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Retail’s Inventory Balancing Act

Retailers contemplating consumers, guessing on stock levels and pushing off risk.

Too little, too much — or just right?

That’s the question retailers are pondering as the holiday season — and the accompanying price promotions — hits full boil. As sale signs scream 40, 50 and even 70 percent off on fall and winter merchandise, retailers face an even tougher quandary: Given the schizophrenic consumer, have they guessed right on inventory levels for spring?

The holiday inventory buys have not been uniform across retail. Some chains are being cautious while others are prepping for sales and market share gains. But, in general, retailers are also trying to push more of the burden off onto vendors, who are increasingly forced to contend with higher cotton costs, supply chain disruptions and global economic woes.

The result is a game of pass-the-parcel between retailers and their suppliers that will play out well into 2012, with whoever ends up holding the package potentially losing big financially. The fallout won’t be truly revealed until vendors and retailers begin reporting year-end results in February.

And even when it’s the retailers who are left with excess inventory to clear — outerwear is a potential trouble spot given the warmer-than-usual weather so far this season — they can be expected to turn to their suppliers for markdown support to help prop up margins.

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“If [retailers] are unable to pass the cost on to the consumer, a lot of that cost is going to get pushed back to the apparel vendors,” said Scott Tuhy, debt analyst at Moody’s Investors Service.

Nobody thinks this year could be as bad as 2008, when the industry was caught flatfooted by the financial crisis. But Tuhy said fourth-quarter profit margins are at some risk, particularly in the moderate sphere, where the shopper is strained economically and chains are trying to force through broad-based price increases related to higher costs in the supply chain. November retail apparel prices rose 4.8 percent over a year earlier, the biggest gain for the month since 1987.

Determining how much inventory to stock is essentially a guess at how shoppers will be feeling several months in the future. And right now, retailers — perhaps like consumers — find themselves more than a bit befuddled.

“We see retailers coming into the holiday season being really bloated or being really conservative,” said David Bassuk, managing director and head of AlixPartners’ global retail practice. “The retailers are really all over the place. The apparel specialty stores were way out of whack” at the end of the third quarter.

“We’re facing a time when retailers are struggling to determine how they plan inventories across all of these channels and categories and we’re seeing a situation where they’re mismatched with perceived demand,” Bassuk said.

Mobile technologies that let shoppers comparison shop have helped change the underlying balance of power in retail.

“The consumer has the power and is now in the driver’s seat,” Bassuk said.

Misjudging the consumer mood can be very costly.

Chico’s FAS Inc. bet big at its flagship division and missed, leaving inventories up 38.2 percent at the end of the third quarter on just a 11.5 percent gain in revenues for the period. “We were really coming off some very, very strong momentum and, honestly, I took a shot,” president and chief executive officer David Dyer told Wall Street analysts. “We went for the inventory. We thought that we could continue that momentum, and it didn’t happen.” Unbowed, Dyer said he was taking the same bet again, this time in the growing White House|Black Market division.

Limited Brands Inc. prefers to aggressively chase inventory and inched ahead with its stock levels up 5.6 percent at the end of the quarter despite a 9.6 percent revenue gain. On the other hand, Lululemon Athletica Inc., tired of chasing goods to keep up with sales, chose to get ahead of the curve with a 76.9 percent rise in inventories on a 31 percent increase in revenues.

Department stores have generally been able to keep inventory more in line with sales growth — although they have occasionally felt pressure on certain categories. Saks Inc., for instance, warned in its third-quarter conference call that sales of women’s designer fashion had been disappointing and that it might have to take more markdowns in the fourth quarter to clear inventories. (For a complete run down of inventory levels at the end of the third quarter, see chart below.)

All of this is playing out in the spotlight of the holiday season, when retailers courted shoppers by extending hours, cutting prices and even opening their doors in the wee hours of Black Friday. But after a first rush of holiday sales optimism after Thanksgiving, retailers have become more cautious as the consumer responds to deals, deals and more deals — and almost nothing else. As holiday shopping ticks down the anxiety is growing — stirring even more uncertainty at retail over just what the consumer mood will be in 2012 and whether retailers struck the right inventory balance when they placed orders this fall.

To help ease their worries, Christian Buss, an analyst with Credit Suisse, said retailers are trying to get vendors to take on as much of the inventory risk as possible.

“It’s better to be a retailer than a vendor right now and it’s better to be a multibrand retailer than a mono-brand retailer,” Buss said. “If vendors are building big inventories and mono-brand retailers are building big inventories and demand were to be light of expectations, than they have markdown risk.”

It’s an environment that plays to the strengths of department stores, which were not long ago seen as the dinosaurs of retailing but now appear to be benefiting from their broad offerings and larger vendor base.

As retailers try to pass inventory risk down to their suppliers, apparel producers are being mindful of how much stock they can handle and how much future business they can expect from their retail clients.

“If the retailers are looking to the vendors to hold more inventory, but are not making commitments, we think that it’s incumbent on the vendors to have a very good handle on what his reorder will be, especially on replenishment,” said Andrew Tananbaum, executive chairman at factor Capital Business Credit. “People who have less visibility of the future needs of the retailers are probably better off maintaining their margins on lower sales.”