by Gilbert W. Harrison
(TMA International Headquarters)
Within a few short months, the consumer has undergone a radical transformation. While the economy eventually will recover, consumer sentiment has changed forever. Consumers can find everything they need in their closet. They will now only buy what they do not have.
To survive in this new reality, brands must be relevant to the consumer to lure them back into stores to buy. Give them something new, differentiated, and exciting, and they will buy. With the right merchandising, consumers temporarily will behave as though there is no recession at all.
For example, TopShop, a U.K. retailer, opened its first U.S. store in April on Lower Broadway in Manhattan, near Bloomingdales. Since then, the lines have been two blocks long and the bags leaving the store are evident. Sir Philip Green, one of the world’s best-known merchant-princes, is giving consumers a mix of products that they do not have: quality fashion at a price.
Part of Green’s secret is his speed to market. TopShop uses a swift supply chain to deliver stylish clothing within a matter of weeks. The new Manhattan location receives deliveries of roughly 100 new items per week, according to Women’s Wear Daily. These short delivery times enable consumers to purchase products as the need arises, and the selection changes constantly. Nothing is bland about the store’s clothes — even basics feature a fashion element. Trend-conscious consumers are compelled to visit TopShop often to keep pace with the latest looks.
Innovation is the other key to attracting customers into stores. For instance, the Apple store in midtown Manhattan, which is open 24 hours a day, is perpetually packed. Consumers are willing to spend up to $300 for the newest iPhone, regardless of their bank accounts. Why? Because they believe that the latest iPhone offers features that render the last model obsolete — not to mention the phones made by competing brands. Apple has given consumers a reason to shop.
Discounting, on the other hand, cannot inspire the type of customer loyalty enjoyed by TopShop or Apple. This was made particularly clear from the deep price reductions of the latest holiday season. In 2008, retailers overbought merchandise by 5 to 10 percent versus the previous year. Once the economic slowdown hit, they were left with an overabundance of product and no market for the goods.
Retailers reacted with unprecedented levels of discounts before Christmas. Even luxury stores reduced prices by as much as 40 percent. Discounting, many contended at the time, was the only way to move inventory in this difficult consumer environment. However, by slashing prices the labels undermined their brand value — the most important asset any retailer possesses.
Abercrombie & Fitch CEO Michael Jeffries did not follow the price slashing trend and continued to charge full price for trendy hoodies and flip flops. Many questioned his decision at the time. While A&F underperformed its peers in terms of comp store sales, the results were hardly disastrous because the retailer maintained gross margins. Perhaps more importantly, A&F customers were not trained to look for discounts. The retailer successfully safeguarded its image as a premium brand.
Balance Sheet Focus
It is important to note that A&F’s balance sheet is extremely strong, with hundreds of millions of dollars of cash and no debt. Many other retailers, enticed by cheap financing over the past decade, were staring at violating debt covenants and needed to preserve cash. A&F’s decision to maintain a cash war chest has proven to be a smart insurance policy, but it is a policy that is better put in place well before a recession begins.
Another master of protecting brand identity is Louis Vuitton, which never puts its products on sale. The luxury accessories maker even goes so far as to destroy fashion merchandise from the previous year to preserve its brand value. As a result of this fierce adherence to identity, Louis Vuitton reported double-digit growth at the end of 2008.
Part of the reason that consumers will still pay a premium for well-respected brands is that the relationship between price and value has changed. Consumers are not just looking for a better price, but also more quality from each purchase. Customers may no longer be willing to pay $600 for any pair of shoes, but some will reconsider if those shoes are well-made and have inimitable style. Brands such as A&F or Louis Vuitton, which consistently deliver quality, will continue to attract buyers.
Many companies that failed to live up to consumers’ newly defined expectations have paid dearly. U.S. Bankruptcy Courts are littered with filings of major retailers, such as Circuit City, Linens N’ Things, Fortunoff’s, and Mervyn’s, all of which sought protection from bankruptcy but failed anyway. These retailers probably should have closed five years ago because their products demonstrated a lack of vision and were no longer relevant to the new consumer.
As the recession continues, many other “tired” retail concepts, namely those that suffer from liquidity problems, probably will suffer these companies’ fate. The trick to survival is to deliver must-have products while simultaneously conserving cash.
Funding is available for troubled companies with strong brands and profitable business models. In this classic “good company, bad balance sheet” scenario, a retailer can obtain “insurance capital,” either in the form of debt or equity, to avoid a potential liquidity crisis, one that could have immediately disastrous results in this economy.
Such was the case with American Apparel, which recently completed an $80 million junior capital raise that allowed it to refinance a subordinated commitment with a short-term maturity. Absent this additional financing, American Apparel was facing a bankruptcy scenario, which the market viewed as likely, as evidenced by its stock trading toward $1 per share. Shortly after receiving new capital, however, American Apparel reported a nearly 30 percent increase in quarterly sales.
But only a healthy balance sheet will save those still struggling with their merchandise. Compare the paths of Circuit City and Ann Taylor, for example. Ann Taylor’s comparable store sales have declined more sharply than what Circuit City reported prior to filing for bankruptcy. However, while Circuit City rapidly crumbled under the pressure of a treacherous consumer environment, Ann Taylor continues to operate safely.
Comp store sales figures only provide the first piece of the puzzle in assessing a retailer’s viability. Unlike Circuit City before its bankruptcy, Ann Taylor has a spotless balance sheet and the ability to manage its free cash flow through the rapid and drastic reduction of corporate costs and capital expenditures. Despite the quarterly public flogging in the media and equity research reports related to its decreasing comps, Ann Taylor is certain to be around for a long time to come.
Aside from bolstering comp store sales, some key elements that troubled companies must have in place to outlast the recession include:
Inventory Management. A mandate by consumers for innovative merchandise does not give retailers license to spend recklessly on inventory. Instead, in an effort to manage next year’s cash flow, retailers can reduce their inventory through lower amounts of product and selective store closures.
Williams-Sonoma, for example, announced that at year-end its inventory balance was reduced by 17 percent, which contributed to a $42 million increase in operating cash flow during the fiscal year — the difference between positive and negative operating cash flow for the year.
As sales levels dropped, the retailer offered highly discounted merchandise to ensure that it could convert its inventories to cash and enter the next year with a cleaner and lighter balance sheet. The company again expects reduction of merchandise inventory to contribute meaningfully to positive cash flow in 2009.
Capital Expenditure Management. In an effort to preserve free cash flow, retailers are looking to reduce discretionary capital expenditures. Uncertain of how much longer the recession could last, retailers need to be certain they have enough cash on hand to sustain their businesses.
To this end, many management teams have begun to opt for liquidity over growth, and have practically ceased opening new stores and remodels. Opening new stores makes little sense when consumers are not buying much in existing locations. Opportunity for new space is also limited because struggling mall developers have halted new mall projects. As such, management guidance for 2009 capital expenditures has ranged from 20 to 70 percent.
Even J. Crew, a strong retail concept with the exceptional leadership of Mickey Drexler, is estimated to reduce this year’s plans for capital expenditures by roughly 30 percent, to $55 million.
Cost Reduction Initiatives. As sales and gross margins erode, management teams can no longer afford to carry unnecessary overhead expenses. Companies must also identify stores or divisions that are not contributing positively to the bottom line. Macy’s, for example, announced the closing of 11 underperforming locations to maximize the company’s return on assets. Tiffany’s also shuttered Iridesse, its struggling 16-store pearl jewelry business.
Both healthy and hurting retailers have begun announcing drastic cost cutting measures, including Wal-Mart and Borders, which revealed workforce reductions of 5 percent and 15 percent, respectively. Macy’s also recently made public a significant workforce reduction of 7,000 employees, from which it expects to save about $400 million annually beginning in 2010.
Recession’s Silver Lining
Despite the tough prospect of restructuring, there is a positive side to today’s economic climate. The recession will shake out me-too players who lack vision and drive other retailers to offer better products. It also will force corporations to embrace fiscal responsibility and readjust their balance sheets. At the end of the day, the recession will create a stronger industry for consumers and investors alike.