While the U.S. economy has made great progress towards recovery since the global financial crisis, the fruits of success aren't equally shared. According to research done by Professor Emmanuel Saez from the University of California, Berkeley, 95% of the average real income growth from 2009 to 2012 was contributed by the ultra-rich. The top 1% of U.S. earners grew their incomes by 31.4% over the same period, while the rest of the country saw flat income growth of about 0.4%.
As a result, there is a polarizing effect when it comes to consumer-buying behavior. The rich don't mind paying top dollar for luxury brands; the less well-off choose to pinch every penny, taking price as the sole criterion for purchases.
Retailers stuck in the middle will suffer
Before assessing which retailers will benefit from the rich-poor divide, it is useful to eliminate those that won't. Top of the list are middle-market retailers like Macy's (NYSE:M). On one hand, its mass-market appeal makes it unlikely to be a shopping destination for the rich and famous.
Furthermore, Macy's lower profitability relative to luxury retailers means that it is difficult for it to invest in both brand building and customer service to improve its attractiveness to the affluent consumers. On the other hand, Macy's also can't compete on cost efficiency and bargain prices because of high fixed costs associated with its brick-and-mortar presence. Moreover, the ease of price comparison with the Internet has fueled bargain hunting to a greater degree.
Recent news flow validates this view. In January, Macy's announced several cost-reduction initiatives, including the laying-off of 2,500 employees and the closure of five stores. While Macy's financial track record has been excellent, having delivered increased sales, earnings, and a stable gross margin of around 40% since fiscal 2010, there is no escaping the fact that the future is fraught with uncertainty. Macy's can neither justify a price premium to the richest customers with the strongest purchasing power nor drop costs and prices low enough to satisfy budget-conscious customers.
Tiffany (NYSE:TIF), a luxury retailer, has established a premium branding that is unrivaled by other retailers. Any diamond placed in its distinctive blue box automatically fetches a price premium, as the Tiffany brand delivers a strong statement about both the buyer and potential recipient of the gift. Also, Tiffany's consistently high gross margin in the high-50's is the clearest indication that consumers are willing to pay more for premium products.
Furthermore, luxury goods are associated with all-in physical shopping experiences that can't be replicated by online retailers. The revenue of Blue Nile, an online retailer of diamonds and jewelry, is slightly more than one-tenth that of Tiffany; and Tiffany's gross margin is about three times that of Blue Nile's margin in the high teens. Luxury retailers are less susceptible to threats from online competitors than their middle-market retailer peers.
Value retailers will benefit
Following the global financial crisis in 2008-2009, frugality seems to be fashionable again. In the U.K., discounter Aldi is giving retail giant Tesco a run for its money. In the U.S., off-price retailers have grown their sales significantly faster than their peers. Based on industry statistics from The NPD Group and Euromonitor, while department stores and national chains have grown their top lines by a compound annual growth rate of 0.5% from 2010 to 2012, off-price retailers have seen their revenues rise by 5.4% over the same period.
One good example is TJX (NYSE:TJX). Its consistent financial performance will put many retailers, if not most companies for that matter, to shame. For the past 32 years, TJX has only registered one year of negative same-store sales--and that was in 1996.
A reason for TJX's economic resilience lies with its customer demographic. Contrary to popular belief, many customers shopping at off-price retailers belong to the middle- to upper-middle income bracket, with some earning in excess of $1 million a year. This signifies the rise of the rational consumer, who saves up on basic necessities and instead spends excess cash on the occasional indulgence like diamonds or luxury watches.
Foolish final thoughts
As the rich gets richer and the poor get poorer, it hurts to be a retailer sitting on the fence. Investors should either choose luxury retailers with pricing power such as Tiffany, or go with cost-competitive value retailers like TJX.