The holiday season should be packed with surprises, but not the kind that retailers are facing: excess inventory, rising shipping costs, increasing returns, and more.

They are also contending with slowing sales growth: In November, nominal sales growth for Bain-defined retail categories decelerated to 4.8% year over year, from 5.8% in October. This could be a result of cooling inflation, which has been propping up nominal sales.

As consumers navigate continued economic uncertainty, their confidence and intent to spend decreased in December, according to Bain’s Consumer Health Index. However, high-income households, which represent around 50% of consumer spending, actually increased in confidence and intent to spend, which could be a bright spot for December sales.

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2022 Holiday Shopping: Inside the Latest Retail Sales

US retail sales slowed again in December, contributing to muted holiday growth.

Supply chains’ holiday blues

In the last few days of the holiday season, retailers are wondering if they can deliver some holiday cheer. Supply chains have broadly improved from last season, which was full of stockouts and delivery delays. The Federal Reserve Bank of New York's Global Supply Chain Pressure Index (GSCPI), which includes key metrics such as shipping prices, delivery times, and backlogs, shows that supply chain stress peaked at 4.3 during last year’s holiday season. It has since fallen to 1.2 this November—still significantly above its long-term average of 0.

Today, US supply chains are under pressure from staffing shortages at rail yards and higher trucking rates. What’s more, as retailers and brands plan for the deluge of time-sensitive gift deliveries, they must also grapple with increased costs from FedEx, UPS, and Amazon. Retailers also expect returns to increase this holiday season—adding to reverse logistics complexities.

At the same time, many are coping with a massive inventory buildup. In the wake of last season’s inventory woes, most retailers ordered a surplus earlier in the year, guessing, not always correctly, what would be on this year’s holiday shopping lists. However, their plans were thwarted by delivery delays. Last year’s goods eventually came in too late to be sold—and, as the large buffer orders finally arrived, consumer demand started to slow due to skyrocketing inflation and rising interest rates.

Thus, inventory levels have ballooned. As of early fall, US retailers were holding an estimated additional $66 billion worth of inventory, or a 21% increase from prepandemic levels in 2019 (see Figure 1). That’s about 26% more than the 2019 holiday season and about 18% of total current inventory across categories. As a result, some retailers are struggling to handle the excess merchandise in their stores and warehouses, and some are flush with inventory that customers don’t want right now.

These issues haven’t hit retailers and categories evenly. For instance, apparel retailers are suffering from a glut of athleisure, thanks to the pandemic-induced boom. And some retailers are still contending with delays. West Elm, for example, warns of longer wait times for furniture due to a foam shortage, resulting from the surge in demand during the pandemic and a lack of current supply from weather disruptions.

The bottom line: a tough holiday to win

Current levels of inventory, and the ways retailers clear out that inventory, can hurt bottom lines. Discounts decrease margins; packing and holding excess merchandise raises storage costs and pulls cash from the balance sheet; canceling orders incurs penalties and hurts supplier relationships; and liquidating through off-price retailers means earning pennies on the dollar while endangering brand equity. In fact, off-price retailers may no longer be as easy an option. Their inventories in the second quarter were up around 40% from a year earlier, according to our analysis of S&P Capital IQ data.

Retailers are already feeling the pain. For instance, Nordstrom estimates gross profits will decrease by $200 million in the second half of 2022 due to markdowns and clearance efforts alone, and Target’s excess inventory offloading contributed to a nearly 90% year-over-year dive in second-quarter profits.

Rising interest rates also mean that demand-forecasting errors are more costly. Rates for short-term, investment-grade corporate debt rose around 300 basis points between November 2021 and November 2022, implying that $66 billion in excess inventory is costing retailers $2 billion. To put it in perspective, that’s more than 20% of this year’s estimated $9.12 billion in online Black Friday sales.

As if the strain from excess inventory wasn’t enough, mounting returns are another burden on retailers’ bottom lines. Optoro, a reverse logistics company, estimates that processing a return can cost 66% of the price of the product, putting formidable pressure on already-slim margins. And with e-commerce sales growth set to outpace in-store growth by 12 percentage points year over year this holiday, the problem isn’t going anywhere. Online purchases are 1.4 times more likely to be returned than in-store purchases. The returns conundrum is an unwelcome holiday guest that will likely overstay.

Can retailers stop supply chain issues from snowballing?

Leading retailers are moving swiftly to mitigate the effects of excess inventory, high shipping costs, and exorbitant returns this holiday season. While no retailer will solve every supply chain problem today, acting now will put some retailers in a better position heading into 2023.

Clearing inventories

To clear overstocked inventories before Santa leaves town, many retailers are hoping to strike the right balance between customer convenience, supply chain resilience, supplier relationships, cost-efficiency, and carbon emissions. While no solution is perfect, they’re taking several actions, including:

• Selling at early and attractive discounts. Amazon and Target have gone this route with early holiday discounts.
• Packing and holding. Kohl’s put last year’s holiday apparel on shelves as early as this October. And Express is planning to pack and hold merchandise with an extended shelf life for its outlet business.
• Canceling supplier orders. Walmart has widely touted this approach as part of its successful inventory glut-reduction strategy.
• Selling to off-price retailers or liquidators. Several apparel retailers have announced they’re liquidating excess merchandise to right size their inventories.

Managing holiday deliveries and returns

Shoppers expect presents to arrive in time for the holidays—and during this time of year, they aren’t as willing to forgive and forget. As the price of fast shipping climbs, leading retailers are taking three actions to deliver on promises while protecting profits.

Set realistic and profitable delivery windows. For many retailers, e-commerce sales are growing faster than store sales, but earning lower margins. Leaders are setting realistic and economically sustainable delivery windows to balance costs and supply chain complexity. Where possible, they provide customers with multiple options, such as standard no-rush shipping and expedited shipping for a higher fee. For example, J.Crew charges customers three times as much for expedited shipping than for standard shipping. Others are increasing shipping fees for customers across the board: M.A.C Cosmetics raised fees by approximately 40% from March to December.

In addition, some retailers, like Amazon, are passing along rising shipping costs to third-party sellers to improve e-commerce operating margins. The company’s fulfillment fees on third-party sellers have risen approximately 20% since 2021.

Steer pickups and returns to stores. Winning retailers are creatively rerouting customer traffic to stores to improve margins, boost sales, and ease supply chain pressure. Many are capitalizing on the increasing consumer interest in buy online, pick up in store (BOPIS), which is expected to grow about 20% in value this year. For instance, CVS is incentivizing holiday shoppers by offering 15% off pickup orders. This bet could pay off: 61% of customers who use BOPIS say they typically purchase additional items.

Similarly, retailers are pushing shoppers to make returns in-store. For instance, Zara is charging a fee on previously free mailed returns. By encouraging in-store returns, Zara seems to have minimized any damage to its top line. Other retailers are also rethinking the customer convenience-to-cost trade-off, with 60% leaning toward stricter return policies, per a recent goTRG survey.

Partner with third-party logistics (3PL) providers. Some retailers are partnering to boost capacity and smooth shipping snags, particularly in reverse logistics. Overstock is pairing up with UPS to create a painless return experience in which customers can schedule home pickup, without even needing to rebox their items. It’s piloting the service this holiday season—a time when shoppers increasingly look for easy returns to ensure a hassle-free experience for their gift recipients.

How to future-proof supply chains for the new year and beyond

While retailers can’t solve the current crisis, industry leaders will prepare for the next one through structural changes that transform their supply chains for the future. There’s no silver bullet, but four universal truths can help retailers chart their own unique journeys.

1. Manual overrides are tempting, but fix the forecasting algorithms instead.

Leading retailers use demand forecasting to minimize the bullwhip effect—a supply chain phenomenon where orders to suppliers have a larger variability than sales to customers. The famous Beer Game supply chain simulation, created in the late 1950s by MIT Sloan Professor Jay Forrester, exemplifies how relying on emotions rather than evidence can lead to inefficiencies like overstocks, poor capacity utilization, and ineffective customer service.

While algorithms aren’t perfect (yet), they’re better than manual overrides, which aren’t scalable. Winning retailers will continuously train and improve algorithms as they rely on data-driven sourcing, allocation, and replenishment decisions. Macy’s cites data and analytics as a pivotal reason it avoided the stock surpluses that have recently plagued its competitors.

2. Decide where and when to be fast.

Free, fast shipping is expensive—so leading retailers will resist the urge to be free and fast simultaneously. Instead, they’ll take a category-based approach, matching Amazon’s speeds where fast delivery matters most, such as groceries. They’ll balance out that investment in other categories, like home furniture, recognizing that most urgent needs can be fulfilled in-store (including BOPIS).

These retailers will also alleviate supply chain complexity by redirecting traffic to stores. While some, like Rite Aid and Petco, are already offering cash incentives to store-goers, the next generation of winners will create a differentiated value proposition in-store—with shopping concierge services, product demonstrations, augmented reality-enabled product recommendations, and more.

Most important, leading retailers will keep their promises. Shoppers often value predictable delivery more than instant gratification. Breaking delivery promises—particularly during the holidays—can frustrate them and erode loyalty.

3. Stop rewarding “buy 3, return 2” behavior.

Ease of returns can make or break repeat business. Without compromising on customer convenience, leaders will lower costs and limit the potential for abuse.

First, leading retailers will mitigate the need for returns. Retailers such as Walmart, IKEA, and Wayfair allow shoppers to virtually “try on” items using augmented reality (AR) technology. Two-thirds of consumers are less likely to return online purchases when they use AR, having made the right choice initially. In addition, giving customers more information—such as images of apparel on multiple body types, the fit model's measurements, or visible customer reviews—has the extra benefit of differentiating the shopping experience.

Second, retailers in some categories can consider offering free returns only in-store and charging shipping fees for mailed-in returns. This helps them avoid reverse shipping costs and pushes shoppers to consider returns at the time of purchase.

Finally, when free returns can’t be avoided, winners will use them as a loyalty and data engine. For example, H&M customers can mail returns for free only if they participate in the retailer’s loyalty program.

4. Act now.

Competitors are already making moves, and inaction today could mean irrelevance tomorrow. To determine where to start, retailers can ask themselves the following questions—and use data and analytics to answer them.

• Who are our most valuable customers, and what are their most pressing needs?
• How well is our supply chain configured to meet these core needs?
• Which suppliers and 3PL partners have an outsized impact on these core needs, and how do we work with them to deliver for our most important customers? How do we cascade their strategic importance into negotiation playbooks?
• Do we truly understand which products must always be in stock, and are we prioritizing those products in our supply chain?
• When we are out of stock, are we out of stock everywhere? Can we rebalance inventories?
• Are we investing in the right tools and data to develop real-time, automated demand-forecasting capabilities?

How we can help

Bain Supply Chain Edge®

Supply Chain Edge® von Bain ermöglicht es Unternehmen, ihre Lieferkette als strategisches Asset einzusetzen.

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The authors would like to acknowledge Anirudha Sharma, Adam Kowalski, Quinn Creamer, Daniella Valverde, and Darsh Jalan for their contributions to this newsletter.