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12 for '12

Retailers are bracing for a year of price wars and shrinking profits as competition heats up ahead of the invasion of the sector's 800-pound gorilla.

U.S. discount titan Target Corp. will roll out about 135 stores starting in March of 2013 following its landmark $1.8-billion purchase of Zellers stores almost a year ago, a defining moment in Canadian retailing that is already beginning to shake up the industry. Incumbents are now racing to prepare for the new entrant. They're trying to improve their operations, including lagging e-commerce sites, in a bid to shore up market share while they can – the better to withstand the onslaught of Target hype.

The fight to woo customers will inevitably put pressure on retailers' margins as they're forced to offer discounts or spend money to dress up their stores. Wal-Mart Canada Corp., the dominant discounter, is dashing to convert more of its Canadian stores to super centres with full supermarkets. It's also planning almost 40 new outlets – also former Zellers stores – in 2012.

At the same time, Zellers will launch going-out-of-business sales before its outlets go dark for Target or Wal-Mart conversions, a move that is expected to touch off a round of price slashing in the sector.

In this intensifying environment, struggling chains, including department-store retailer Sears Canada Inc. and clothier Le Château Inc., will have a last gasp at fixing their problems before the popular U.S. discounter arrives.

"They all have 2012 to prepare and get their house in order," said Alex Arifuzzaman, partner in retail real estate specialist InterStratics Consultants. "It's really going to change the retail landscape."

The retail transformation will play out amid fears of a worsening outlook for consumer spending. Consumer debt in Canada is already at record levels, and global economic woes will likely put a damper on shoppers' spending in 2012.

As uncertainty becomes the new normal, retail sales gains will be modest, rising between 2 and 3 per cent in 2012, about the same as the previous year, predicted Darren Kirk, a vice-president at Moody's Investors Service. His outlook on profit margins is grimmer – they will be flat in 2012, compared with a slight gain of between 0.1 and 0.2 per cent in 2011, he estimated.

"The continuing arrival of U.S. retailers into Canada and the expansion efforts by existing U.S. players will add to the sector's competitive pressures," he said.

The changes are forcing retailers to take bold initiatives to defend their turf. Some merchants, such as Sears Canada, have installed new executives. Others, such as dollar-store chain Dollarama Inc. and upscale retailer Sporting Life, are bulking up by adding more stores, while still others are focusing on adding more products in specialty areas.

Canadian Tire Corp. scooped up Forzani Group Ltd., the leading sporting goods retailer, last summer to bolster its business and try to prevent another big U.S. rival – Dick's Sporting Goods Inc. – from landing here.

"I think Target – any new competitor coming into the country – increases everybody's game," Stephen Wetmore, chief executive officer of Canadian Tire, told a recent conference. "It will increase our game."

With a new ad slogan – "Bring it on" – Canadian Tire is following a strategy that underscores the urgency retailers feel to raise their game. It's focusing more effort on the auto business, which isn't an area of strength at Target.

But the company will also be concentrating on its home goods – one of Target's biggest strengths – particularly kitchen products, which is one of Canadian Tire's best-performing categories. The retailer "will not be giving up any kitchen sales without a fight," said Mark Petrie, a retail analyst at CIBC World Markets.

Others are bolstering their offerings of specialized categories. Drugstores, squeezed by new generic drug laws, will aim to lure customers to their pharmacies while Target temporarily closes the Zellers' drugstore sections during lengthy renovations. Drugstores also trumpet their pharmacists as free medical advisers. "It's a little more difficult to do that type of one-on-one servicing in pharmacies in a large store," said Andy Giancamilli, outgoing CEO at Edmonton-based Katz Group, which owns a number of drugstore brands, including Rexall.

Katz is starting to focus more on areas in which it can stock a broader array of merchandise than Target, such as vitamins, nutritional supplements, first aid and dental items, he said.

But retailers such as Katz will feel the need to lower prices on other product lines such as shampoos, deodorants and cosmetics in which they compete toe-to-toe with discounters. "There will be some impact on us in the [non-pharmacy]front of the store when it comes to health and beauty aids because Target is pretty strong in them," Mr. Giancamilli said. "You'll see some margin come off."

Merchants also grapple with another byproduct of Target's looming presence: higher rents in malls with Target stores, as landlords bank on the chain attracting more shoppers.

Still, Target's impending arrival will also bring some cheer to retailers. "In fact, I'm looking forward to it," Larry Rossy, CEO of Dollarama, said recently. "I think they're going to bring traffic where we're situated, close to the Target stores."

Supermarket retailer Sobeys stands to benefit because it has sealed a deal to supply groceries to Target. The agreement probably won't improve the retailer's profit much but rather help it gain sales, economies of scale and – perhaps most important – insights into how the new competitor operates, said Perry Caicco, another analyst at CIBC.

Gaining knowledge of a rival helped Sobeys almost two decades ago when it supplied Wal-Mart with groceries when it first arrived here. It taught Sobeys "not to panic over that new entrant," Mr. Caicco said.

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