June 7, 2022
The first earnings release of the year from major big-box and discount retailers has shifted supply chain conversations and highlighted a wealth gap disparity in a post-pandemic economy. Supply chain constraints that built up during the pandemic have largely lifted, and now companies are working through the excess inventory ordered to offset pandemic lead times. Consumer purchasing trends are evolving as the pandemic lockdown ends and Federal stimulus checks cease. Unfortunately, much of the retailers’ inventory surplus was ordered before this shift in purchase behavior. Supply chain optimization and just-in-time inventory management are being replaced with supply chain resiliency and adaptability. The focus has turned to how to get current inventory to the correct location given changes in purchasing behavior, high transportation costs, and the lack of available warehouse space.
The change in consumer purchasing trends and consumer wealth disparity are key topics as pandemic social restrictions have lifted, Federal stimulus checks have stopped, interest rates are rising, and inflation is at a 40-year high. It’s becoming a tale of two customers – those who are insulated from the macroeconomy and those who are not. Last quarter, Target and Costco saw higher-end customers shift their demand for home amenity purchases to experiential and travel related categories (luggage, tires, ticket sales) this year. Conversely, Walmart and Dollar General saw sales in discretionary categories tighten and experienced an abrupt increase in private label and lower unit packages when the Federal stimulus checks stopped. Notably, Costco has not seen private label sales increasing which insinuates the wealth effect is insulating higher income consumers. Insights from Macy’s and Nordstrom’s May 2022 earnings calls, where year-on-year sales increased, confirm that high-end customers are splurging. Luxury sales are a standout category as high-income customers are excited to return to and dress for social occasions.
As consumer behavior evolves, supply chain disruptions are settling. The excess inventory retailers accumulated over the past year reveal limitations in current supply chain operations. Mainly that there is effectively no company warehouse space to store the surplus inventory and no additional space available to rent. (Attributable e-commerce’s normalization of 2-3-day shipping and free returns that require extensive warehouse space. Real estate analytics company Reonomy noted that both Walmart and Target have tripled their investments in warehouses over the last two years, as well as Amazon’s doubling of warehouse holdings since 2019. To remain competitive, other retailers have followed suit.) If fortunate to find a warehouse availability for the glut of inventory, rates have risen by 18% since 2021.
Companies are left grappling with what to do with the inventory. It’s costly to store inventory and costly to move inventory, in part due to the truck driver shortage. Some companies are racking up unplanned demurrage fees. Last quarter, Walmart’s supply chain costs were over $400 million higher than expected, and Amazon’s costs were $4B over plan. Target opted to liquidate some excess seasonal inventory rather than store it or offer it at a discount. Costco executives have stated that they are storing its 2021 holiday merchandise that arrived in 2022 until next season. The severe disconnect between customers’ rapidly changing preferences and inventory positions cannot be overstated. Less than three weeks after issuing quarterly earnings, Target issued additional guidance that profits will suffer as they markdown inventory and cancel orders. If these big brand retailers are struggling with inventory, cash flow and margin issues then less cash-rich companies may not be able to sustain these unprecedented supply chain issues.
The short-term priority is to work through bloated inventory levels. There are competing philosophies on how to do it – hold inventory until next season, sell inventory in stores now at a steep discount, liquate inventory to make room for new products, or cancel orders and incur cancellation fees. There is no crystal ball, and each will take a hit to the bottom line. However, to remain competitive in the long run, retailers must narrow in on logistics and forecasting. The use of AI to better understand consumer demands is part of the solution. Advanced forecasting methods account for the gaps in economic and wealth disparities. Advanced technology is better at informing companies on fulfillment plans, allowing for better allocation inventory and controlling warehouse costs. Retailers are also building additional distribution centers and securing warehouse space (including dormant malls). However, these solutions take time.
By Shannon Doyle & Elizabeth Parvarandeh