Who’ll Blink First

And How to Get Out of the “Value Vise” that Kills

The Robin ReportThe light at the end of the tunnel is not what you think it is. It’s a train. And, it’s loaded with a bunch of stuff freshly made in China and elsewhere bearing, on average, a 10% cost increase, according to Li & Fung, arguably the world’s largest sourcing agent, at a recent Goldman Sachs conference. This rise in costs, according to L&F, will be driven primarily by higher raw material prices, cotton being the major one for apparel, as well as labor and transportation, to be tacked onto larger orders than last year (due to “shelf” replenishment going into the Holiday season.)

Who among the many players in this pipeline staring contest is going to blink first in accepting these higher costs?

Well, just as with death and taxes, the only thing we can be sure of is that consumers will not be blinking at all, only nodding – and only at lower prices.

Hanesbrands, VF Corporation, Jones, Carter’s and JC Penney have all declared they will be raising prices next year. Two words for them: good luck!

Go ahead and raise prices and observe how quickly your customers spot equivalent value for a lower price right across the aisle. Then observe how quickly your margins shrink as you put your stuff on promotion.

In support of this rather obvious opinion is an American Pulse survey recently conducted by BIG research in Columbus, Ohio. First of all, 81% of Americans don’t think the recession is over, and 71% feel they are better qualified than economists to determine its end. 78% say they lost wealth in the last two years due to declines in the value of their home, lost jobs and declining interest rates on their savings.

So, the final fact that 77% of them say they are not ready to start spending like they did prior to the recession is kind of a no-brainer.

Also weighing in is Bruce Cohen, a partner at Kurt Salmon Associates, who commented that KSA’s recent consumer survey found “….consumers are saying pretty loudly that they are in no mood for price increases this holiday season given the economic and employment uncertainty. We know the industry will be under great pressure given this tough environment. Price increases, if they occur, will be made with surgical precision as opposed to being broad based, and will be quickly mollified by promotion if volume declines occur.”

Therefore, while Terry Lundgren, CEO of Macy’s, commented at the same Goldman Sachs conference that sometimes a little inflation is a good thing, referring to the possibility of raising prices slightly, I found myself blinking in disbelief several times at his unabashed optimism.

Instead, I’m betting with William Simon, head of Walmart’s U.S. stores, who said during the same meeting: “We expect a very, very competitive and aggressive Christmas and holiday selling season, price-focused. Customers are focused on their savings, and challenged by unemployment close to a 26-year high.” He’s clearly blinking ahead of the pack. And he is likely blinking into 2011 as well.

On the other hand, and perhaps with a wink, Manny Chirico, chief executive of Phillips-Van Heusen Corp. (owner of the Calvin Klein and Tommy Hilfiger brands), told the Wall Street Journal: “Everyone’s talking about raising prices.” He also said costs are up 5% to 7%, and that he hopes to recoup some of that by increasing prices 3% to 4% starting late this year. I’m guessing that wink will turn into a full-blown blink before too long.

Finally of course, as the currency issue and its effect on trade continues to heat up the debate between China and the U.S., I find myself shaking my head about the paradox the U.S. seems to be setting itself up for. It wants China to increase the value of the yuan so U.S. goods will be cheaper, thus increasing exports and putting people back to work. Blink, blink, indeed! I ask: what is it we actually produce today? (see article on pg.18). And, how much of it would we need to export to make a dent in our economy? And, the paradox arises out of the fact that as the yuan increases, it further raises the prices on their goods which will completely alienate already price-conscious consumers in the U.S., who just happen to account for 70% of GDP, which itself is gasping for air. Talk about shooting oneself in the foot, the U.S. seems to be doing a lot of it these days.

Returning to the question of who will blink first, the only blinking that will be going on will be between wholesalers and retailers, and there will be a lot of it, maybe even spasmodically, as they put their higher priced goods on promotion and watch their margins take the hit.

And, to add further potential fuel to the fire, since retailers and wholesalers had been so good about controlling and cutting inventories to the bone, thus enjoying a decent run of higher profitability, the issue has been raised that if the gamble on “shelf” replenishment and higher inventories is placed on the wrong number, there could be a lot of blood-letting. And some evidence that this may be the case comes from The Ports of Long Beach and Los Angeles, which handle about 40% of all American imports. In August, when holiday shipments arrive, they had about 710,000 containers, which was more than in the same month during 2007, when the economy was vibrant.

So, if the consumer only nods at promotion-mania, leaving trainloads of stuff on the shelf, a lot of CEOs will find bags of coal under their trees, and no job to go back to after the Holidays.

IS THIS A “ONE-OFF?” OR A “KEEPER”

So, is this pesky inflationary build one that so small and insignificant we’ll be able to “toss it back in,” or is it a keeper? Is it going to stick and possibly get even stickier?

It’s not only going to get stickier, the ability to find low-cost producing countries that can meet the complex requirements of today’s giant retailers and wholesalers of response times, logistics, quality, and other operational and distribution standards, is going to get tougher, eventually hitting a wall. And when it does, a ton of small and medium sized businesses are going to disappear. Only the biggest ones, those with margins fat enough to absorb the higher costs, will survive.

Maybe this is when we will finally see a purging of the excessive wasteland of stores and stuff across this country. You know I’m not betting on that one. Somebody will prop up the losers, hoping to preserve an “iconic brand” or somehow to magically turn it around, or, if “too big to fail,” there’s always the government (read: us, the taxpayers). I digress.

Even now, the narrative around inflation, particularly in China and particularly among the big players, is that even though Vietnam and Bangladesh are lower cost producers, there are now all those other requirements mentioned above, that have become “baked into the cake” so to speak. So, for giants like Nike, Walmart, VF Corporation, Jones NY, and many others, to move their production for lower costs alone would not only be enormously disruptive to their current businesses, but the costs, time and effort required to re-establish the “in the cake” operating standards they’ve grown to expect from China would be enormous. Further, they risk the potential that such requirements may not be possible in these other countries.

China is attempting to address the rising labor cost issue by replacing the manufacturing of lower-cost apparel, footwear and toys along its eastern coastal areas with higher-cost technology and electronics. They plan to move the lower-cost production further west, into the mainland, accompanied by massive highway and infrastructure construction in an attempt to maintain lower costs (additionally providing jobs), and to maintain a semblance of the service requirements expected by Western businesses, in order to keep them from pursuing another country.

THE “VALUE VISE” THAT SQUEEZES COMPANIES TO DEATH AND THE WAY OUT

Having said all of this, for as far as we can see into the future, pricing flexibility will continue to be squeezed. Market saturation in the U.S. will simply never go away for more reasons than I have room for here. This of course results in consumers’ refusal to pay another penny for something that’s no more valuable than hundreds of equally compelling choices right at their fingertips. And, horrifically, they will continue to demand more value for the same price, because that too, they can get.

Why? Because, you, poor reader, (if you are a supplier), will jump through hoops to give it to them, knowing if you do not, you will soon disappear.

This is what I call the “value vise” that ultimately squeezes companies to death. Because, the most direct knee-jerk reaction for most businesses is to relentlessly pursue lower and lower production costs, a treadmill that never ends, until the lower cost cannot be found. And then, it’s curtains.

There are only three ways to address the “vise” for survival. First, regardless of the size of the business or sector (luxury included), one must relentlessly drive a competitively low cost model (across the enterprise, not just for production), combined with maximiz-ing productivity, and constantly adjusting both.

Second, rather than dropping the cost and productivity savings to the bottom line, they must be invested in innovation and/or raising the perceived value of the product, brand or services.

The innovation and investment must be in three areas:
1. developing new distribution platforms to gain preemptive access to consumers ahead of the hundreds of equally compelling competitors;
2. creating an overwhelming, neurologically connecting experience whenever and wherever the consumer is touched by your brand or store or website; and
3. the relentless pursuit of gaining control over your entire value chain to ensure the preemptive distribution of your addictive experience from creation all the way through consumption.

Unfortunately, this daunting scenario, with the consumer in the catbird seat never having to blink, does not describe a future of outsized profits and growth, happiness and bliss. Rather, it’s a reality show that suggests joy can be found through the pursuit of quality over quantity, where size doesn’t matter and a nice tidy profit can put one into a nice quality of life.

Sorry about the “bluebird of happiness” sermon, but hey, it truly is the small, entrepreneurial-centric century, which will ultimately consist of an infinite number of finite market segments, being served by an infinite number of finite brands, and distributed through an infinite number of distribution platforms.

So mega-brands, start blinking. The entrepreneurs are coming.

If you’re interested in learning more about Robin’s view of the future, and how to get out of the value vise, look for the book he co-authored with Michael Dart of KSA entitled The New Rules of Retail: Competing in the World’s Toughest Marketplace, to be released by Palgrave-MacMillan on December 7th.

Robin Lewis About Robin Lewis

Robin Lewis has over forty years of strategic operating and consulting experience in the retail and related consumer products industries. He has held executive positions at DuPont, VF Corporation, Women’s Wear Daily (WWD), and Goldman Sachs, among others, and has consulted for dozens of retail, consumer products and other companies. In addition to his role as CEO and Editorial Director of The Robin Report, he is a professor at the Graduate School of Professional Studies at The Fashion Institute of Technology.