Low Price - Low Equity?

No surprise, but department stores and other medium- to upscale emporiums are throwing their big name labels overboard in an attempt to keep their own ships afloat. The Times has given its story today an amusing, or terrifying depending on which end of the chain you sit, title: “Never Mind What It Costs. Can I Get It 70% Off?” 

For manufacturers, one big implication is pretty depressing: Never mind creating ‘manufacturer’s recommended prices’ at retail. All it’s good for is as a denominator for the store’s bid for more floor traffic and clearance sales.

A store can, I suppose, be excused for thinking that price cuts are the only game in town these days. But they’re not. Products and services can still sell; on trust, quality and long-term payback. And manufacturer/retailer distribution systems can still outdraw rival channel systems by offering superior customer experiences. Even in a very down market, may the best value win.

Best value isn’t the same as lowest cost. Jim Anderson, my colleague at Northwestern’s Kellogg School, underlines that Value = Benefit – Cost. Benefits – the good stuff, what people actually want – are half the equation. Heck, they’re at least half the equation, aren’t they?

Manufacturers are potentially giving retailers too much room to destroy their equity with consumers. They don’t have to. They should insist on a “no lower than” for their goods – not necessarily their initially recommended price but something that doesn’t debase the brand either. In 2007 the Supreme Court gave manufacturers new latitude to write contracts specifying resale price minimums. The litmus test of RPR legality? Genuine benefit to end customers must be demonstrable (get legal advice!).

I would only add, no manufacturer wants to alienate its downstream partners by strong-arming them or depriving them of room to maneuver against their competitors. The spirit of partnership has to be there. I think it can be. Resale price maintenance agreements” can be an instrument to promote rather than destroy that spirit.

 

Into the (Discount) Looking Glass

You have to admire Eileen Fisher, who designs luxury women’s apparel and sells it through department stores. She’s exasperated with her retailers (not uncommon among manufacturers).  They’re deep-discounting her entire line, along with others, almost as soon as her garments touch the racks. And she’s doing something about it (not common at all).

 The Wall Street Journal reports Ms. Fisher has suggested retailers use “scalpel markdowns” to prune only the weak SKUs while preserving margins on the vast majority of her items. She’s also preparing to rent space in host retailers herself. Store-in-store, as this technique is known, will allow her to control merchandising and impose needed discipline on pricing. 

She  might want to consider another alternative.

A couple years ago the Supreme Court showed new-found openness to certain types of price discipline.  In ruling on Leegin vs. PSKS, the Court basically reversed a sweeping precedent created almost a century ago, a time when manufacturers were the only ones that were big and strong,  and retailers were almost all small and relatively weaker in setting market policies. Today’s situation is nearly the reverse; it’s now the manufacturer who often stands in need of legal recourse.

If a producer can demonstrate, the Court has now decided, that it's distribution system is doing extra things to create more choice for consumers, then it should be permitted to require its retailers to uphold the price minimums needed to fund those extra costs. Not in all cases, and only under certain circumstances, but a watershed new channel strategy opportunity nonetheless.

I think Ms. Fisher should look into some new contracts. Establishing legally structured price management tools to ensure adequate activity in the retail system would likely be a lot easier than forward integrating into company-owned retail. If she approaches her partners adroitly, and it looks like she’s good at this, I predict the stronger influence she seeks over consumers' experiences will actually lead to stronger working relationships with retailers. 

Of course, she should work closely with her lawyers to do all this in a legally defensible way. They always want a piece of the action!

 

 

 

Signs of New Distribution Era Emerging

Signs are everywhere that a sea change is occurring in how branded product makers and their channel partners chart growth strategies together. Many will start moving away form old-school adversarial relationships to find new ways to re-focus on providing consumers with the benefits of trusted brands.

For too long, manufacturers and their dominant distribution partners have danced around the trade-offs that price- and cost-only systems create. The trade-offs are especially acute when a marketplace is supplied by long, overseas supply chains where oversight and quality control are more difficult to assure. While long supply chains are an important part of the global economy, they still demand operating oversight which drives up costs and investment. Contract manufacturers (and distribution channels building their own store brands) are finding out there's more to sourcing than "spec and buy".

• NYT on risks of cost-only sourcing: a sales manager at a company in southern China said leaded paint was about 30 percent cheaper than paint without lead...it depends on the client’s requirement, if the prices they offer make it impossible to use lead-free paint, we’ll tell them that we might have to use leaded paint. If they agree, we’ll use leaded paint. It totally depends on what the clients want.”
  
• WSJ on toys supply chain: After a summer of toy recalls, toy licensors and trade associations are counting on stepped-up safety pledges to reassure parents before the holiday shopping season...some industry analysts question the effectiveness of tighter safety measures by companies that own brands and images but may have little manufacturing know-how...licensors have less experience... toy manufacturers such as Mattel and Hasbro Inc. are better seasoned at quality control.
  
• NYT on government oversight: A working group appointed by President Bush recommended preventing problems by building safety into manufacturing and distribution, intervening when risks were identified and responding quickly after an unsafe product made its way into the country...Representative Rosa DeLauro [said] the plan should detail how bad actors will be held accountable, how strict safety standards will be developed and enforced, and how such a system would be funded

What's important about this development is the impact it has on total system costs and end prices. It turns out that buyers who came back from overseas sourcing trips exclaiming - "it seems too good to be true" - were spot on. It was, and consumers are getting more and more concerned about who to trust.

In a related development, earlier this summer the U.S. Supreme Court seemed to anticipate such developments when they overturned a nearly 100 year old ruling to give manufacturers the right to set minimum resale prices. Why would the court suggest that higher prices are better for consumers?

The underpinnings of the court’s new reasoning were developed long ago by economists at the University of Chicago who argued that allowing manufacturers to stipulate prices on branded products can lead to greater benefits for end consumers when increased retail margins are used to fund required service levels. In reaching its new decision, the 2007 court acknowledged and embraced this view of consumer market dynamics, and concluded that any given instance of resale price maintenance is now within the law – if the manufacturer can show it has not concentrated market power to drive a supplier or retailer cartel, and if it can show that in setting a minimum price at retail, it is promoting consumers’ best interests and driving up overall demand.

Current consumer sentiment seems to be supportive of the Supreme Court's direction. None of this, however, suggests that manufacturers and their resale channel partners have free reign to drive up prices beyond what customers are willing to pay. But watch for new developments. In the new era of distribution, forward-looking manufacturers and their channel partners will once again offer trusted products at price points required to actually deliver on the brands' promises.

Resale Price Maintenance Commentary

For some intersting commentary on the U.S. Supreme Courts recent Resale Price Maintenance ruling read what Harvard economist Greg Mankiew has to say here:

Greg Mankiw's Blog: Resale Price Maintenance

Pricing Wars in Canada Fraying Relationships

Wal-Mart announced today that their stores in Canada will no longer be stocking best-selling LEGO building block products. For some time, Canadian's have been lamenting that retail prices of goods sold in canada have been too high relative to what the canadian dollar can purchase in neighboring US markets. It seems that retail prices have not been adequately correcting for shifts in US dollar-Canadian dollar exchange rates.

With a long legacy of building relationships based on muscular strong-arming of suppliers, it's hardly a surprise to anyone that Wal-Mart is looking outside the company to extract retail price relief from vendors. When that doesn't work, they start looking to boost sales of more vulnerable (and compliant!) second-tier products on their shelves. in LEGO's case, that means Wal-Mart is reallocating it's shelf space to Mega blocks (made by Montreal-based Mega Brands).

Two strategic problems with Wal-Mart's old school strong-arming tactics. First, consumers want LEGO brand products. Does Wal-Mart really have research to the contrary? I wouldn't bet your stock investments on it!

But secondly, LEGO products are euro- (or kroner-) denominated purchases. They're made in Denmark. If you look at what's happened to euro (and kroner) exchange rates, you see that it's US retailers feeling the squeeze in 2008 as their cost of goods sold rise in US dollars. LEGO products selling for $35 (CN) today at a 40% gross margin have COGS of $21 (CN). That $21 (CN) is equivalent to 14 euros. And that same 14 euro wholesale price from Denamrk (with similar mark-up) would be priced at $35 in the US. The same pattern holds for kroners.

So where is the pricing gap? (US and canadian dollars are essentially at parity today) .

We know what's really behind the news, and so does LEGO. Wal-Mart is disingeniously using this exercise as a PR smoke screen to strong-arm LEGO into margin concessions. Not surprising.
The good news for consumers is that LEGO is standing firm. Passing system efficiency gains on to consumers in the form of lower prices is smart retailer-vendor strategy. But unhealthy and unrealistic price pressure to simply grab retail share in a tough market can only lead to cheapened products, cheapened brands, and eventually safety problems as subcontractors make risky cost-cutting decisions.

But then, Mega Brands knows that story well. Remember the toy recalls last year? It seems that price isn't the only concern consumers have.

Western Competencies Surge as Supply Chains Falter

“China has been the world’s factory and the anchor of the global disconnect between rising material prices and lower consumer prices,” said Dong Tao, an economist for Credit Suisse, to the New York Times. “But its heyday is over. We’re going to see higher prices.”

This has to be welcome news for American manufacturers. Maybe offshore price competition will ease a little in the short run. The $64,000 question is what’s the best way for Western branded manufacturers to respond? Most manufacturing executives would redouble their R&D efforts. That’s just going to intensify competition.

My vote is for more attention to distribution.

American businesses know U.S. business systems intimately. They have an advantage in cultural as well as linguistic fluency. They have long and deep relationships with wholesalers and retailers. We’re not talking competition on Internet time here. Well into the future, Pacific-based corporations – even those with U.S. subsidiaries – will be disadvantaged in the nuts and bolts of overseeing how their products are marketed by trade partners.

What’s more, end customers are showing resistance to the low-price pitch when it’s attached to bland, shoddy or possibly unsafe products. Now is the time for mature Western manufacturing enterprises to step it up, and differentiate in a space where their ultra-low price rivals simply cannot: on-time deliveries, in-store training, more flexible returns procedures, and above all by putting superior knowledge of the end customer to work in the retail sales environment.

Customers will respond positively.

What is more, U.S. legal precedent now allows the possibility for manufacturers to set prices for their goods at the retail point of sale (see prior 360 Degree View post: Signs of a New Distribution Era Emerging). In other words, a branded manufacturer can work on distribution differentiation selectively with a few quality retailers, every party assured that a store down the street will not undercut them.

A Moment of Truth in Retail Prices and Distribution

A large-scale consumer educational campaign is unfolding as retail shoppers are taught more than they ever wanted to know about the trade-offs of juggling low prices with quality, safety and other retail total experience attributes.

A combination of reputation-saving market forces along with increased regulatory oversight will soon drive home to wary shoppers the inherent strategic realities of an intensely competitive global marketing and distribution environment.

An associated Press article today indicated that "....shoppers can expect price increases up to 10 percent next year to pay for increased vigilance by toymakers and stores after more than 3 million lead-tainted toys from China were recalled worldwide since June. That means a $6.99 Barbie doll could go up to about $7.70, or a $70 child-friendly digital camera could retail next year for almost $80. Consumers could also see higher prices on other Chinese imports such as fish and children's apparel, but the big price gains in toys could be more jolting. Shoppers have become accustomed to cheap playthings from China because Wal-Mart Stores Inc. and other discounters have waged cost-cutting campaigns. Critics say real safeguards were sacrificed to keep prices low, however."

Sleeper Brand Responds to Retail Distribution Shifts

The Nautica brand of apparel is being re-invigorated for a more growth-oriented retail distribution strategy. The company, owned by VF Corporation, has seen its branded product position weaken considerable as dramatic shifts in retail clothing channels have played out. In particular, overall sales at midtier retailers, Nautica's core channel, fell 1% in the 12 months ended July 31, according to Customer Growth Partners, a retail consulting firm. Sales at luxury retailers, by contrast, increased 11.1%, and sales at discounters jumped 9.2%.

The WSJ reports that Nautica's brand and distribution moves are part of VF's broader strategy to focus on brands with growth potential, amid shrinking demand for middle-market labels, department-store consolidation and a move by these stores to promote their own private-label merchandise -- much of which looks similar to the middle-market labels' clothing. Sales of upscale and high-end brands are growing at a faster clip than moderately priced brands, and they tend to be sold in venues that don't discount as heavily or often as middle-market department stores, which also increases profitability.

A less noticed aspect of Nautica's strategy is it's hints about the emerging strategic importance of resale price management (RPM) as an important key to successful brand repositioning. (WSJ: "...as well as adding more luxurious fabrics, the "halo" collection [will be priced] an average of 15% to 20% higher..."). The recent Supreme Court ruling in the Leegin case means more and more firms will be leveraging RPM in their efforts.

In the end, we believe we're seeing the tip of an iceberg, and expect that there will be a considerable push by Private Equity firms to buy up and invest in aggressive growth strategies for other sleeper brands across many U.S. retailing sectors.

Sleeper Brand Responds to Retail Distribution Shifts

The Nautica brand of apparel is being re-invigorated for a more growth-oriented retail distribution strategy. The company, owned by VF Corporation, has seen its branded product position weaken considerable as dramatic shifts in retail clothing channels have played out. In particular, overall sales at midtier retailers, Nautica's core channel, fell 1% in the 12 months ended July 31, according to Customer Growth Partners, a retail consulting firm. Sales at luxury retailers, by contrast, increased 11.1%, and sales at discounters jumped 9.2%.

The WSJ reports that Nautica's brand and distribution moves are part of VF's broader strategy to focus on brands with growth potential, amid shrinking demand for middle-market labels, department-store consolidation and a move by these stores to promote their own private-label merchandise -- much of which looks similar to the middle-market labels' clothing. Sales of upscale and high-end brands are growing at a faster clip than moderately priced brands, and they tend to be sold in venues that don't discount as heavily or often as middle-market department stores, which also increases profitability.

A less noticed aspect of Nautica's strategy is it's hints about the emerging strategic importance of resale price management (RPM) as an important key to successful brand repositioning. (WSJ: "...as well as adding more luxurious fabrics, the "halo" collection [will be priced] an average of 15% to 20% higher..."). The recent Supreme Court ruling in the Leegin case means more and more firms will be leveraging RPM in their efforts.

In the end, we believe we're seeing the tip of an iceberg, and expect that there will be a considerable push by Private Equity firms to buy up and invest in aggressive growth strategies for other sleeper brands across many U.S. retailing sectors.