United States / Analyst Insights
M&A Sector Report: Consumer, Luxury & Retail
by IBISWorld
Mar 13 2013

As featured at the 2013 M&A Advisor Cross Border Summit.

The US Retail sector as a whole is growing and will continue doing so as long as the economic recovery and current consumer spending trends maintain their steady courses. Across the sector, profit margins average 3.6% of revenue and annualized growth is expected to maintain a steady 2.1% rate through 2018. While these figures paint a serene picture, the sector’s landscape has some outlying trends on both ends of the spectrum. For example, spending on luxury items like jewelry and accessories has increased, and industries with high-end retailers are bringing in much wider profit margins. The appealing margins and strong outlook then encourage current companies to expand, new companies to enter and investors to invest. On the other hand, some industries are falling out of favor with consumers, leading to declining establishment numbers and revenue. But these industries in decline can be particularly intriguing, as some still have wide profit margins due to the specialty of the product.

Luxury goods in high demand


Luxury items, like designer handbags and lingerie, took a back seat to necessities when the recession forced consumers to pull back on spending. Since then, Americans’ wallets have fattened as the economy has entered recovery, giving them the freedom to spend more liberally. After slow annualized growth of 1.2% over the past five years due to drops in 2008 and 2009 – the first in nearly 30 years –consumer spending is expected to grow at an annualized rate of 2.9% through 2018. One of the industries expected to benefit most from this increase is US Lingerie, Swimwear & Bridal Stores. Because products sold by this industry have typically low input costs, markups create a wide profit margin, estimated at about 13.2% of revenue in 2013. While some lingerie and swimwear stores discounted items to retain customers during the lower spending period, bridal retailers were somewhat protected as stores introduced items that catered to lower budgets. Still, most wedding dresses and associated garments are personalized and purchased on an as-needed basis, keeping revenue and profit high. Retailers that marked down prices during the recession are already moving back to standard pricing to recoup losses and take advantage of strengthening consumer spending activity.

The second-highest profit margin in the sector belongs to the US Handbag, Luggage & Accessory Stores industry at 10.8%. This industry has been growing thanks to Generation Y’s expanding buying power. This demographic of consumers, born from 1980 to 1995, gave rise to the term “aspirational shopper,” which refers to consumers that seek out luxury items at discount prices. Many of these luxury retailers, such as Coach, appeal to these consumers who are starting to earn more money. In response to the trend, in 2009, Coach launched its Poppy line of handbags, which is priced below the company’s other handbag lines in order to take advantage of aspirational shoppers’ newfound buying power. In cases such as this, the brand still carries its high-end reputation and yields high returns, despite having a lower-priced product line. Enticed by strong demand and high margins, entrepreneurs and investors will increasingly look to this industry. As such, over the next five years, the number of companies is forecast to grow 2.9% per year on average. Similarly, current companies will expand, opening new store locations at a 3.6% annualized rate.

US companies are expanding overseas too. As the domestic market approaches saturation, with limited geographic space available for new store openings, retailers are being encouraged to look overseas to expand. According to Women’s Wear Daily, Asia and Canada were US retailers’ most promising target markets. The magazine noted that China is now the fastest-growing foreign market for accessories and Asian consumers largely drive sales of luxury goods. Nearly 25.0% of Louis Vuitton’s sales come from Asia. Major player Coach has operations throughout Asia and has expansion plans for the near future. Asia’s recovery from the 1997 financial crisis has helped create a new generation of wealthy consumers.

Establishing expansion


Some of the sector’s industries are growing by leaps and bounds, not only in terms of revenue and profit, but also in the number of physical locations. As consumer spending improves and more of these industries’ respective products are sold, new businesses will look to take advantage of high demand and strong profit. Companies that have already established themselves will open more stores to gain exposure and create more outlets to garner revenue. For example, the US Jewelry Stores industry, which generates profit levels of 9.2% of revenue, is forecast to add 6,680 stores from 2013 to 2018. These new locations are not only for existing companies either; about 6,412 new companies will launch during this time. Because of this increased competition, stores will hire more specialized workforces to set themselves apart. While these employees cost more in terms of wages, the returns on jewelry sales remain high.

Another US industry that is taking full advantage of increasing consumer spending, particularly discretionary purchases, is Beauty, Cosmetics & Fragrance Stores. There is an expected 24,087 new locations by 2018 and 12,421 new enterprises. Competition from drug stores and mass merchandisers increased during the economic downturn, but the customers that fled to cheaper options will return to industry stores once again. As such, revenue is expected to grow at an annualized rate of 5.2% percent in the five years to 2018.

This will occur especially as upstream domestic and global cosmetics manufacturing industries innovate and introduce new and reformulated products for consumers with loosened purse strings and greater interest in personal care. For example, new avenues of revenue – and, thus, investment – exist in naturally derived produces as people become more concerned about the environment and their personal health. Chemically laden makeup has been proven detrimental to the human body. A 2007 study conducted by the Organic Consumer Association, a nonprofit organization that focuses its research and education on health and sustainability concerns, concluded that women who wear makeup on a daily basis absorb about five pounds of chemicals into their bodies each year. These concerns have led to breakthroughs in organic makeups, which can be sold at higher margins.

As a result of the innovation and product shifts, some of the new business ventures anticipated in the Beauty, Cosmetics & Fragrance Stores industry will be niche stores that focus solely on healthier alternatives. Additionally, major brands will look to expand internationally as the industry becomes increasingly globalized. This factor is resulting in a number of new players entering the industry at the retail level. Within the United States, for example, a number of global players have entered the market, including the likes of Parfumerie Douglas (Europe’s largest cosmetics and fragrance retailer, with more than 600 stores across Europe) and Sephora, a division of the luxury goods group Moet Hennessy Louis Vuitton.

Risky business


While the high-profit cosmetics industries are expanding, other industries aren’t fairing so well, with both revenue and establishment numbers on the decline. The US Camera Stores industry has shuttered stores at a 7.4% annualized rate over the past five years as consumers take to the convenience of the internet for products industry stores sells. In addition, the proliferation of smartphones with cameras has led to fewer purchases of standard cameras. The industry’s relatively wide profit margin is a result of the specialization of those products, but it is still shrinking because industry firms are lowering prices in an attempt to retain customers. Despite the high margins, camera stores are anticipated to continue closing at a 3.1% annualized rate through 2018. And the shift toward new technologies and retailers is projected to continue, impairing industry potential and revenue growth. As a result, IBISWorld forecasts the industry’s growth risk score, which measures expected future performance on a scale of 1 to 9 (9 being the highest risk), to remain relatively high at 6.27.

The US Record Stores industry is another that is falling at the hands of the internet and advancing technology. Smartphones with greater memory capacity and the availability of online music have decreased the need for record and music stores. Upstream music industries, such as record labels and publishers, are focusing on the production and distribution of digital music by shifting resources away from physical CD and DVD releases. This shift is leading to revenue and establishment declines, and squeezing already small profit margins – all characteristics of a risky industry in decline. In fact, IBISWorld estimates the Record Stores’ growth score at a high 7.71. Unable to stay afloat, stores will close at an estimated rate of 5.7% per year on average through 2018; parent companies will leave the industry at a similar rate.

Over the next five years, the surviving, successful operators will be able to capture more profit by expanding into sources of revenue other than CDs and DVDs. For example, selling electronics and tickets to concerts have proven to be important revenue streams for record stores as the traditional products sold by this industry are decimated by internet listening and buying options.

Outlook: growth and decline


As the recovering economy leads to greater discretionary spending, luxury goods will remain in high demand in the immediate future, benefiting the relative US industries’ operators and investors. The trend toward luxury and the expansion of aspirational shoppers will contribute to the overall Retail sector’s growth over the next five years. Concentrated expansion efforts by brand-name retailers will lead to revenue and profit growth, propelling them to the top tier of businesses in this $3.39-trillion sector.

Unfortunately many retail industries are being made obsolete by quickly advancing technologies and the escalating trend of e-commerce. And IBISWorld expects the shift from brick-and- mortar retail locations to internetbased retailers to only accelerate over the next five years. Because convenience usually overtakes the need to visit a storefront, stores that sell goods that can also be purchased online will bear the brunt of the losses during that time.