Why Retailing Looks Rocky


By Robert Berner While shopping recently at Gap's largest Chicago store, Gary Petertyl couldn't help but notice that the display tables and clothes racks seemed to be spaced farther apart than usual. The tip-off: wide aisles of varnished wood floors -- more wood than he had seen in years. "Looks like a bowling alley," thought the 48-year-old consultant as he peered down one aisle. Merchandise wasn't stacked quite as high, either.

Petertyl is onto something. From apparel retailers like troubled Gap to department stores like Macy's, many retailers have cut inventory levels sharply this summer. They're hoping to avoid a repeat of last year's second half, when sales essentially stopped dead, rising a mere 0.3%, according to Standard & Poor's. Retailers resorted to steep markdowns to drive even that meager sales gain. Consequently, profit margins fell 37% in the second half of 2001, vs. the same period a year before.

Will retailers' conservative inventory strategy lead to a better second half this time around? Industry insiders believe things can only get better compared with last year. "Now, we are in a recovery," says Rosland Wells, chief economist at the National Retail Federation.

TAKING TERRITORY. But they could be too optimistic: Consumers are showing signs of getting tapped out. Add to that the fact a handful of discount powerhouses, from Wal-Mart Stores and Target to Kohl's and TJX, are expanding aggressively. Their bid to take business could inflict pain on higher-priced retailers, despite their conservative inventory plans.

Warnings about the strength of consumer spending are starting to mount. On July 1l, many retailers posted weak sales results for June. Sales at Gap stores open at least a year fell 6%. Sales also dropped at Sears by 3.8%, Federated Department Stores by 0.4%, and J.C. Penney by 0.3%. Meanwhile, Kohl's sales rose a 14.8%, Wal-Mart's climbed 7.9%, and Target was up 4.9%.

Shoppers are showing other signs of pulling back. In June, consumer confidence dropped to the lowest level since February. Retail sales in May fell a surprising 0.9% from April, the Commerce Dept. reported. For the rest of the year, consumers could opt to spend less.

LESS WIND. Unlike last fall, they won't receive tax rebates, which pumped $35 billion into their hands. Most of the bang from home refinancings is gone. With credit-card defaults at an all-time high, according to S&P, credit won't be as easy to come by. Wage growth has slowed, and economists expect unemployment to reach higher levels than during the last part of 2001. "The wind in the consumers' sails is dissipating," says Richard Church, managing director at hedge fund Shumway Capital Partners.

As a precaution, many retailers have cut inventories. Gap's are down 10%. At Federated Department Stores, which operates Macy's and other chains, on-hand supplies are down 8%. With less merchandise, many retailers hope to boost profits by avoiding last year's discounting.

The strategy could be difficult to pull off, since the stronger, lower-price retailers are expanding in a long-term effort to take a bigger share of the retail pie. Wal-Mart, Target, Kohl's, and TJX, owner of T.J. Maxx and Marshalls, will add 600 stores this year. Through their new stores, Wal-Mart, Target, and Kohl's alone will add nearly $2 billion in apparel selling capacity, estimates American Express analyst Henry Kaczmarek.

ZERO-SUM GAME. Kohl's is likely to expand in-store inventories as well. Seeing its department store rivals pare back, it expanded those inventories in the latter part of last year. That's one reason its sales at stores open at least a year rose 10.1% in the second half of 2001, while department store sales fell 2.9%. Says Kaczmarek: "Retailers that believe last year will be easy to beat assume no new capacity coming on line."

Having less inventory can certainly help profits, but it's no sure bet. While too much can hurt gross margins, due to added markdowns, too little can limit selection and hurt overall sales. Because expenses are being spread over less revenue, retailers risk hurting operating margins. Just ask J.C. Penney: It blamed weaker-than-expected sales in June on low inventories. Analysts cut second-quarter earnings estimates due to the chain's reduced expense leverage.

Of course, the discount retailers that are expanding aggressively could easily overplay their hand. But retailing is much like a zero-sum game, with one player taking share at the expense of another. With consumers running out of steam, they're more likely to choose lower-price formats, to save money. That could translate into a sluggish second half for all but a few retailers. Berner covers the retailing industry from BusinessWeek's Chicago bureau


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