Black Friday, Red Ink: Big Discounts Will Kill Profits

It’s that time of year again. The holiday shopping season has shifted into full gear, and so have the economists, analysts and retailers who wring their hands over things like Black Friday sales figures. Or those of its fake, and widely mocked, online counterpart, Cyber Monday (which is far from the busiest shopping day on the web — online sales at Amazon, for example, typically peak in mid-December).

Overall, a modest improvement over last year’s dismal performance is expected. Forrester Research projects an 8 percent rise in holiday sales online, up from the 5 percent growth rate last year. comScore sees growth at 3 percent, all but erasing the 3 percent drop last year. But while online retailers are sure to see stronger sales than their offline rivals, the desperate discounts happening across the board threaten to erode any profits they may have once hoped for this season.

For my money, the best indicator is the average consumer shopping budget. Despite all the hot items for sale, we’re still feeling the pinch of the economic downturn, and as such, budgets are back in vogue. A Gallup poll showed consumers plan to spend an average $638 per household this season, up $22 from last year. But a survey by the National Retail Foundation said they will spend $683 dollars, or a decline of 3.2 percent, following on the heels of an 8 percent drop in spending last year.

Think about that. The NRF — the trade group pushing the annual Cyber Monday charade — expects consumers to spend even less than last year. And with respected analysts publicly predicting a double-dip recession, such caution on the part of consumers is more likely to grow in December than abate.

To that end, retailers are responding the way they did last holiday season — with ultra-steep discounts early on. The price war that Wal-Mart is waging against Amazon may stretch consumers’ dollars, but it’s hell on other retailers, who must either match discounts or risk losing customers. Already, 2009 is shaping up to be a repeat of 2008, when retailers desperately slashed prices to entice wary consumers.

That is undoubtedly worse news for brick-and-mortar stores than it is for online stores, where operating costs are lower. Many big retailers like Wal-Mart and Best Buy are responding by pushing deep discounts on their web sites, but in doing do, they risk cannibalizing sales from their offline stores, while the costs of running those stores remains the same. Which means that even if overall holiday sales figures do increase by a few percentage points, profits at many retailers may decline or be eliminated entirely.

The Black Friday deals tracked on Twitter aren’t just a stream of bargains, they also measure the desperation retailers are already feeling. Gap’s site was offering sweaters at 50 percent off. Betsey Johnson took 40 percent off everything in its online store. Even Apple is getting into the deep-discount spirit.

Discovery-oriented sites like Twitter are helping to spread news about bargains, further boosting the appeal of online shopping among consumers, as Colin noted earlier this week. In Apple’s iTunes store, the second best-selling paid app last week was RedLaser, which scans barcodes and offers instant price comparisons with online sites.

As with last year, there is likely to be one outstanding success story in this bleak retail environment: Amazon. In an environment where penny-pinching consumers are driving down retail profits, Amazon – the master at thriving on razor-thin profit margins – is thriving. Goldman Sachs and Piper Jaffray recently raised their revenue estimates for Amazon, citing a rise in unique users and overall traffic.

As long as the economy remains weak, the progression of the retail industry remains clear: All retailers must become more like Amazon – low prices, tiny margins – or suffer a slow death.