The holiday shopping season opened with a bang this year, with retail sales in November surging 0.7% from October -- the most in five months, according to the U.S. Commerce Department. Additionally, retail sales grew 4.7% last month from the year-ago period, as stores from Target (NYSE:TGT) to Macy's (NYSE: M) lured shoppers to their stores with steep price cuts and special promotions. However, for retailers, offering deep discounts often comes at a price: thin profit margins.
This is particularly concerning because holiday sales can make up as much as 40% of annual revenue for some retailers, according to the National Retail Federation. Let's take a closer look at which stores could suffer this holiday season as a result.
More sales vs. profitable sales
Discount retailers including Target (NYSE:TGT) and Wal-Mart (NYSE:WMT) were big winners during Black Friday weekend. This year, more than 5 million customers participated in Wal-Mart's One-Hour Guarantee promotion, while more than 22 million people shopped at its stores on Thanksgiving night. Target also had a record showing. The bull's-eye chain said both sales and traffic on its website on Thanksgiving were among the highest Target has ever seen in a single day.
Yet while both Wal-Mart and Target achieved record sales over Black Friday weekend, those sales also bear the burden of thinner profit margins. Price pressure on retailers this year is hurting many companies' bottom line. Margins at retailers including Target and department store chain Macy's have fallen to 5.2% down from 6% as a result, according to data from Thomas Reuters.
One of the problems is that stores are trying to one-up each other on price this holiday season. Target and Wal-Mart, for example, have been locked in a pricing battle on Apple (NASDAQ:AAPL) products they sell. Wal-Mart was the first big-box to slash the price of Apple's new iPhone 5c earlier this year. However, Target quickly followed suit, offering the 16GB version for $79.99 with a two-year service contract, down from Apple's retail price of $99.
For Black Friday, Target gave away $100 gift cards with every iPad purchase. Additionally, throughout the holidays Target is selling Apple's latest version of the device, the iPad Air, for $479. That's a $20 savings over Apple's price for the product. Still, the real winner here is Apple. In fact, Apple's 16GB iPad Air was the top-selling device at Wal-Mart and Target stores on Black Friday, according to InfoScout.
Unfortunately, other retailers haven't been as lucky.
A challenging retail environment
For Target and Wal-Mart, this highly promotional holiday season is eroding profits. While it's true that more people shopped this year during Black Friday weekend, customers actually spent less compared to last year, according to early reports from the National Retail Federation. Wal-Mart said same-store sales growth for the holiday quarter would be "relatively flat." Nevertheless, Wal-Mart continued its sharp discounting on Dec. 13, with the retailer dropping prices on popular toys, electronics, and apparel as part of its "Christmas countdown savings event."
Meanwhile, Target said "category rate pressure from seasonal markdowns" led to a 0.3 percentage-point decline in gross margins for its recent third quarter. As a result, Target also lowered its earnings guidance for fiscal 2013 full-year results. Nevertheless, investors will have to wait until after the holidays to find out which retailers were most hurt by the heavy discounting. For now, one thing is certain: Stores will continue slashing prices to compete even as their profits suffer.
Fool contributor Tamara Rutter owns shares of Apple and Target. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.