Just like consumers staggering into stores post-Thanksgiving dinner, many retailers will be overly full this holiday season.
While customers can blame that extra slice of pumpkin pie, retailers can blame West Coast port disruptions in late 2014 and early 2015, which helped lead to the highest inventory levels in the U.S. since the height of the Great Recession (see Exhibit 1).
This summer, ports began to clear inventory backlogs, flooding stores with excess fall inventory. The result: a 5 percent year-over-year increase in inventory-to-sales ratio in August. The problem is particularly serious for apparel retailers, which carry highly seasonal inventory with a limited shelf life. So how can they avoid feeling the worst side effects of this accidental overindulgence—and prevent the resulting heartburn and margin erosion?
Exhibit 1: U.S. Manufacturing and Trade, All Businesses, Inventory/Sales Ratio (Source: U.S. Census Bureau Department of Commerce)
This inventory glut is something of a double whammy for apparel retailers: the actual excess is bigger than for other types of retailers and has more serious consequences (see Exhibit 2 and 3).
Exhibit 2: Apparel retail risk factors impacting inventory positions and retailer response
Not only are apparel retailers staring down their most important season loaded with extra merchandise, they’re also trying to make up for weak sales earlier this year caused by the same inventory disruptions.
For example, 12 percent of Macy’s first quarter inventory was delayed. This played a role in disappointing Q2 2015 earnings per share, which were down 20 percent from last year. Or consider lululemon, which, in its Q2 earnings report, cited a 370 basis point decline in gross margin, 190 basis points of which the brand attributed to port closures. And Kohl’s cited a $120 million margin hit in its Q2 earnings report for its decision to pull its fall inventory forward.
Exhibit 3: U.S. Clothing and Clothing Accessories Stores Sales and Inventory (Source: U.S. Census Bureau Department of Commerce)
All of this creates the perfect conditions for a uniquely intense rivalry for holiday market share.
Anticipate deeper discounts this holiday season, as retailers attempt to clear excess inventory before the end of the year. Additionally, expect intense channel friction between traditional retailers and discount outlets like TJX and Ross. With more first-quality product flowing into the off-price channel, consumers may find discount shopping more attractive than ever.
Deeper discounts, increased carrying costs and more “flush” product will likely yield disappointing Q4 performances for many retailers, some of which we are already seeing.
How to Avoid Eating Profits
So how can retailers avoid holiday season pricing remorse? By proactively and profitably funneling merchandise to their highest-value sales channels before giving into the temptation to binge on rock bottom prices. More specifically:
1. Optimize inventory positions across channels
While inventories in aggregate are high, out-of-stocks in select doors or select styles can still drive missed sales. Now is the time for retailers to address out-of-stocks, as sub-optimal allocation often translates to unmet demand for full-price, promotional or only slightly discounted items.
Sales and margin lift from reduced out-of-stocks is truly incremental and can make a significant dent in excess inventories if properly addressed. For example, trailing rate of sale calculations can predict a retailer’s most valuable shelves and inform weekly door-, style-, color- and size-level replenishment. In select cases, refined allocation and replenishment algorithms coupled with improved rapid replenishment capabilities has resulted in sales lifts of 5-7 percent.
2. Optimize prices regularly, and remove the crutch of the standardized markdown ladder
Next-generation pricing capabilities are laser-focused on product lifecycle management. Predictive demand and elasticity analytics inform optimal depth and frequency of price cuts, which means retailers are better able to sell-through excess inventory at the desired rate without leaving money on the table.
Implementing more targeted promotions within store segments based on anticipated demand changes will mitigate cumulative inventory builds and protect margin. Taking a more nuanced approach can drive a sales lift of 5-10 percent and unit lift of 15-20 percent on seasonal products.
3. Leverage an omnichannel test-and-learn approach
The e-commerce channel offers the unique opportunity to test and analyze the effectiveness of new pricing, promotions and product launches in real time. These learnings can then be applied to brick-and-mortar stores.
A/B testing, consumer loyalty programs, and digital marketing tools will play a vital role in capturing these learnings. Cross-functional teams can prioritize and tackle critical test-and-learn opportunities.
While this holiday season may prove challenging for all retailers, targeted intervention can prevent shrewd players from closing out the year laden with leftover inventory. Best-in-class omnichannel inventory management and pricing practices can help save retailers from making unhealthy decisions this holiday season, and will get them in shape for whatever challenges the New Year brings.