Surviving A Soft Retail Market

Managing risk prudently, with a focus on maintaining margins and protecting cash flow, will enable retailers to come through this period well positioned to increase their business significantly once things improve.

There are some early signs that the retail downturn may be starting to ease. It's still very early, and there are some very strong headwinds, notably $4.00 a gallon gasoline, but in several retail segments and categories there's finally signs of life. Whether it's the Fed's aggressive interest rate cutting in January that has kicked in, or consumers beginning to spend in anticipation of their federal tax rebate checks arriving in the mail, or shoppers simply tired of sitting on their hands, it appears the worst may be behind us.

Having said that, there are many retailers that haven't seen any sign of a rebound yet, and those that feel the recovery will be slow and anemic at best. Business is still likely to be difficult, and retailers large and small are likely to remain under financial pressure for the foreseeable future.

For small and independent retailers, this has certainly been a challenging period. For those in carefully carved out premium niches, offering their customers a compelling shopping experience and outstanding service, things haven't been quite as daunting. For many others, it's been tough to sleep at night.

The key for most small and independent retailers to weathering these turbulent times, and staying liquid until business opens back up, is to adhere to basic retail fundamentals. Yet for many, there's a temptation to try to drive sales through an increase in promotional activity.

Many small and independent retailers are so focused on the top line that it's very tempting to order up a sale and break out the sale banners. But this can be a very counterproductive direction to take. Most customers of small and independent retailers aren't price customers, they are more interested in value -- value that's not necessarily denominated in dollars, but in perceived product quality, personal values or aspirational appeal.

In this environment, it's near impossible to simply sell your way out of the situation. The top line stubbornly doesn't want to turn up. Many of my clients report that the weakness they've experienced has been primarily in traffic counts, and to a lesser extent in units per transaction. Promotional efforts on their part didn't necessarily drive more traffic into their stores, and only had a minor impact on units per transaction, but significantly reduced the sales dollars per transaction, and most critically, cut the legs out from under gross margin dollars per transaction. It left them squeezed having to pay vendor bills with severely discounted gross margin dollars. Their customers, not primarily motivated by price, didn't buy more; they just paid less for what they did buy.

In a downturn margins invariably come under pressure, but maintaining gross margins is critical, both as measured in percentages as well as in actual dollars. Maintaining gross margin percentages assures that there will be enough cash coming from each sale to pay for the goods sold and keep vendor payables from backing up. And gross margin dollars are essential to covering all of the other bills.

The key is to bring inventory levels into line with realistic sales forecasts. Excess inventories in a weak sales environment back up very quickly, creating enormous markdown pressure, far beyond any competitive markdown pressure. For those small and independent retailers whose customers are not motivated primarily by price, it often takes exceptional discounts to begin to move the unit inventory necessary to bring inventories into line. And those markdowns eviscerate gross margins.

Prudent sales plans begin with an honest assessment of the current sales trend. It is simply not prudent, for example, to plan for a 10 percent increase if the current trend has been a decrease, even if the comparables are favorable. It does not matter what kind of an increase the business might need, or how compelling the new assortments might be. What does matter is that customers haven't yet signaled they are ready to spend more. I have been advising my clients not to plan an increase until an increase occurs. To plan otherwise is to unwisely increase markdown risk, and imperil margins.

The frequent response that I hear is if you don't plan for an increase, you won't get an increase. But there are very few categories right now that look like there might be breakout increases on the horizon. More commonly, any potential increases appear to be fairly modest, and in most every case additional inventory simply isn't necessary in the short term to capitalize on that potential. Most small and independent retailers can run an increase of a few percentage points over plan for the several months necessary to increase inventory levels.

Once plans have been developed, I strongly advise my clients not to spend it all upfront. Many small and independent retailers feel they have to commit all of their dollars upfront in order to get the merchandise they want, and even ship it right away so it doesn't get sold out from under them. In a soft market, however, there's much less urgency to do this. It's far better to stay liquid by holding dollars back, and flowing merchandise receipts out through the season as close as possible to the time of expected sale. That way, inventories remain lean, customers are always seeing fresh arrivals, and there's cash to spend on long-margin, opportunity purchases late in the season.

Challenging times like these are fraught with risk. Managing that risk prudently, with a focus on maintaining margins and protecting cash flow, will enable small and independent retailers to come through this period well positioned to increase their business significantly once things improve.

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