Deep Discounts Damage Christmas Sales

Happy holidays! The figures are in and we are looking like winners all around. Retail sales were up 2.3% this holiday season, compared to a measly 0.7% increase last year. Open up the champagne and get ready for 2014 -- what's that? Discounting? Promotions? Oh, I'm sure these guys don't know anything about any "discounting" -- these sales were all at full-price, right, guys? Hey, where'd everybody go?

How low did they go?
According to analysts, 2013 turned out to be the most promotional holiday season since 2008. Apparently the end of the year didn't make stagnating wages, government ineptitude, and taxes disappear. As a result, we went out to spend more only if we were going to get more.

The increase in traffic could end up paying off for businesses, and any company that managed to stay above the fray may have benefited from the extra foot traffic driven by everyone else's sales. This quarter, however, is likely to look rough for many brands.

Companies with already weakened brands are going to be the hardest hit, as they are the ones that will need the deepest cuts to get traffic. Two businesses that spring to mind are J.C. Penney (NYSE: JCP  ) and lululemon athletica (NASDAQ: LULU  ) .

Can weak brands bounce back?
J.C. Penney has been on the ropes all year, that's not news. The added trouble it may see is from the overly promotional environment. In its Black Friday update, J.C. Penney's CEO said that the company expected "the environment will remain as competitive as ever," but it looks like even that bar may have been exceeded.

The retailer's gross margin has been crushed over 2013, falling to just 29.9% for the first nine months of the year -- in 2012 it was at 32.5% for the same period. A discounting environment will have damaged that margin and set the business up for a difficult 2014, with customer expectations on price dropping to new lows.

Lululemon is a different bailiwick. The company's gross margin is still above 50%, but it's been pressured by product and brand problems all year long. Heavy promotion over the holidays will have forced the company into a tough spot, as it competes with Nike and Under Armour for Christmas sales and New Year's-resolution shoppers.

For Lululemon, this holiday season was less about survival and more about regaining its position at the top of the yoga/studio charts. Promotional pushes will have made that climb much more difficult.

Keeping an eye out for discounting
While the overall rise in sales is good news, the fallout for investors and businesses is on its way. Fourth-quarter margins are going to see a hit, giving retailers less to work with going into 2014, and that's not a recipe for success. Be on the lookout for weak players to get weaker while stronger brands take advantage to pick up more market share -- and don't bust out the bubbly just yet.

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