FORECAST: CONSUMER OUTLOOK IMPROVING, BUT SUPERMARKETS WILL LOSE SHARE TO RIVAL FORMATS

JON SPRINGER

COLUMBUS, Ohio -- The U.S. economic outlook is improving, but conventional supermarkets will be challenged to benefit, according to economists at Retail Forward here.

In a conference call recently, the group noted that conventional supermarkets need to develop concepts focusing on upmarket customers because competition from supercenters will continue to gain share of the lower end over the next five years, they predicted.

"Most of the growth of supermarkets over the past five years was simply a result of climbing food prices," said Steve Spiwak, an economist with Retail Forward. "Although food inflation this year is benefiting growth, easing inflation thereafter should put further pressure on growth in this channel."

Conventional supermarkets will be among the five retail sectors to experience the least growth over the next five years, Spiwak said. Supermarkets will experience a 2.5% nominal compound annual growth rate (1.8% when adjusted for inflation) between 2003 and 2008. The sector grew by 3.6% (2.3% when adjusted for inflation) between 1998 and 2003, Retail Forward noted.

Apparel stores, shoe stores, conventional department stores and discount department stores will also experience slower growth. Supercenters will grow by 15%, Spiwak added, followed by drug stores (6.9%), home improvement retailers (6.2%), small-format dollar stores (6.2%) and warehouse clubs (6%).

Total retail sales, excluding automobiles and gasoline, will experience 5.3% CAGR during 2003 to 2008.

"Those [supermarkets] who have best survived competition from Wal-Mart [Stores] have been those geared more toward organic food or geared upmarket with more services," said Frank Badillo, an economist with Retail Forward. "Those that survive are going to be those who can create new formats serving more specialty, higher-end, higher-income markets and essentially leave a bulk of the lower-end market to the Wal-Marts."

Modest inflation, gradual rises in mortgage and interest rates, and a rebound in jobs will help the U.S. economy improve overall, Badillo said. "The good news is the general outlook for retailing is very good. The U.S. economy is again going to be among the strongest economies in the world."

Soft goods will see strong unit demand, but will have difficulty overcoming deflation brought on by collapsing trade quotas, creating a shift toward lower-cost sourcing, said Badillo. "We're going to see a wide variety of goods shift toward lower-cost countries. There's a lot of protectionist rhetoric going on, but I don't think that will stop the shift. It's just a temporary barrier."

While that shift will put pressure on retailers in such industries as apparel and furniture, the lower prices will ultimately benefit the U.S. consumer, he said.

Badillo predicted only modest price inflation in other categories. "Inflation fears have heightened in recent months, yet it seems it was only yesterday there were all kinds of concern about deflation," he said. Modest inflation would spur the federal government to raise short-term interest rates gradually, he added.

"I would expect over the next year that [the federal government] will increase short-term rates two percentage points -- less than the last time around [in 1994]," he noted, adding that persistent inflation fears in the bond market could spark higher rates and faster climbs.

Home mortgage rates could rise to as much as 7% over the next year, Badillo said. "Even approaching 7%, that will continue to sustain a healthy level of demand for homes and home goods. We're not going to see the robust demand for homes that we've seen over the last few years."

Jobs are growing in the U.S. service and manufacturing industries, Badillo observed. "This jobs rebound should build up steam to the end of the year, and sustain the strong pace of retail sales we've seen across the home goods and soft goods sectors," he said.

Badillo asserted that the state of the economy would determine the presidential election and that trends point toward the re-election of George W. Bush.

Mandy Putnam, vice president and manager of the group's monthly shopper survey, said recent surveys revealed that higher gas prices were keeping down-market shoppers closer to home, but gas prices were having little impact on middle-market and upmarket households. Baby boomers (age 40 and over) as a group were showing caution in spending on apparel for themselves, while "Generation Y" (ages 18-27) was freely spending on electronics, clothing and home goods.

Supermarkets Move to Slow Lane

In terms of compound annual growth, supermarkets are a slow-growth channel. The chart below illustrates how demand has shifted to the supercenter channel where compound annual growth rates are pacing ahead of all other channels except e-commerce. Nominal growth represents dollar sales and real growth represents units sold.

RETAIL SALES: COMPOUND ANNUAL GROWTH RATES BY RETAIL CHANNEL

Retail Channel: CAGR 2003-2008 (Forecast) Nominal; Real; Inflation; CAGR 1998-2003 (Actual); Nominal; Real; Inflation

Total Retail Sales*: 5.3%; 5.6%; -0.3%; 5.1%; 5.2%; -0.2%

E-Commerce: 26.8%; 33.2%; -4.8%; 82.2%; 105.4%; -11.3%

TOP 5 CHANNELS

Supercenters: 15.0%; 15.6%; -0.5%; 23.3%; 22.7%; 0.5%

Drug stores: 6.9%; 3.7%; 3.1%; 8.6%; 5.1%; 3.3%

Building/hardware: 6.2%; 5.0%; 1.1%; 5.7%; 5.9%; -0.2%

Small-format value: 6.2%; 6.7%; -0.5%; 6.1%; 5.6%; 0.5%

Warehouse clubs: 6.0%; 6.5%; -0.510.6%; 10.0%; 0.5%

BOTTOM 5 CHANNELS

Apparel and accessory stores: 4.4%; 8.7%; -3.9%; 4.1%; 6.3%; -2.1%

Supermarkets: 2.5%; 0.6%; 1.8%; 3.6%; 1.3%; 2.3%

Shoe stores: 1.4%; 3.8%; -2.3%; 0.4%; 1.9%; -1.5%

Discount department stores: 1.0%; 4.3%; -3.1%; 0.3%; 2.1%; -1.7%

Conventional department stores: -1.0%; 2.2%; -3.1%; -1.7%; 0.0%; -1.7%

* Not including auto and gas

Source: U.S. Department of Commerce and Retail Forward