BDO Consumer Business Report: Looking Ahead to 2016

Canadian Consumer Businesses Aim to Leverage Pockets of Opportunity

For some economies, the term "recession" elicits deep, reverberating pangs of fear and havoc. However, for Canada, it's proving to have the opposite effect. While Canada is operating amid what is technically a recession due to contracting Gross Domestic Product (GDP) the first two quarters of the year, according to some economists, like Doug Porter, Chief Economist at the Bank of Montreal, it is the "Best. Recession. Ever."

Why? Despite facing a number of challenges, such as sharply declining oil prices and the impact of China's devaluation of the yuan, Canada's economy is exhibiting signs of promise. The Globe and Mail reports, "The Canadian economy posted its second straight month of impressive growth in July, strengthening the case that the country's economic fortunes have turned a corner following a trying first half of the year."

From an increase in jobs and consumer spending to GDP growth, Canada's economy may, in fact, be on its way to recovery. These glimmers of economic hope not only have helped to strengthen the overall economy, but also Canada's consumer businesses. Testament to this, Canadian retail sales increased 0.5 percent in August, fuelled by growth in the motor vehicle and parts, food and beverage, home furnishings, and clothing sectors, according to Statistics Canada. Despite an unexpected decline in September, the Globe and Mail reported year over year growth remained strong at 12 percent. Auto sales in Canada rose 3.7 percent in September, as well, according to data compiled by DesRosiers Automotive Consultants.

This increase in sales and consumer confidence could suggest that consumers and consumer businesses alike have acclimated to the country's new economic normal. However, for retailers to not just survive amid a challenging and unpredictable financial climate, but also thrive, they must remain one step ahead of the economy. This requires closely monitoring market indicators in order to take advantage of the pockets of opportunity that present themselves to move sales performance from "maintaining" to "growing."

Canada's Economy—Under Pressure

Canada's economy, which has been historically dependent on commodities, has been significantly impacted by the collapse in crude oil prices. To hedge against this sharp decline and the slow recovery of non-energy exports, the Bank of Canada has already cut the main interest rate twice in 2015.

These rate cuts were implemented to minimize the deleterious effects of declining crude prices, which have cut into the country's national income and threatened to drive inflation below target for an extended period of time, reports the Financial Post. The interest rate reduction was also intended to resuscitate the value of the country's struggling loonie, which the Financial Post reports is, "the second-worst performing Group-of-10 currency this month [in September]."

Also contributing to Canada's economic woes is its total household debt. Currently at C$1.82 trillion—C$1.3 trillion in residential mortgages—total household debt now exceeds Canada's C$1.6 trillion GDP, reports Business Insider. Additionally, household debt is greater than 160 percent of disposable income—meaning families would need approximately 20 months to pay off their debt if interest rates were zero percent and they spent their entire disposable income to do so. While consumers have found freedom in borrowing because of the interest rate cuts, high household debt continues to pose a significant risk to the country's financial stability.

These factors, among others, culminated in the country entering into a textbook case of recession during the first half of 2015.

In Reaction to Recession, Consumers Rally and Retail Sales Rise

Even with these economic pressures, Canada's retail sales continue to rise at a moderate pace. Contributing to this slight gain are job growth, low interest rates and tax cuts, all of which are keeping retail sales slowly humming along this year. Spending on big-ticket items like cars and houses is holding up, even as households take on record debt loads and lower commodity prices threaten incomes in provinces such as Alberta and Newfoundland, reports Bloomberg Business.

Possibly contributing to this very mild peak in retail sales is a boom in tourism. The devaluing of the loonie has prompted an influx of vacationers, especially Americans. Destination Canada, the government agency responsible for marketing Canadian travel, reported that overnight trips to Canada from the U.S. rose by 7 percent in the January-to-August period, compared to the same time range last year. That equates to almost 9 million Americans who came across the border and stayed at least one night, almost double the number who came from the rest of the world combined.

Tourism, however, could also be partly responsible for the hollowing out of Canada's midmarket retailers. Luxury brands like Nordstrom, Jimmy Choo and Saks are holding steady as high-net-worth individuals continue to shop as usual, and travellers from the U.S. cross the border to take advantage of Canada's weak currency, scoring luxury goods at a lower price relative to the U.S. dollar. Meanwhile, discount brands are benefiting from the evolving Canadian middle-class shopper, who may be more price sensitive as a result of the current economy. Unsurprisingly, discount stores have become increasingly competitive, with retailers like Walmart and Old Navy pushing to be leaders in the "bargain hunting world." This division of shopping preferences leaves mid-tier retailers in a precarious position—too expensive for the average consumer, but not elite enough for the luxury shopper. It remains to be seen what the effect of Canada's new government and the promise of tax cuts to the middle-class will have on price sensitivity and consumer confidence heading into the holiday season.

Retailers Strengthen Defences to Weather Unpredictable Economy

As the Canadian economy continues to vacillate and drive new consumer trends and behaviours, retailers are moving to explore new strategies in order to remain competitive. One approach retailers are using is right-sizing, or consolidating their real estate footprint to reduce operational expenses as a cost-cutting measure. For example, Loblaw Co. announced in July it would close 52 unprofitable stores over the next year to help boost its bottom line. That announcement followed a similar one from Empire in mid-2014, which closed about 50 locations following its $5.8-billion purchase of Safeway Canada, according to Global News.

It's important to keep in mind that a reduction in physical real estate through right-sizing does not necessarily stunt a retailer's reach. As some Canadian retailers shrink their brickand-mortar footprint, they are simultaneously growing their digital presence as way to offset the loss of square footage.

While e-commerce has historically been a lesser priority for Canadian retailers because of web access and infrastructure, lack of selection and the sheer cost of trying to serve a market spread across a country that's slightly larger in geographic size than the U.S. (but has only about 10 percent as many people), it has found its way closer to the top of their to-do lists as more Canadian shoppers buy online. For example, according to Financial Post, "Best Buy Canada recently opened up its website to so-called 'marketplace' sales from external retailers and will serve as an online ordering hub and brick-and-mortar pickup point for the outside retailers." Forrester projects that in 2019, online spending will account for 10 percent of Canadian retail spending, putting it nearly equal on a percentage basis to the 11 percent expected in the U.S.

Beyond right-sizing, retailers are embracing strategic acquisitions as a hedging tactic. This is also a manoeuvre that allows retailers to create an influx of available cash. Loblaw recently acquired drug and grocery stores Shoppers Drug Mart and Safeway in a move to eliminate head-to-head competition and net bigger slices of cash from consumers. These types of acquisitions not only benefit retailers, but also their consumers. According to a CIBC World Markets report, big consolidations like these should come bearing fruit for consumers in the form of reduced pricing and increased promotions.

Retailers are also exploring local flagship expansions as a means of guarding against volatility while raising cash. Hudson's Bay, Canada's iconic department store, recently took out a $1.25 billion mortgage on Saks Fifth Avenue's flagship store in New York, highlighting a move to expand into a more stable economy. Moreover, according to the Wall Street Journal, Hudson's Bay also completed a $2.8 billion purchase of German retailer Galeria Kaufhof in the hopes of boosting further international growth.

Retailers Adapt To New Type of Consumers

While adjusting their business approach to respond to a volatile and skittish economy, retailers are also feeling pressure to evolve with their consumers, especially their growing preference for online shopping.

According to CBC News, Canada Post found that about 76 percent of Canadian households shopped online last year, and about a quarter of Canadians have become "frequent" shoppers, which means they're buying on the Internet four to 10 times per year. Canadian retailers have now realized it is critical to bring their digital infrastructure up-to-speed to meet today's e-commerce demands.

This is especially crucial as millennials grow to possess more buying power in the country. According to Retail Insider, "The millennial generation represents approximately 26 [percent] of the Canadian population, or about 9 million people. The population is growing quickly, with spending predicted to exceed that of baby boomers. Remarkably, Canadian millennials average over three devices per person. Social media acts as their primary medium of communication, versus the 'old days' of watching the news, reading the newspaper or speaking on the phone."

As Canadian consumers start to turn more frequently to the web to both purchase and research potential purchases, retailers are now battling the "showrooming" effect—when consumers visit brick-and-mortars to experiment with products before buying them online for a better bargain. To combat this, Canadian retailers must remain diligent in evaluating their pricing strategies to remain competitive in both the physical and online marketplaces, consider rebranding their available products to make price comparison more challenging, and create engaging in-store experiences that build customer loyalty.

A Positive Look to the Future

Even with Canada's challenging economy, bright spots remain on the market's horizons, specifically for consumer businesses. Canadian retailers are positioning themselves to weather this economic storm. Undeterred by changing consumer trends, competition from outsourced and e-commerce businesses, and other factors, retailers are leveraging multi-faceted investor, consumer and marketing strategies to buoy themselves. By making these course corrections and integrating thoughtful business approaches in response to market shifts, the Canadian consumer business industry has been able to create a sense of optimism that, while cautious, bodes well for the future.

To learn more about how BDO can help your company with these and other challenges, contact your local BDO office or

About Retail & Consumer Business Practice

BDO recognizes that it is critical to both build and protect your brand, as well as to take advantage of recent developments in innovation and technology. Our industry professionals understand the varying priorities and concerns for retail and consumer businesses in Canada. We help our clients across the industry prosper in both good and challenging times, grow their revenue in new markets, build their brands, and control costs to maximize profitability.

About BDO

BDO is one of the largest national accounting and advisory partnerships in Canada with over 100 offices nationwide. Our professionals have the expertise to serve owner-managed businesses, large enterprises, public companies, the public sector, and communities and not-for-profit organizations in a broad range of industries. As a member firm of the international BDO network, we also have access to advisors around the globe with more than 1,300 offices in over 150 countries.

www.bdo.ca/consumer-business

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name of the BDO network and for each of the BDO Member Firms.