The Fed’s Folly and the Future of Retail

How retail businesses are adapting to the market volatility

Today, Jerome Powell and the feds raised the interest rate by 25 points, signaling their determination to fight inflation at all costs. Never mind that Janet Yellen, the Treasury Secretary, had just admitted that she couldn’t guarantee the safety of all bank deposits in case of a crisis. Never mind that Wall Street was already jittery and confused about the economy’s direction. Powell and his colleagues seemed to have one thing on their mind: keeping prices stable, even if it meant risking financial stability.

But what does this mean for the retail sector, which has been struggling to adapt to the market volatility caused by the pandemic? How are businesses that sell things to consumers coping with the changing consumer behavior, rising costs, and uncertain demand? And what are they learning about their business models in the process?

To answer these questions, I looked at three companies: Tonal, Vans, and Nike. All three are in the business of selling physical products directly to consumers (DTC), but they have very different stories to tell.

Tonal is a high-tech home fitness system that uses artificial intelligence and digital weights to create personalized workouts. It was one of the hottest startups during the pandemic, as people flocked to buy its $3,000 machines instead of going to gyms during the pandemic. But now it faces a harsh reality check: its sales have plummeted, its valuation has been slashed by 90%, and it has laid off hundreds of employees. What went wrong?

Tonal, blinded by the behavior changes brought along by the pandemic, got caught up in its optimism and enthusiasm for its product. They ignored the warning signs and did not anticipate how quickly consumer behavior would change once gyms reopened and people resumed their everyday lives. We can look at Tonal as another cautionary tale of how not to run a DTC business because of its 90% valuation cut, but many other companies have suffered or are on the path to suffering the same faith.

Unlike Tonal, Vans has been around for over 50 years and has built a loyal fan base among skaters, surfers, and musicians who love its iconic styles and culture. But while Vans sales grew 24 percent in the year ending March 2019, they fell 13 percent in the final three months of 2022 and are now unable to find extra growth in their existing business model. Now Vans must toe a fine line and start focusing on profitability. Vans hopes to streamline its marketing efforts, exit weak wholesale accounts, and introduce new, technical styles that appeal to the trends of their core customers and hope it helps them attract new ones. Only to then use this new streamlined operation to find growth in DTC by investing in its digital capabilities to enhance its direct relationship with consumers.

Nike is another shoe company with massive profitability from investing in DTC. It has been a pioneer in using data analytics, digital platforms, and innovation to create personalized customer experiences. Nike’s DTC sales, including its website and owned-and-operated stores, hit $5.3 billion last quarter, growing 17% year-over-year.

Despite that success, Nike faces rising costs associated with scaling its direct-to-consumer (DTC) channel. Despite impressive DTC sales growth, the company has seen a rise in selling and administrative expenses, inventory levels, and a drop in gross margin. The road ahead for Nike may be rocky, but the company strives to adapt to these new realities.

But the Fed’s rate hike and the pandemic are not the only forces shaping the retail landscape. There is also a giant elephant in the room: Amazon. The e-commerce behemoth, valued at over $1.6 trillion, is slashing an additional 9,000 jobs while boosting its profit margins by exploiting its third-party sellers.

Amazon’s strategy is simple: it wants to sell more stuff but not necessarily make more stuff. It wants to leverage its vast trove of data on consumer behavior and preferences to target ads and offers to its sellers and customers. It intends to provide tools and services that make it easier for anyone to set up an online storefront and use its platform. And it wants to charge more for these services, knowing that online sales will only keep growing.

What does this mean for the future of retail? It means that Amazon is shifting its focus from being a consumer-centric company to being a seller-centric one. It means that Amazon is cutting back on investments that don’t directly contribute to its bottom line, such as streaming content or innovation labs. And as growth becomes harder to find and financing harder to secure, Amazon knows it can find profitability by being the middleman between sellers and buyers rather than being the seller or the buyer itself.

Every brand is trying to find growth, even Designer Brands, a footwear and accessories retailer that owns DSW, Shoe Warehouse, and The Shoe Company. Designer Brands has been on a tear lately, reporting a 32.1% increase in sales for its owned brands last quarter.

Designer Brands knows it cannot find the needed growth by selling shoes. So now they want to sell lifestyles. That’s why it has been on a buying spree, snapping up brands like Le Tigre, Topo Athletic, and Keds. These brands give Designer Brands access to new markets, such as athleisure, outdoor, and casual wear. But they’re not just buying these brands for revenue; they have a bold vision to double sales from owned brands in the next five years and make them account for nearly a third of its total revenue. Designer Brands is betting that DTC is not just a fad or a necessity. It’s a competitive advantage. It believes that owning more brands and selling them directly to consumers through its stores and websites can create a loyal customer base that values quality, style, and convenience.

The retail sector is facing a reckoning. For years, many DTC businesses have been blitz-scaling their way to growth, taking advantage of the cheap money and high demand that came with a 0% interest rate environment. They thought they could disrupt the traditional retail model by selling directly to consumers online, bypassing the middlemen and offering better products, prices, and experiences.

But now the tide has turned. The Fed’s rate hike, the pandemic’s aftermath, and the threat of a financial crisis have created a new reality for retail. It is a reality where growth is harder to come by, costs are rising faster than revenues, and consumers are more cautious and selective about what they buy. A reality where consumer businesses have to adapt or die.

Some might argue that this is too pessimistic. After all, consumers are still spending money. Just look at Easter: according to a recent survey by the National Retail Federation, Americans are expected to spend a record $24 billion on Easter this year, up from $20.8 billion in 2022 and $21.7 billion in 2020.

But that’s not the whole story. When we dig deeper into the numbers, we see that most spending is not on products but on experiences: cooking a holiday meal, visiting family and friends, attending church, and planning an Easter egg hunt. And when consumers do buy Easter gifts, they are more likely to shop at discount stores than online or at specialty stores.

What does this mean for retail? It means consumers are looking for value over novelty, for quality over quantity, for meaning over materialism. It means that retail businesses need to focus on efficiency and profitability rather than on gimmicks and tricks from the past. It means that DTC businesses need to rethink their business models and find ways to deliver value to consumers in a changing world.