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December 17, 2017
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The American consumer and the retail supply chain

Comment
After their 2013 experience, retailers are likely to tighten store inventories during the 2014 holiday season. Here's why.

In the United States, consumer demand drives the economy. For most supply chain managers, therefore, consumer behavior matters.

And how is the American consumer faring these days? Even in the face of uncertainty—about anticipated economic growth, expected improvements in job prospects, and growth in housing wealth and equity markets—consumers have continued to manage their household finances and spending. But when they do shop, they are less likely to spend their money at traditional brick-and-mortar stores than in the past.

Article Figures
[Figure 1] Consumption and disposable income
[Figure 1] Consumption and disposable income Enlarge this image
[Figure 2] Saving rate
[Figure 2] Saving rate Enlarge this image
[Figure 3] Wage gains outpacing inflation
[Figure 3] Wage gains outpacing inflation Enlarge this image

More spending, less saving
Real personal consumption expenditures grew 2.6 percent (annual rate) in the final quarter of 2013—the strongest annual increase since the first quarter of 2012. That growth was not uniform across all sectors, however. Although the fourth quarter saw stronger-than-usual spending on nondurable goods and services, durable goods spending was weaker than expected. Some of the added strength in nondurables was weather-related—spending on clothing, heating oil, natural gas services, and electricity increased—because November and December were unseasonably cold.

For the full year 2013, real consumer spending growth came in at 2.0 percent, the weakest showing since 2010. Real disposable income, meanwhile, grew a measly 0.7 percent, the weakest growth since 2009. Both are shown in Figure 1. The payroll-tax cut that expired in January 2013 took 2 percentage points out of households' paychecks and approximately 1 percent out of disposable income. With less after-tax income, many Americans put less money aside, sending the savings rate down to 4.5 percent in 2013, the lowest since 2007. (See Figure 2.)

Despite the weak growth in disposable income and spending during 2013, the average monthly reading of the Reuters/University of Michigan Consumer Sentiment Index for the year was the highest since 2007. Indeed, consumers had some encouraging news in 2013, as the housing market gained traction, job prospects improved, and inflation remained relatively subdued.

Housing strength and consumer spending
Housing prices and sales gained significant traction in 2013, although they are still below their 2006 peaks. The relatively strong housing numbers helped boost consumer spending in two ways. First, new and existing home sales are associated with increased purchases of "white goods" (home appliances, such as refrigerators, dryers, and washers). And second, the so-called "wealth effect" also had an impact. Many economists believe that people are likely to increase their spending when they "feel" wealthier or when their actual assets (typically real estate and stock holdings) increase in value, and that appeared to be the case in 2013.

In the third quarter of 2012 household net worth surpassed its previous peak, registered in the third quarter of 2007, by US $511.5 billion. By the fourth quarter of 2010, household financial asset holdings surpassed its previous peak, also set in the third quarter of 2007. In addition, household nonfinancial asset holdings (mostly real estate) are likely to surpass their previous peak, registered in the first quarter of 2007, during the second quarter of 2014.

Then again, not all wealth is created equal. Econometric research by Nobel laureate Robert J. Shiller clearly indicates that an increase in real housing wealth has a stronger impact on consumer spending than does an increase in financial wealth. Rates of home ownership are still elevated in the United States, so gains in housing wealth are distributed more widely through the economy. Since the fourth quarter of 2012 and through the third quarter of 2013, household nonfinancial asset growth outpaced the growth of household financial assets. In fact, year-over-year quarterly growth in household nonfinancial assets was in the 9.3-percent to 10.2-percent range in every quarter of 2013. Thus, due to higher household wealth, consumer spending kept pace with 2012 despite anemic increases in disposable income.

A few other indicators suggest that consumers' prospects may be improving somewhat. For instance, wage gains have started to outpace price increases on a year-over-year basis, mostly because price increases were very modest. (See Figure 3.) This helps consumers' budgets, as they are able to maintain a certain level of purchasing power. Both job opportunities and the unemployment rate improved in 2013; however, declines in the unemployment rate were mostly attributable to many people leaving the labor force.

Lackluster holiday retail sales
Holiday retail sales—defined as not seasonally adjusted November plus December retail sales less autos, gasoline, and food services—increased 3.3 percent in 2013 compared to 2012. Any increase is a boost to the economy, but last year's growth was the weakest since 2009.

"Black Friday" week (the busy holiday shopping period immediately following Thanksgiving) was not particularly stellar on the brick-and-mortar front. In fact, many retailers experienced an inventory build-up in November due to lackluster sales. Moreover, many retailers introduced heavy price discounting in order to lure shoppers into their stores, hoping to increase revenue by bringing in more foot traffic and generating more sales even as their per-unit margins were hurt. In addition, slower growth in many emerging markets and eurozone economies has kept global commodity and import prices relatively muted. Consumer goods prices, excluding food and energy, fell on a year-over-year basis every month in the last two quarters of 2013.

Looking ahead

Retailers whose profitability took a strong hit last year are unlikely to discount as heavily in the last quarter of 2014 as they did during the holiday season of 2013. In addition, they are likely to keep inventory holdings on the low side next holiday season to minimize the risk of engaging in excessive price discounting in order to move product if sales are weak.

The outlook for online retailing is more upbeat, however. E-commerce retail sales represented 6 percent of retail trade (total retail sales less food services) in the fourth quarter of 2013 and are likely to grow to 7.0 percent of retail trade by 2016.

In sum, although retail supply chain managers should see relatively robust purchasing activity by American consumers this year, retail chains will be very cautious with their inventory stocking levels. With online sales growth expected to outpace the growth of traditional in-store sales, 2014 could turn out to be a challenging year for retail store supply chains, especially in the last two quarters of the year.

Chris G. Christopher, Jr., Ph.D., CBE is executive director of the U.S. Macro and Global Economics practice at the research and analysis firm IHS Markit. Kristin Reynolds is a senior principal economist with IHS Global Insight's consumer markets team.

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