The effect of technology on the industry

E-commerce and the continuing outperformance of online sales are hitting traditional brick and mortar operations hard. As the merging of online and physical operations presents new challenges, retailers primarily focused on brick and mortar locations are looking to viable e-commerce offerings as a solution for their struggles and, instead of avoiding brick and mortar companies altogether, some acquirers are targeting companies with physical locations that also manage their own e-commerce and websites, as explained by one acquirer at a recent Nixon Peabody LLP private equity roundtable event focusing on consumer products and services in middle market transactions. This move away from brick and mortar companies has been noted across various sectors in the market, including apparel. However, some sectors, including the perishable products and home furnishings spaces, appear to be somewhat protected against digital disruption because consumers still crave the touch and feel factor for these products—they want to access them in person to assess quality and other factors. In 2017, the number of liquidations and bankruptcies among the brick and mortar sector are expected to increase as changing retail industry dynamics and shifting consumer purchasing habits weed out companies that fail to remain relevant and engage consumers.

In addition, many consumer-driven companies are now successfully using augmented reality (AR) technology and AR apps to enrich their customers’ experiences and interactions with their brand, and ultimately to boost sales. This use of technology, such as trying on reading glasses virtually over the internet instead of going into a brick and mortar store to try on and purchase glasses, is here to stay and will continue to change the retail space in the coming years. If a customer cannot experience a product online, it’s likely that such product will be less successful and, in some cases, avoided altogether.

The millennial generation effect

Private equity investors continue to focus on trends both created by and important to the millennial generation, which is steadily gaining more purchasing power. Within the consumer products and services industry, the millennial generation is focused on:

(a) paying for experiences (such as home furnishings and travel), rather than goods;

(b) healthier foods, including transparency around food chain sourcing and whether such production chains are environmentally friendly and, in some cases, come from sources that observe sustainability practices;

(c) paying up for customized offerings blended with an experiential setting and for convenience;

(d) new and different apparel as brand loyalty fades; and(e) in some cases, the charitable giving practices of the providers of their products and services.

These various trends have caught the attention of private equity investors because private equity investors want to capitalize on this generation’s increasing purchasing power.

The Trump effect

The presidential election victory of Donald Trump, along with the Republican hold of the House of Representatives and Senate, signal changes ahead, including potential tax cuts and changes in trade policies and regulations. Given these potential changes, buyer hesitation across many sectors, including the consumer products and services sector, is reasonable; therefore, a focus on quality and clear established rationales for acquisitions will remain paramount.

Worry exists in the industry about the potential regulatory changes that the Trump Administration has promised to implement, including the potential for an import tax. No one knows what the import tax will be or how or when it would be implemented, and investors at the Nixon Peabody roundtable event are factoring this uncertainty into investment decisions. For example, one investor recently passed on submitting a bid for a target company that had a large number of imports from China but whose largest competitors did not also similarly import its products from China, given the risk of a potential future import tax. Another investor noted that his firm continues to bid on target companies, but requires an escrow of funds for a certain period of time following closing so that the seller bears the risk of potential import taxes and increased labor costs for a certain period of time following the purchase. In addition, changes in trade policies and trade agreements could lead to increased prices for imported goods, which would reduce spending power and lead to job cuts in export sectors.