A Retail Revolution Is Revving Up

 | Aug 28, 2014 | 5:00 PM EDT
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In yesterday's column, Revisiting the Liquidity Trap, I promised to review sectors and companies that would be impacted if the five-year trend of residential rental costs continues to increase faster than incomes continues.

In this column, I'll consider the apparel sector and companies within it. A series of economic, sociological, and technological events and situations are beginning to converge, bringing extraordinary changes to the retailing industry. Along with this will be opportunities for profits and potential for losses.

The apparel industry has one of the highest marketing costs of all industries that have multiple similar brands competing for the same consumer dollars. The traditional model of apparel manufacturing, marketing and sales is to spend an enormous amount of money marketing a brand, selling the concept of that brand to consumers, and convincing them to pay a premium for relatively low quality items that have the brand logo emblazoned on them.

The increased costs for housing and other necessities are growing faster than the incomes made by those in the age groups of 25-34 and 35-44. This is causing the net available discretionary funds for the purchase of other items to decrease and leaving the apparel retailers with shrinking demand. From a business model perspective and investors' interest, the first question that needs to be answered is whether or not this is a short-term phenomenon that will reverse when economic activity increases or a structural or longer-term issue.

Indications are that this is indeed a longer-term issue that is causing the millennial and X generation to eschew branded products because they can't afford them and to prefer non-branded products. This is likely a symptom of a sociological shift in which people convince themselves they don't want something they can't afford.

Forbes ran an article on this issue last July and a similar story today following the poor earnings results posted by Abercrombie & Fitch (ANF) that has sent the stock down by about 5%.

Compounding this is that these consumers want to stretch their consumption dollars further by wanting higher quality products at lower prices. This interest was indicated by the success of a very high quality hoodie produced by private startup American Giant and discussed by Slate in December 2012.

The convergence of these economic and social trends is turning the traditional retail business model literally upside down. Low-quality, high-cost, highly marketed, branded products are being replaced by demand for high-quality, low-cost, hardly marketed, non-branded items.

The impact this will have on the branded retail industry can't be overstated. Many of the apparel retailers will not be able to survive because the business model shift will be too great. Others will have to merge.

This brings me to the technology issue. There will be an enormous opportunity for the retail distribution outlets to produce their own high quality, private label, low price, non-branded products to meet the new demand and/or to begin to offer products produced by startups such as American Giant.

Technology, especially the internet, lowers barriers to entry for private start-ups or traditional large retail distributors, seeking to access manufacturers. The potential winners of the publicly traded companies are The TJX Companies (TJX), Ross Stores (ROST), Burlington Stores (BURL), Costco (COST), Target (TGT), Wal-Mart (WMT), and Amazon (AMZN).

The companies most hurt by this shift are the branded producers of apparel products targeting the 25-44 year old demographic. They include Victoria's Secret owner, L Brands (LB), Abercrombie & Fitch, Aeropostale (ARO), American Eagle Outfitters (AEO), Express (EXPR), The Gap (GPS), Ascena Retail Group (ASNA), Urban Outfitters (URBN), Chico's FAS (CHS), ANN (ANN), Ralph Lauren (RL) and PVH (PVH).

I plan to track the performance of these two groups along with this trend and report on it quarterly. 

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