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Cover Story October 15, 2009, 5:00PM EST

The Hard Sell

How retailers are fighting for the hearts and minds of the new consumer

By Jena McGregor

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Restoration Hardware's Friedman is selling pricier items this season Thomas Broening

U.S. consumers at nearly every income level and spending stratum have pulled back over the past year, trading down from department stores to discounters or delaying purchases altogether. According to one poll, 60% of Americans say they're wearing clothes several times between washes to cut cleaning costs. And 72% say they now haggle before they buy some items, up from 56% two years ago, says C. Britt Beemer, chairman of America's Research Group.

That frugality has retailers running scared as they near the all-important holiday season. Even if the economy picks up, some retail veterans think it could be 10 to 15 years before pre-bubble abundance returns. "They're looking at a new era," says Allen Questrom, a former CEO of J.C. Penney (JCP), Barneys, and Neiman Marcus who is now an adviser at Lee Equity Partners.

So smart retailers are starting to rethink their approach. Instead of just slashing stock levels, slowing expansion, and discounting deeply, they're getting creative about managing inventory, adjusting product lines, and dumping their addiction to promotional pricing. A few risk-takers are even adding stores or raising prices. Over the coming weeks they will find out whether those initiatives will set them up to thrive during another tough season—or at least survive. Here are a few strategies they're using in this year's brutal sales battle:

Creating Scarcity: One of the biggest changes shoppers may notice this holiday season won't come on their first trip to the mall but their second. That size 6 sweater you were going to buy for your sister? It may be out of stock. "Retailers are not overcommitting on anything," says retail consultant Walter Loeb. "They can't afford to take the chance."

CEOs such as Myron E. Ullman III at J.C. Penney remember last year's pain all too well. "They didn't have to use the heart paddles on me, but it was a jolt," he says, recalling how the Plano (Tex.) chain missed last year's sales projections by $2 billion. This year he's holding back about 60% of inventory—both finished products and fabric—in warehouses, far more than the 20% held back last year, says Deborah Weinswig, a retail analyst at Citigroup (C). She calls Penney's efforts particularly sophisticated and aggressive. With more in warehouses, goods can be sent quickly to stores in need or cut into apparel styles that are selling well, avoiding the pile-ups that lead to heavy discounting or the empty shelves that result in lost sales.

Gap (GPS), too, heightened its focus on inventory management as it introduced a redesigned jeans line this fall, an ambitious effort to offer premium denim for $60 to customers used to paying up to $250 for boutique and department- store jeans. The line—which includes six women's styles, two to four "washes" (or shades), and six men's styles—meant rolling out a vast array of choices without knowing what would sell. So Gap North America President Marka Hansen and her team sought fabric that could be dyed into any of the shades and cut more of the denim after seeing which jeans sold best. Says Hansen: "We wanted to leave ourselves as much flexibility as humanly possible in reacting to what the customer voted for."

Kicking the Discount Habit: Retailers sideswiped by the recession last fall were left with little choice but to slash prices or cope with excess inventory. "There really was a bloodbath of markdowns and such an erosion of margins that it has created scar tissue" for executives, says Arnold Aronson, managing director of retail strategies at Kurt Salmon Associates and a former Saks Fifth Avenue (SKS) chief executive.

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