And How the Pub Effect Fits in the Picture

As consultants it is important for us to stay a step ahead of the game. We spend a lot of time reviewing the facts and trying to use them to project the future. By projecting the right future, we can advise our clients to take actions that maximize their results. We are in a period of flux that is greater than we have seen in our memory. Sorting it out and making sense of it is not easy nor is it a science but I wanted to share my analysis. I welcome comments and other viewpoints in the interest of identifying what will happen long before it does.

The First Domino to Fall

We all know about the housing bubble that was created by easy credit and subprime mortgages. I believe that was the first domino to fall in a bloated economy. Our economy is based on growth and the concept of supply being less than demand. When that happens companies invest in new capacity so factories are making new machines and money is flowing from investors to creditors to companies and everyone is happy. When people began the process of defaulting on their loans for homes and the banks foreclosed, there was an increase in the number of houses available for sale. That increase in supply created a drop in price since supply exceeded demand. The drop in home prices cut into the value of the biggest asset most Americans own. When that happened, they no longer felt comfortable buying as much on credit and building a level of debt that they did not have assets to cover. When they cut back on buying all of a sudden we had the same level of supply in the manufacturing and distribution pipeline but the demand dwindled. At that point, no company would invest in new capacity so the companies that make the machines, build the warehouses and so forth cut back. I could go on about how this trickles down throughout the economy but I think you get the picture. Every conceivable industry was stuck with last year’s level of inventory and a new lower level of demand.

The Special Case of Retail

Retail is a special case of this same phenomena. The reason it is special is that every season represents a complete cycle in retail. Retailers depend on sales forecasts and accurate merchandise planning to predict the level of demand for each classification. Merchandise planning is not a trivial matter nor a simple task. When we determine the OTB (Open To Buy budget) for a retail store, we include variables to indicate the economy, trends, bellwether stores, distance from a coast, latitude, local business indicators and more. This is all in addition to the review of sales trends, markdowns and LY (last year). What happened this year to big box stores and chains is that they either did not factor in the right information for their plans or they did not believe the outcome. They bought based more on LY than on current indicators. When the fall and holiday inventory hit the stores, they then realized the demand was gone. They quickly took huge markdowns to try to adjust for the oversupply. The early indicators are that they are taking early markdowns on new spring goods as well which indicates that they did not learn or plan well and need to adjust again. Thankfully our stores, the independent retailers, came out of holiday in great shape with inventory in line for the new reality.

Department and Big Box Stores

These companies will be hard pressed to survive without the help of bankruptcy courts or favorable infusions of cash. They have huge mortgages and overhead to cover and they cannot do that with merchandise at 70% off. They will pass along some of the losses to the vendors from whom they buy which will force many of them into bankruptcy as well. I believe that the reduced level of demand will be adjusted primarily from this sector. They need a certain level of revenue to survive and if their merchandise plans indicate that level of demand does not exist, they buy that level of merchandise anyway. This is due to their top-down planning that starts with profit and revenue as the goal.

Independent Retail

This new environment bodes well for the specialty retailer who has good planning on which to base his buying. We use a bottom-up plan which means the most important driver of the plan is demand. In a changing and turbulent sea of retail, predicting demand will lead to optimal results and the bottom-up plan is the way to go. Some of the department stores are beginning to get into bottom-up planning but with 19 years of experience, we feel we are way ahead of the game.

The other advantage that the specialty retailer has is what I call the “Pub Effect”. This is where the local shop is the hub of a community. The retailer provides much more than merchandise. This is a place where everybody knows your name and you are just as likely to stop in to say hello as well as to buy. CRM (customer relationship marketing) has been around for a while but we are leading our retail clients to a new level of connection, service and relationships. Event planning will become a key function in the store and the larger stores will hire a dedicated event manager to keep the store exciting! This is an advantage that is not only more important in this economy and current situation, it is one the mall, department store or big box store cannot emulate.

The Internet Factor

No discussion of the future of retail can ignore the internet. The internet e-commerce is growing rapidly and offers many advantages. A shopper can evaluate prices across a wide spectrum quickly and efficiently. People are gaining more confidence in ordering merchandise with the advent of PayPal and the ratings of quality vendors on sites. Freight charges may be an issue, however it is negated by the absence of sales tax if the company does not have a location in your state. Watch for states to close this loophole to raise the tax revenue they are losing from the dying department stores and chains! This change will not happen fast enough to save many of the brick and mortar big box locations.

The Mall at All?

The mall is a dying entity. Just as fast as the malls came on the scene in the ‘60s and ‘70s, they will largely depart in the next 10 years. No longer can retailers afford the high rents. Gas prices will creep up again and driving to a mall will be an expense that many will not pay. A mall requires a rising level of demand which is not likely for a few years.

With the rise in internet shopping, there is a decrease in demand for the mall stores. There will always be a need to try on merchandise, see it, feel it and so forth but that level will not be sufficient to support a mall environment. That is why the specialty retailer will prosper.

When the anchor to the mall closes its doors, the mall tenants will require rent abatement to survive the decrease in traffic. The lower rents will not provide capital to pay the debt, utilities, security and maintenance to keep the mall going and many will tumble. Look to malls to be the new community center refitted with a pool, gym, local community college classrooms and other uses beyond retail.

Conclusion

Many economists and retailers have developed a myth that “If I just make it through this season, we will be back to NORMAL.” My view is that “normal” as we knew it is gone forever. A new reality is emerging and the retailers who adjust and adapt the fastest will be the most successful. Much of this analysis is speculation – albeit based on experience and a position to closely witness the market changes and effects. I would appreciate feedback and other thoughts you may have that can result in a more robust analysis and prediction of the direction our future will take.