down to dollar and discount stores and mass chains like Walmart, Costco, Primark, TJMaxx and Target, which have low prices and strong value perceptions. Some apparel chains, including Lululemon, Athleta, Zara and Aerie, are expected to continue to perform, while home furnishings and electronics businesses are seen remaining soft. There are also signs that luxury sales, after a two-year boom, are slowing.

For the midtier retailers, the key to getting through 2023 rests in having finessed strategies that elevate their appeal and their value propositions. Private label offerings must offer higher quality fabrics, greater style and distinction, at sharp prices that still yield decent margins.

“People are more sensitive about what they are paying and they’re shopping around,” observed R.J. Hottovy, head of analytical research at Placer.ai, which provides location analytics and counts traffic to help retailers understand trends and the effectiveness of promotions. Licensing deals tying in to celebrities, sports figures and pop culture; for newness and exclusivity; additional payment options, and beefed-up loyalty programs should be part of the agenda as well.

Michelle Gass, the former chief executive officer of Kohl’s Corp. who joined Levi’s as president on Monday, during her presentation at the WWD Apparel and Retail CEO Summit last October observed the obvious — that middle-income shoppers are pulling back on discretionary spending, though with those at the $100,000 or higher income level, “there was growth there. Unfortunately, not enough growth to make up for the others.”

“That being said, we saw customers responding to value and our private label brands,” Gass added. “We’ve taken that learning to make sure it can influence the remainder of 2022 and certainly into next year. Sephora at Kohl’s has seemed quite resilient to the economic pressure.”

Sephora is part of an “entire Kohl’s transformation” involving “owning” the active and casual lifestyle with such brands as Tommy Hilfiger, Nike, Adidas and Under Armour. “That, coupled with high-value private brands, which we’ve done a lot of work on in the last couple years, that’s really powerful as we think about competing,” Gass said. In other innovations, Kohl’s is experimenting with a marketplace business model for kohls.com, operates a media network, and has a strategy to open 100 smaller format stores.

The JCPenney Marilyn Monroe capsule collection is size inclusive.
Licensing deals are important for midtier stores. Here, J.C. Penney’s Marilyn Monroe spring 2022 capsule line.

At Penney’s, the mission is “to celebrate and serve America’s diverse working families,” Marc Rosen, the retailer’s CEO, recently told WWD. “They deserve a retail experience where they don’t have to make the trade-offs between style and value and experience and that’s what we can offer. We are uniquely positioned with the products and the brands that we have,” he said, citing Worthington, the long-standing private brand for women’s for the office and the after hours, and Mutual Weave, the men’s denim lifestyle private brand launched in early 2022. He said the plan involves intensifying marketing around inclusivity and serving America’s diverse working-class families, and rolling out new beauty departments at a rate of roughly 75 a month, offering mass, prestige and emerging founder-led brands, which will replace the Sephora departments that previously were there before the beauty retailer switched to Kohl’s.

“You are going to see us lean in heavily and make investments in the areas that matter and that is really digital, supply chain and technology,” said Rosen. “There is a significant amount of investment we have to make to build that digital experience for the customer.”

Penney’s business is about a 50-50 split between private and national brands. “The goal is to serve our customer and to build out the assortment in that good, better, best tiering,” said Rosen. Authentic Brands Group, the brand development, marketing and entertainment company, is a strategic partner in Penney’s and has been a big factor in feeding it merchandise, such as the Juicy Couture and Forever 21 labels.

Industrywide, expectations about 2023 sank in early December when the U.S. government reported an unexpected 0.6 percent drop in retail sales during November from the month prior, sending retail stocks plummeting and compounding angst among investors that the Federal Reserve’s interest rate hikes will drag the economy into recession in 2023, causing a decline in consumer spending. The Fed said it will continue to hike rates through 2023 to peak at 5.1 percent, from over 4 percent currently.

“For the lower-income group we are in a recession and in 2023 we are going to be for the upper-income group too,” predicted veteran retail analyst and blogger Walter Loeb.

Added David Silverman, senior director, Fitch Ratings, “We expect 2023 retail volumes to decline modestly, given a confluence of difficult comparisons, shifts in spend to services, and softening tailwinds in savings and employment. Recent moderation appears largely to some pulled-forward demand in 2020-2021 and consumers refocusing budgets toward services, including travel and other experiences. The effects of above-average inflation on overall spending is somewhat unclear, although it appears to be playing a role in decision making for lower-income consumers.”

According to Silverman, November retail sales showed “a still-resilient consumer, although some signs of softening are emerging after several years of strong retail gains. With weaker results centered around categories like consumer electronics, home furnishings and apparel and strength in bars/restaurants, we believe results demonstrate some retail buying fatigue and budget shifts to consumer services. Consumer health remains generally robust, although the combination of recent home and equity price declines and high inflation has likely moderated sentiment somewhat from historically high levels.”

Silverman also said that he expected the holiday season’s “noisy promotional environment” to continue into early 2023 as retailers create “calls to action for consumers.”

While there is no official definition of middle income, it’s often perceived as those with a family income of around $70,000 to $75,000 on average. The real median household income in the U.S. was $70,784 in 2021, according to government statistics.

“The key point is that people in the lower two income quintiles, the bottom 50 percent of the population, are all struggling and redirecting spending to focus on essentials and squeezing discretionary spending,” said Craig Johnson, president of Customer Growth Partners.

“Unless things dramatically change, assuming having inflation at least through the end of 2023 and higher interest rates here through the end of 2023, we assume there will be nominal retail sales growth of 5 to 5.5 percent this year, slightly above the 20-year average. But this is not going to be great year, a little bit above average, and on a real cost basis flat or slightly down,” said Johnson.

Regarding a recession in the U.S., Johnson said, “We don’t think it’s a certainty by any means. If it does occur, it will be mild, with a shallow slowdown or flat to 1.5 percent GDP growth, and that is not a recession but may feel like a recession, when we have inflation at 7 or 8 percent. There is still job growth, not as much. People are still enjoying modest wage growth, but there is clearly some slowdown in savings.”

On the positive side for middle-income families is that on New Year’s Day, 23 states and Washington D.C. increased their minimum wages, according to the Economic Policy Institute. An estimated 8.4 million workers across the country will be putting a total of more than $5 billion in extra money into their pockets, the EPI reported. “The state with the stingiest increase is Michigan with a 23-cent raise bringing the total to $10.10 an hour, while the biggest hike of $1.50 an hour is in Nebraska, raising the rate to $10.50 an hour.”

Also helping Americans on a budget are gas prices which have significantly dropped from over $5 in June 2022 to just over $3 currently, though there is speculation that gas prices could jump back up to around $4 later this year.

“The impact of gas prices will be a net positive for retailers. On the other hand, home energy costs are through the roof. People will have much higher winter heating bills, and inflation, while cooling, is still mid- to high-single digits, and on a lot of stuff that is very visible, particularly groceries,” said Johnson.

“Clearly, consumers are tapping the brakes on spending, but they are still spending, with households in the lower two income quintiles focusing their purchases on food, energy and household essentials.  But while upper-income consumers haven’t reduced their spending — whether on discretionary or essential goods or on services — they are making ‘considered’ purchases.”

According to the Conference Board, “Uncertainty and volatility will be the dominant themes of 2023. While a global recession is still not the Conference Board base case, regional recessions across mature and emerging and developing economies are almost certain.

“Lingering effects of the pandemic, the ongoing war in Ukraine, elevated inflation, tightening monetary policies, and weak growth will characterize the economic outlook globally and for individual economies. Risks remain tilted to the downside and gray swans are manifold.

“In 2024, the global economy will likely experience a modest revival as pandemic recoveries should be complete and central banks stop hiking or even cut rates after having tamed inflation,” the Conference Board added. “However, growth rates in 2024 and beyond are likely to be below the pre-pandemic trend.”

Loeb believes that after weeks and weeks of clearing bloated inventories, “I think stores will not be left with a lot of merchandise. That said, we are still going to have markdowns” heading into the new year. The Fed’s rate increases, Loeb said, “will slow down sales more this year.”

Jack Kleinhenz, the chief economist for the National Retail Federation, had a more positive outlook, stating, “In terms of looking forward, I feel that the consumer has kept the U.S. economy afloat and will continue to. If you are feeling good about your job you will feel good about spending even though you may not have a lot to spend. The less affluent will continue spending but not as significantly” as in 2022.

Citing www.tracktherecovery.org, which combines anonymized data from private companies to provide a real-time picture of economic indicators, Kleinhenz said, “Growth in spending at the low-income level as of Dec. 4, 2022, was up 18.8 percent since the pandemic, while total spending is not growing as fast as low income, and spending by the high-income cohort is not growing as fast…It’s the upper end of the income spectrum seeing job security concerns. Look at the tech layoffs just announced. That to me is an indication of some softening in spending along that line.” Kleinhenz also said the volatile stock market “has taken a big hit on people’s finances,” reducing some spending by high-income consumers.

“As we think about the outlook, consumer spending is still growing, not stopping. Where there is job security, people still have the wherewithal. The problem for a lot of people who don’t own their homes is that rents have skyrocketed, putting a lot of pressure on budgets.” In addition, “inflation hits hardest those who have the least. It’s really like a tax,” said Kleinhenz.

“I’m not an economist, but all indications are that low-mid-income consumer spending has been artificially propped up by COVID[-19] savings and slightly higher wages, but these funds are likely to run out soon, accelerated by inflation and higher interest rates,” said Brent Hollowell, chief marketing officer at Volumental, which provides in-store 3D foot scanning to recommend better fitting shoes.

“I’ve lived through several recessionary periods as a marketer at brands like Foot Locker, Adidas and others. One consistent observation is that people continue to need and want footwear, apparel and other core accessories but they will be shopping less often and typically spending less per visit.”

Click here to read the full article.