Staying ahead of the curve
Go on the offensive It's too late to be defensive
A new playbook must be developed for the evolving environment. Going forward, new, differentiated and unique merchandise, targeted to the right consumer, is a must. While value will likely remain a key ingredient to purchase (as the closet is still full), retailers need to stoke want and desire with excitement driving incremental sales with targeted, sharper merchandise presentation.
Retailers and manufacturers must think about the business differently; looking at what you did yesterday, but trying to do it better, will not be enough. Your customer of yesterday is different today and will be different tomorrow.
Fittingly, your business plan should evolve, rather than be etched in stone. New issues arise daily and should be addressed on a timely basis. A shorter cycle, from concept to consumer, coupled with maintained lean inventory, will enable quick reaction to both competitive and fashion changes.
Staying ahead of the curve is a recipe for success. New and fresh merchandise creates excitement, while driving traffic and conversion. The goal should be quality of sales and cash flow generation both of which can then be reinvested in areas consistent with longer-term corporate strategy. Profitability will reflect excellence in execution.
Thinking about it differently
The management of most companies have already taken action reducing discretionary spending, slowing expansion, curtailing payrolls and tightening inventory controls. While these steps are reminiscent of past recessionary periods, management is beginning to realize it will not be business as usual during this recovery and are planning accordingly.
With credit harder to obtain, emphasis will be on financing ongoing operations rather than pursuing innovation, the historic driver of sales. There will be less investment in store openings, entry into new markets and implementation of new growth concepts. It is through the appropriate and strategic allocation of cash flow that companies find ways to profitably grow market share.
Consumer spending patterns have been changing and will likely continue to evolve. The consumer is shifting to less expensive products, buying less clothing and eating out less often. These are likely to be longer-lasting trends, as the lower- and middle-income groups fall further behind in their bills and debt repayment over the near term.
More affluent shoppers have historically been the first to rebound; however, higher taxes are likely to put a damper on even their spending. We could witness a different path to recovery, likely buying fewer goods, as opposed to significantly trading down when it comes to the quality or brand status of purchases, coupled with increased focus on lower price points within existing brands.
Conventional wisdom dictates that during recessionary periods, consumers will shop more at value retailers, returning to preferred stores as the environment improves. However, recent studies have shown that some customers will be lost for good buying less expensive versions of national or high-end brand products, replacing them with store brands, shopping routinely at discount and value-format stores, and/or trading down to less expensive brands. However, in most cases quality still remains a high priority, which retailers can largely maintain in a variety of ways for this new consumer.
Retailers and vendors must develop a new game plan to grow and prosper in this different environment; those that don t will be left further behind.
Doing it differently
The first step is for retailers and manufacturers to engage in an intense self-analysis. This includes consumer research in order to determine the wants and needs of target customers, increase value proposition with new and differentiated merchandise, find a path to a more efficient sourcing and logistics structure, strengthen the brand (whether national or owned), and finally, implement a multi-channel distribution network.
Inventory management is one of the important keys to managing the distribution process. Simply put, inventory management is the means to ensuring that the appropriate selection and quantity of merchandise is in place to ensure a higher rate of sale at regular price and/or at the first markdown. The strategy of a steadily increasing initial markup to offset the increasing markdown rate/allowance must be reversed so that the consumer perceives greater value at the outset, as opposed to searching lower-priced channels.
This will help preserve integrity of the brand and limit the amount of branded product distributed through off-price outlets and discount formats.
This issue has been compounded as the tempo of promotional activity increased steadily in recent years, while at the same time, inventory turnover rose. The consumer has been well educated to wait for the sale, with much of the price drops funded by manufacturers taking on an ever-higher rate of markdown allowances. A number of retailers have tried to wean customers off this promotional cadence, only to see store traffic and volume decline.
The sourcing strength of large organizations is a significant advantage, especially for owned brands and creating pushback on the manufacturer. Now, the latter step is becoming more difficult due to deterioration of vendor financial condition; better collaboration between the two could provide the incentive of fresh, new and differentiated product. The largest of the national retailers have become too commoditized through their brand s reliance on safe merchandise, with buying decisions today reflecting a trend towards the overly price sensitive.
Management mindset is gravitating towards the specialty store model, focused on turnover and profits per square foot. This again comes back to Retailing 101 knowing your customer, providing the appropriate level of service and offering the right product (at the right time and at the right price). Delivering on that back-to-basics mindset should drive traffic, sales productivity and profitability.
It will not be business as usual
Apparel deflation over the last 15 years reflected growth in lower-priced imports from China, helping expand gross margins for vendors/retailers. That trend reversed briefly in 2007, only to see prices soon retreat again alongside the weakening economy. There is currently excess production capacity in Asia, which should hold prices down over the near term, but the threat of inflation will likely loom as the economy recovers.
This should not necessarily limit restoration of profitability during an economic recovery. Shifting production to lower-cost countries and actively seeking supply chain efficiencies will likely be a temporary offset, although the financial stability of many suppliers remains a wild card at this point. Importantly, management needs to take its planning and strategy to a higher level. A large part of improved profitability between 2000 and 2007 was structural reflective of the benefits of a shorter cycle time and reduced inventories making their way through the entire pipeline.
Markdowns (and the corresponding inventory levels from which they result), will continue to have the most significant impact on margins, regardless of the merchandise issues that have also been a factor. Quantity and quality are critical issues, but the industry must strive to have a better balance of merchandise. The allocation process needs to be fine tuned by market and region; while available technology provides data, that data is not always translated into actionable knowledge that informs business decisions. Such data must be better analyzed by both retailers and vendors.
Developing a more profitable business model
For many years, high cash flow provided rapid retail expansion and diversification into new formats, driving further store growth. Today, store rationalization is fully underway. There is still excess space; more importantly, there is too much sameness. A consumer can walk into any mall in the country and find it difficult to ascertain where they are shopping.
The only clues are the exception to the rule some regional differences in design, or perhaps a regional department store chain. Furthermore, each end of the mall is nearly identical, the sole point of differentiation is which storefront is the first to markdown its wares.
This homogenous look could intensify with the prospect of further consolidation. If anything, management must focus on redirecting cash flow towards greater differentiation. A top priority would be intense research into its target consumer, something very few brands or retailers do on a consistent basis. The answer to why mall and store traffic has been on the decline for most is simple aside from the economic slowdown of recent quarters, there is little incentive for consumers to visit when the expectation is that they will not see anything new.
Store uniqueness, differentiation, merchandise excitement and newness will drive consumers into stores on a regular basis. This had provided brands such as Abercrombie, Coach, Nike and Ralph Lauren with the pricing power necessary to offset higher operating costs.
Many apparel and footwear brands have operated retail stores for many years. At first, factory outlet stores helped liquidate excess merchandise (and in many cases, evolved into a format carrying merchandise dedicated to that channel). More recently, a trend took hold in which full-price stores were opened as part of an effort to reduce dependency on the department store channel. This yields better understanding for retailers/vendors of both their customers as well as their customers motivation to purchase, all of which should translate to more, full-price selling over the long term.
Rising inflation is occurring in many sectors, with reduced consumption as the result in some instances. Consumers have less spendable income and are more discriminating in their choices, particularly for apparel and related items. The ability to raise prices has to be thought of in two distinct segments, with the high-end and must-own brands most likely to maintain pricing power.
As for the larger part of the market, it will be dependent on retailers such as J.C. Penney and Wal-Mart. While these retail giants have substantial buying power, there is likely not much room to negotiate further discounts. Therefore, the decision becomes maintaining the price point or margin; the direction appears to be moving towards the latter.
Unit consumption of apparel outpaced total spending in real terms in prior years (because of deflation), and could now perhaps slow to in-line, or slightly below. In some ways, modest inflation could actually be a boost to overall top-line growth and ultimately be more profitable for the industry, such as if sales grew faster than overall costs.
The thought of a return to apparel inflation is worrisome however. Looking back prior to the early 1990s, inflation prevailed and retailers prospered. Granted, that was a period of tremendous store expansion, with new units contributing to overall comparable store gains. Today, we see the reverse, with the elimination of less productive and redundant store capacity.
Easy comparisons, low inventory levels and reduced markdowns will only be temporary contributing factors during an economic recovery, as will the store rationalization process. Increased focus on driving gross profit per square foot may allow retailers to offset lower or slower growth in comparable store sales and the resultant cost pressures. The industry is past the days of moving the markup higher, rather, the strategy should evolve towards a higher rate of sell-through and inventory turnover.
Stores have long pushed many of the cost pressures back on the apparel vendor, with markdown allowances and chargebacks intensifying annually and eroding their financial strength. Instead, there must be new programs aimed at increasing efficiency along with coordinated efforts towards individual store profiling, with appropriately adjusted size and product assortments.
Private label was a margin enhancer for retailers in recent years, although that has proven to be a two-edged sword thanks to the long lead-time required and the inability to push back costs to a manufacturer. That percentage will probably continue to rise within the department store merchandise mix. Exclusive brands offer an alternate strategy, as they provide the retailer with unique product, differentiation and the ability to better control margins.
Higher average selling prices had been positive
The market had witnessed inflation-enhanced retailer and vendor sales growth in recent years as consumers traded up, purchasing more luxury and aspirational merchandise. Profitability was leveraged by lower sourcing costs due to both a more efficient model and increased imports. But now, the average selling price appears to be declining.
Lower inventories and reduced markdowns are currently contributing to gross margin improvement, and lower sourcing costs later this year could also play a role in improving that margin. Expense reduction has been significant, minimizing the impact of lower sales, and profitability will likely be on an uptrend over the next few quarters.
Easy comparisons, low inventory levels and reduced markdowns will only be temporary contributing factors to margins over the next several quarters, as will the store rationalization process. Retailers need to increase their focus on driving gross profit per square foot to counteract growth concerns. They are past the days of moving the markup higher; rather, the strategy should evolve towards a higher rate of sell-through and inventory turnover.
Average selling price declines
Low inventories and reduced inventory clearance enabled the average unit retail price to edge higher over the last two quarters. More importantly, we are witnessing a broadening of price points and a shifting in the mix within product lines, both reflections of retailers focus on a more value-conscious consumer. Many retailers are looking for vendors to develop a lower starting price point, in an effort to offering customers a choice of good, better or best within a number of vendor categories. This shift in mix has reduced the average selling price roughly 10 percent. At the same time, department stores that had already traded up from the lower end of better (going so far as to even eliminate moderate), are now beginning to reverse that strategy. This represents a shift in mix, rather than a reduction in gross margin.
Sales increases remain challenging
Rationalizations of store space, inventory reduction and a slower consumer recovery have been the key issues behind tempered growth expectations by retailers and vendors. The lower average selling price will be a major contributing factor, although perhaps offset by market share gains. Vendors will likely experience additional pressure as store consolidation and space rationalization continue. Finally, consumer spending will probably trail income growth as consumers rebuild savings and liquidity.
Adding to the uncertainty is the merchandise-planning process; open-to-buy is usually based in dollars. Unit growth exceeded dollar growth last year because of sharp price reductions, making it difficult to develop a base to plan growth over the next 12-to-18 months. Conservatism will prevail and most stores still appear to be budgeting lower inventory dollars.
A potential offset for vendors may be the broadening of a brand s product line and expanding channels of distribution wherever applicable.
Profitability becomes more difficult
The recession created excess production capacity to the point that value pricing can be maintained over the near term; margins could improve because of lower inventories and reduced markdowns. However, over the longer term, a more efficient business model needs to be developed one that has a lean and scalable cost structure.
Expense reduction and cost savings programs have already been implemented by most management, but many of those programs need to be escalated. Initiatives should include sourcing, productivity and inventory management. In some instances, streamlining and an altering of the buying decision-making process should also be considered. This focus has to be ongoing and similar to the painting of the Golden Gate Bridge once you arrive at the end of the process, it is time to begin the process anew.
Retailers should engage in an ongoing, extensive sourcing analysis, examining the costs of direct sourcing versus agent sourcing, as well as consolidating suppliers. Most suppliers have excess capacity today and have reduced prices to maintain sales volume, however, further economies could be achieved through collaboration and more efficient planning to maintain or improve quality.
Logistics and distribution also have to be factored into the equation. The lowest manufactured cost in a remote region might not be the lowest landed cost, due to factors such longer lead times and/or greater shipping distance. Further savings could probably be achieved through exploring direct shipping to a store or regional distribution center to minimize handling and time in transit.
Thinking about it in another way, the manufacturing cost might equal 20-25 percent of the selling price at retail. If, up to this point, the greatest focus had been on production efficiencies and sourcing, management must ask whether the same effort has been placed on logistics, distribution and other economies.
Accountability could also produce incremental savings with respect to brand management and customer responsibility. A detailed cost analysis of each product can determine whether the product needs to be redesigned or eliminated. Intense scrutiny by retail customer and store distribution should provide insight into improved sell-through and profitability.
Markdowns and promotions generally degrade the brand, instead of building a solid foundation upon which to grow business profitability. It would be idealistic to say, Ship to only A and B stores, as the retailer generally needs to assort its less profitable C and D stores.
Unfortunately, this practice is a large source of markdowns. Retailers and vendors need to routinely monitor poorly performing locations. Rent reductions might be an option today, but in reality, such actions are only a Band-Aid if traffic and customer base deteriorate. Store renovation might be an option to enhance attractiveness, but such a decision must be justified by a targeted return on investment.
SKU rationalization as a means to profitability
Avoid the trap of broadened assortments accumulated over the years. That has led to the perceived need for a larger store, a major miscalculation by many a management. This in turn led to lower sales productivity and profitability. That downward spiral has taken time to reverse, but we are beginning to see its effects today.
Wherever possible, minimize clutter in presentation. Inventory reduction and allocation has been a prime focus over the past 12 months. Retail traffic and sales declines will likely stabilize over the next few months due to easier comparisons and slow improvement in economic activity. The consumer will remain value focused and promotional activity will continue. However, merchandise presentation and differentiation should be a catalyst to drive higher conversion, transactions and sales.
Reducing inventory assortments could provide a more customer-friendly shopping environment, making it easier to tell your merchandising story and create excitement. A too varied and wide selection can blur the message; by simplifying the selection process with fewer distractions, more full-price selling can result. Eliminating the marginal units and redundancy in the assortment should lead to a higher gross margin.
Multiple benefits can be realized for both retailers and vendors. Narrower assortments could lead to lower labor costs and fewer out-of-stocks for retailers, and perhaps a little more buying power. Vendors can benefit from sourcing efficiencies from fewer suppliers and lower markdowns/allowances, consistent with an improvement to retailer profitability.
A better-managed pipeline can also improve profitability. By concentrating on fewer SKUs, the global supply chain should benefit from economies of scale. These would include the already-mentioned question of logistics, from manufacturing point to the customer. Ensuring products hit the stores on a timelier basis can provide fashion excitement ahead of competitors.
Focus on maximizing gross profit per square foot
Quality of sales is more important than quantity. Management needs to begin considering how to move back to a model that includes more full-price selling through lower inventory, a better mix and balance. It is better to lose a sale than have too much excess at the end of the season.
Customize the assortment and tailor to the customer while consumers are most focused on value, they are also interested in differentiated and unique merchandise, an important component of the price-value equation. Breaking the 80/20 rule with greater variety and more frequent flow creates excitement, drives traffic and results in conversion. Shorter cycle time and replenishment will be central to maintaining a fresh look.
As noted previously, store expansion has slowed and is even contracting. Sales growth will likely result from existing stores, rather than new stores. The merchandise mix must be tailored to a specific customer segment and/or local market. For those looking to move towards a more profitable business model, the days of offering something for everyone are over.
Better utilizing online marketing, wherever applicable, offers great opportunities to leverage a brand. In many cases, multi-channel distribution can be more profitable than single line. Up-to-date product and pricing information is most key as the consumer looking for customized and unique products is likely to also be most the responsive.
Improving the shopping experience as a way to differentiation cannot be overlooked. Increase store and brand loyalty by increasing the satisfaction of your consumers; offer more value-added services. Knowledgeable and helpful sales associates can generally initiate sales opportunities, drive a higher average ticket and shorten the transaction time. Engage your customer and be responsive to questions, problems or issues such actions can drive repeat visits and result in full-price selling.
Execution is critical in implementation. Many of these initiatives should be included in the planning process and assessing results on a regular and timely basis is critical. Management must be ready to react to any deviation from the plan and not wait, hoping that a situation will improve; in reality, the odds are that a situation will only worsen. Both the brand and the product must remain relevant and the needs of the consumer should be constantly reevaluated.
Sifting through the rubble, building a business at the top
The specialty store grew and thrived for many years by addressing the wants and desires of its customers, but the strategy to maintain a high rate of store openings eventually led to a dilution of the ability to cater to a target consumer. In many cases, the problem was only compounded by management shifting its focus on brand and format diversification.
Retailers and vendors need to develop a closer working relationship, as each looks to develop a more profitable business model. They must be willing to reach out and establish best practices in establishing a new partnership. Over time, entrepreneurial and visionary management have been replaced by executives with a primary focus on growth unfortunately, the needs of the consumer were forgotten in this transition.
Strategy has to shift back to the consumer, and truly understanding their wants and needs. There has to be more collaboration between retailers and vendors in managing the merchandise assortment. More importantly, the key to higher returns is higher gross profit per square foot. That mission can be driven by turnover, rather than markdown allowances; realized by fashion-right merchandise with less, rather than more, inventory; and a better in-stock position, with reduced breadth and a heightened focus.
This is a terrific time for companies that:
Are already established
Have a detailed plan for the future (the next two to three years)
Have a strong balance sheet
Have plenty of cash available and a projected cash flow
With courage and foresight, those are the same companies that will be able to "steal" market share, moving up the ladder quickly and enjoying the spoils that can result from this current operating environment.
