By Paula Rosenblum, Managing Partner
8/4/2009
In our continuing quest to understand what Winning Retail strategies will look like this holiday season, and the potential impact of a possible CIT collapse, we spoke with two different people last week, Gary Edwards, EVP of Empathica, a company that helps retailers measure and manage the customer experience through web surveys and exit interviews, and Richard Hastings, CCE, Consumer Strategist for Global Hunter Securities, LLC.
We ended up spending far less time talking about CIT than we did talking about the overarching consequences of our current environment. Mr. Hastings, in particular, believes that when cash is king retailers buy for gross margin dollars rather than assortment. Of course, the trick here is making sure you’ve got enough of what customers want to keep them happy without breaking the bank. Ironically, it turns out an early adopter of this “gross margin is king” strategy was none other than Edward Lampert, CEO of K-Mart/Sears.
A Few Words about CIT
Economists can opine about the causes and systemic risks associated with a CIT collapse better than we can (and there’s little retail technology can do to forestall this collapse in any case), so we’ll forgo that debate. Instead we’ll talk about retail risk. Mr. Hastings’ biggest short-term concern associated with such a collapse revolves around a loss of innovation, particularly in fashion. Apparel watchers know that innovation tends to come from smaller companies: boutiques and privately held firms (very small boutique retailers with a tremendous role in fashion leadership), and suppliers with $10-$50mm dollars in annual revenue. These are typically the suppliers who turn to factors like CIT to help fund their receivables. Over the course of several seasonal cycles, those innovations are transformed into lower and lower priced items for the mass market. While those cycles have quickened from years to months, they still exist, and without factors like CIT, our apparel stores could turn into more of a sea of sameness than they already are. This is Mr. Edwards’ biggest concern – the decline of consumer satisfaction associated with boring assortments and further spending contraction.
Buying for Free Cash Flow
This brings us back to the big picture again – credit is scarce and cash is king. If we believe that consumers are still disinclined to spend, or if we’re just not sure what spending is going to look like (after all, who could have predicted the wild success of “Cash for Clunkers?”), the focus shifts to free cash flow and net gross margin dollars. We believe the following scenario is familiar by now to many if not most of our retail readers.
Our soon-to-be-released benchmark report on Inventory Management tells us retailers want to decrease the amount of money they spend on purchasing inventory. Mr. Hastings agrees. In good times, the assortment plan was to present (in Mr. Hastings’ words), “a tropical rain forest of inventory” when a customer walks into a store. BUT that rain forest represents a lot of cash commitments. Retailers just don’t want to tie up as much working capital anymore.
Retailers are cutting back on other cash commitments as well, including new store openings, remodels of existing stores, and ironically, store closings (it costs real money to get out of leases if you’re not in Chapter 11). Just as the new consumer luxury is a paid off car and mortgage, the new retailer luxury is to have no money outstanding on revolvers, and few if any non-essential personnel. Retailers are also using technology to focus on gross profit rather than just sales. Hence we see continued interest in price optimization and management software along with that which supports inventory localization and tools to measure what have become irregular patterns of behavior.
Retailers are also working with the most responsive merchandise vendors they can, which often translates into those vendors with the best infrastructure and optimal distribution network.
Once you’ve decreased all your spending, you find yourself into a very different philosophy. You stop trying to fill up the stores with merchandise and instead, you let unprofitable space stay empty. This brings us to Edward Lampert, an early adopter of this philosophy when he took over K-Mart. His philosophy was to stop growing the chain, and start growing margin. Early on, Wall Street rewarded him for this. We are fully aware that Mr. Lampert is not the most beloved CEO in retail, but in these times, his philosophy is not wholly without merit.
Mr. Hastings tells of taking a store tour in Kmart in 2003. Senior executives were talking about margin and expenses. It turns out that “notions” and curtain hook hangers were the highest margin items the store. They made a huge contribution to pre-tax profit. Mr. Lampert’s philosophy was to maximize the inventory value of those peg hooks. We have heard a similar philosophy from JoAnn Fabrics, whose notions wall is a huge profit maker as well.
Mr. Hastings also contends the emotional “pop” associated with having a full assortment has diminished because of the internet phenomenon. Cross-channel shopping can allow the retailer to fill the shopper’s order from other parts of the chain. While RSR’s data most often tells us retailers are trying to drive shoppers into the store, Mr. Hastings believes there are a significant number of retailers who prefer to drive customers to the web. By driving the customer online, the retailer creates data and moves instantly beyond anonymous transactions and amorphous shopping trips. In a worst case, if a product is out of stock, a retailer can direct ship from the factory, even if that factory is in China.
He believes “buying for gross margin” is here to stay. A philosophy that was lurking on the periphery has been put into the center of the game for most retailers. It is worthy to note he believes Walmart is not adopting that philosophy. It doesn’t have to. While many retailers may believe it’s better to be out of stock than to take excess liquidation markdowns, Walmart can push much of that risk back on its vendors. Being big has its privileges.
All in all, I found these conversations fascinating. I’m not sure I buy into this story hook, line and sinker: it feels very risky, but it was interesting to get another point of view on our under-stocked world. What do you think?
| 
