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Sales surging but the retail apocalypse continues

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After 2018 – one of the most impressive years of growth in the post-recession era – 2019 has seen its fair share of challenges in the freight economy. Manufacturing activity, which serves as the foundation for much of the goods that get transported throughout the U.S. economy, declined outright in both the first and second quarters of the year. Housing construction is still struggling to find its footing and has not grown consistently for several quarters. Slowing global growth and protectionist policies in the U.S. and abroad have weakened international trade performance, and record cold and flooding during the first half of the year put a damper on the spring produce season.

All of these factors contributed to significant weakness in the freight transportation sector, particularly during the first half of the year. FreightWaves SONAR data on load tender volumes show that year-over-year growth (OTVIY.USA) has been negative throughout most of 2019, only crossing over into positive territory in a sustained way recently. Similar softness has persisted in other modes as well, as carloads and tonnage are down in intermodal and rail to this point in 2019.

FreightWaves SONAR Ticker: OTVIY.USA

Amidst this weak environment, the retail sector has stood out as one of the lone sources of strength in the goods economy. Real consumer spending on goods grew at an 8.3 percent annualized pace in the second quarter, which is the strongest quarter of growth in the post-recession era. Retail sales, which is a nominal monthly measure of consumer spending on goods in the economy, also saw rapid growth during the quarter, rising at a 7.8 percent annualized pace. This helped to offset declines in business investment, trade and housing to keep the demand for goods overall in the economy positive. 

In fact, it has been an impressive run for the retail sector over the past year and a half. Consumer confidence has been at elevated levels since the 2016 election, and rapid job growth and the Tax Cut and Jobs Act helped to kick retail spending into high gear last year. Total retail sales growth (RESLG.USA) hit multi-year highs last year, and has stayed solid (around 3.5 percent) throughout most of 2019 despite difficult comparisons to last year. This is all good news as retailers head to the two strongest sales periods of the year – the back-to-school sales period of August-September, and the holiday months of November-December.

FreightWaves SONAR Ticker: RESLG.USA

All of this strength in sales has not helped hiring in the retail sector, however. Employment within retail hit an all-time high of 15.9 million at the start of 2017, but the sector proceeded to shed over 130,000 jobs throughout the remainder of the year. Employment remained essentially flat in 2018, but the job losses have resumed in 2019. Hiring in the sector has been negative in each month since January, with a total of 65,000 jobs lost so far this year. All of this in an economy that is slowing, but still growing at a solid pace and job growth averaging over 150,000 per month this year. 

FreightWaves SONAR Ticker: EMPS.RETL

Much of the reason for the downward trend in retail employment (EMPS.RETL) is that many major retailers are still closing physical locations. According to a new report from global marketing research firm Coresight Research, more than 7,600 retail stores are already slated to close in 2019. That is already more than the 5,800 store closings in 2018, with estimates that that number could get as high as 12,000 by the year’s end. Major retail brands like Payless ShoeSource, Gymboree and Dressbarn have announced plans to shutter all of their retail locations this year after filing for bankruptcy. Other retailers, such as Walmart, the Gap and Walgreen’s are consolidating their retail footprints, with each planning to close hundreds of stores even as they remain far from bankruptcy.

Some of these store closings get offset by new retail locations opening up, of course. But the general trend in brick-and-mortar retail remains negative despite the generally strong economic environment for consumer spending.

E-commerce’s takeover

The most obvious reason for the decline in physical locations is that e-commerce continues to drive much of the growth in overall retail. Indeed, online shopping has been one of the most consistent sources of strength in the economy over the last 15 years. Retail e-commerce sales have grown over 10 percent year-over-year in every quarter since 2010, advancing through the many ups and downs in the overall retail sector. 

During this time, e-commerce has risen from roughly 4 percent to over 10 percent of total retail spending. Electronic shopping and mail order retail sales, which serve as a monthly proxy for e-commerce activity, have actually seen stronger growth in 2019 even as retail spending growth has come down. Year-over-year growth in electronic shopping sales (RESLG.ONLN) accelerated throughout the second quarter, ending at 14.7 percent in June. In fact, even among traditional retailers, the best performing companies are the ones like Target and Walmart that have developed successful e-commerce platforms and omnichannel solutions to help bridge the gap between physical stores and online shopping.

FreightWaves SONAR Ticker: RESLG.ONLN

As a result, the strength in the headline retail numbers vastly overstate the health of all of retail. Excluding electronic shopping, retail sales growth is significantly slower, averaging roughly 2 percent to date in 2019. 

Pricing power and rising costs

Declining share of retail purchases is only one of the concerns facing traditional brick-and-mortar stores, however. The general model for retail has been put under pressure by a few developments over the past couple of years, with margins being squeezed on all sides as a result.

For one, retail stores have increasingly been affected by rising rents for commercial real estate in key areas. Malls located in suburban areas where land is less costly have seen declining foot traffic for years. Consumers instead have opted for shopping experiences located in urban areas, which have helped sustain revenues but come with rapid rent increases. Barneys New York, which filed for bankruptcy earlier this month and plans to close more than half of its namesake stores, cited high rent costs along with online competition as the chief reasons for reducing its physical footprint as it tries to avoid liquidation.

In a traditional setup, some of these rising rent costs would likely be passed on to consumers in the form of higher prices to protect margins. However, retailers have found themselves with less pricing power in the marketplace than they previously enjoyed. As a result, cost increases have to be absorbed by the retailer, putting further pressure on the profitability and viability of physical stores.

The reason for this loss in pricing power goes back to the proliferation of online shopping. Along with the convenience of having retail goods delivered to their homes, consumers now also have the ability to easily compare prices with other retailers online. This has made it difficult for retailers to raise prices relative to both online and offline competition, for fear of losing sales to other businesses. This type of behavior can be seen in some of the consumer price index data, where inflation for goods excluding energy has been flat or declining for most of the past six years.

As a result, retailers are forced to operate with comparatively slimmer profit margins, and need to optimize operations in order to survive in the modern retail landscape. This is part of the reason why the most recent wave of announced tariffs on Chinese imports was so concerning. Most of the goods targeted by the initial wave of tariffs in 2018 were industrial supplies and components of production, which are the sectors that are operating with higher margin and can more easily absorb tariff impacts. The tariffs announced in late July that were originally scheduled for September were focused on consumer goods coming from China. Retailers likely do not have the ability to absorb these tariffs and would be forced to pass them on to consumers just as the peak spending season for retail was going to begin. These tariffs have since been postponed until December, in no small part because retailers voiced concerns about what they would do to the holiday season.

Impact on freight movements

With all of these changes happening within retail, the big question is: what does this all mean for freight and the movement of goods? After all, these retail goods, still have to be produced, and still have to find their way from the manufacturer (or importer) through the economy into the consumers’ hands. Indeed, there is still a large portion of transportation spend dedicated to the retail environment. And because e-commerce involves additional last-mile delivery services to the end consumer in most cases, the rise of online shopping has been a boon to the overall transportation industry.

It is important to note however, that this does not translate to all modes of freight. Consider that a traditional model of retail would typically involve big shipments of goods from manufacturers or ports to large warehouses in sparsely populated areas where land and warehousing space is cheap. These goods would then be transported from warehouses in big shipments to physical retail locations when the retail stock ran low. These freight movements were most likely done by full truckloads, stimulating freight demand.

In the e-commerce space, the supply chain can work quite differently. Because e-commerce retailers have increasingly focused on fast delivery to the end customer, retail goods are increasingly being stored closer to population centers in distribution centers. In these areas, the cost of warehousing is higher and the amount being stored in each location is comparatively smaller. Depending on the retailer, these shipment still may travel via full truckload, but are increasingly being fulfilled by less-than-truckload (LTL) shipments. Then, instead of traveling to a single retail location for final purchase, these goods often travel directly from the distribution center to the end consumer. These kinds of last-mile services are becoming a bigger part of truckload and LTL freight, but are still overwhelmingly dominated by parcel carriers such as UPS, FedEx and the U.S. Postal Service.

As a result, the shift away from traditional physical stores has been of huge benefit for parcel companies, at least from a volume perspective. Small package volume has consistently outperformed the overall goods side of the economy, buoyed by the consistent strength of e-commerce growth. The trucking industry still sees some activity as a result of strong retail environment, but with traditional outlets still struggling, the headline retail numbers may be a bit misleading during the retail peak season.