Back-to-school price wars

NEW YORK (CNNMoney.com) -- After Wal-Mart announced this week that it would slash prices on thousands of back-to-school products, industry analysts said they expect a price war to erupt.

Competitors Target (Charts, Fortune 500), Best Buy (Charts, Fortune 500), Circuit City (Charts, Fortune 500), Sears (Charts, Fortune 500) and other mass-merchant chains could soon be trimming their own discounts further in response to Wal-Mart's move.

Wal-Mart's latest price cuts are in addition to sales that it had already put in place for this year's back-to-school merchandise.

Typically when the world's largest retailer initiates a second round of price cuts, rivals feel compelled to slice their prices as well or risk losing sales.

Retail industry experts say a price war would benefit cash-strapped consumers, who have been hurt by spikes in gas prices as well as softness in the housing market this year.

"Consumers win any time there's aggressive pricing competition," said George Whalin, CEO of Retail Management Consultants.

But would deep discounts hurt retailers' businesses? Not necessarily, said Whalin.

"I don't know any retailer that goes into the back-to-school season with big discounts across the board on all products," Whalin said. In other words, a merchant may accept a loss in one product category, hoping to lure more people into their stores and sell them other merchandise near full price.

Back-to-school is a sales game and not necessarily a race for bigger profits, although most stores would prefer a healthy boost to both their top and bottom lines.

"Retailers selectively discount [products] to bring people in through the front door. It's a marketing strategy that works for them and we see it happen every Christmas too," Whalin added.

Wal-Mart needs the low-price ploy to work.

Sales at its discount stores open at least a year, a key measure of retail performance, continue to trail same-store sales growth at its main competitor Target (Charts, Fortune 500), and its stock is up a mediocre 4 percent vs. an almost 14 percent jump in shares of its rival.

Overall, sales at chain stores open at least a year are up a moderate 2.7 percent so far this year, according to sales tracker Thomson Financial, which tracks sales at 47 chain stores nationwide, including Wal-Mart. But excluding the drag from Wal-Mart's weak sales growth, same-store sales year to date are up a stronger 3.8 percent.

While Wal-Mart's aggressive pricing moves may boost its sales early on, it doesn't guarantee a strong finish when the back-to-school season ends.

Wal-Mart was also first out of the gate to chop prices on toys, electronics and other popular categories for the 2006 holiday shopping season. However, when the final sales tally was rung up, its same-store sales rose a disappointing 1.6 percent in December.

"Wal-Mart is being more aggressive with prices now because it's in a predicament," said George Rosenbaum, chairman of Chicago-based consumer research firm Leo J. Shapiro. "It really needs a month or two of good comparable sales to satisfy its investors."

According to the National Retail Federation (NRF), back-to-school is the second-most important selling period for retailers after the fourth-quarter holiday period.

The NRF estimates that families with school-age children are expected to spend an average of about $564 this year on new computers, clothes, shoes and other items, a healthy 6.9 percent increase from last year. Total back-to-school sales are forecast to rise 4.5 percent to $18.4 billion.

"The consumer [sector] is the only sector that is keeping the economy afloat when overall growth is slowing," said Rosalind Wells, chief economist with the NRF. Consumer spending fuels two-thirds of the nation's economic activity.

The U.S. economy grew 0.7 percent in the first quarter, slightly below expectations, and its slowest pace of growth since the fourth quarter of 2002.

Fortunately, consumers continued to spend, despite high gas prices and mortgage market problems, Wells said. Otherwise, "we would've had a terrible first quarter," she said.

So what's keeping Americans' spending spirit alive?

Rosenbaum credits relatively low unemployment and year-over-year gains in income level for giving Americans "a sense of job security."

He cited his firm's July survey of 450 households nationwide that showed consumers were spending more freely as they worry less about prices rising.

"The greatest inhibitor to shopping is fear of inflation," Rosenbaum said. "In April, May and June, consumers said they were concerned that higher energy and gas prices would be responsible for higher retail prices. But that didn't materialize and in July they began to relax about inflation."

Also, gas prices at the pump have retreated about 30 cents a gallon from their highs in May, which could rev up consumers' school-shopping spree.

Although Rosenbaum's firms doesn't forecast sales, he anticipates that this year's back-to-school season could be very strong in overall sales "but profits may be squeezed."

"This is because of Wal-Mart setting the tone early where other retailers will be reluctant to raise prices," he said.

Besides the general merchandisers like Wal-Mart and Target, electronics sellers Best Buy (Charts, Fortune 500) and Circuit City (Charts, Fortune 500), office supply merchants like Staples (Charts, Fortune 500), and some clothing chains will steal a chunk of the $18.4 billion back-to-school bounty, said George Whalin of Retail Management Consultants.

"Online sales could do even better than last year because it's so convenient to finish shopping [for school] from home," Whalin said