Have consumers maxed out their spending?

Ominous economic conditions fueled by debt ceiling uncertainty and sticky inflation are taking a toll on consumer confidence while compelling consumer products companies to build resilience in pursuit of profitability.

The University of Michigan’s Index of Consumer Sentiment in May fell to 57.7 from the April reading of 63.5. However, consumers have remained resilient despite stubborn inflation and significant increases in the federal funds rate throughout the year. April retail sales were generally positive, increasing 0.4%, with a few specific sectors showing some signs of softening.

So, how long can consumers continue this trend if sentiment is eroding?

A blow to purchase power

Consumers have made the most of their credit cards to support spending habits. According to the Quarterly Report on Household Debt and Credit issued by the Federal Reserve Bank of New York, credit card debt rose to $986 billion in Q4 2022 and remained consistent through Q1 2023, surpassing the pre-pandemic high of $927 billion. While consumers have built up significant savings, higher prices have caused many consumers to use both savings and credit for purchases.

Aside from credit, many consumers have come to rely on recurring financial windfalls to bolster their spending; however, one such infusion of cash is not materializing for many consumers this year.

According to the Internal Revenue Service, the total amount of tax refunds issued this calendar year through the week of May 5 was nearly $262.9 billion—7.9% less than the prior year—despite having processed 0.5% more returns than at the same time last year. The average refund amount fell 7.3% year-over-year from $3,025 to $2,803, reducing the disposable income of many who rely on the annual payment. It remains to be seen how the combination of savings and credit will be deployed in future spending.

Balancing inventory

On the other side of the spending equation, retail inventories have largely normalized since the severe supply chain disruptions brought on by the pandemic. As consumers grapple with economic uncertainty, this is a key time to reinforce strong inventory management to avoid accumulation of excess inventory and the associated carrying costs. Retailers should focus on the shifting buying habits of consumers as the expectation of a longer battle with inflation becomes more engrained in the consumer mentality.

If consumer spending declines more significantly in the coming months, many retailers may find themselves facing weaker profit margins due to increased costs and steeper discounts required to encourage sales in an unpredictable economic environment. Focusing on efficient processes and automated infrastructure to support a lean inventory process will be critical to maintaining profitability.

A line graph depicting the relationship between consumer sentiment and retail inventory-to-sales ratio since January 2019.

The takeaway

As consumer liquidity begins to dwindle, middle market businesses in the consumer products industry need adaptable tools coupled with strong data to understand consumer loyalty, enhance the consumer experience and control inventory to ensure profitability.

Read more in our spring 2023 consumer goods industry outlook and retail industry outlook.

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This article was written by Thomas Hamill, Karen Galivan and originally appeared on 2023-05-19.
2022 RSM US LLP. All rights reserved.
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