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Slashing The Fat

Stores and vendors are doing an admirable job of counting cost calories, but some wonder whether it has gone way too far and creativity is suffering.<br><br><br><br>Retailers and fashion vendors are taking cues from their models.<br><br>While top-line...

Stores and vendors are doing an admirable job of counting cost calories, but some wonder whether it has gone way too far and creativity is suffering.

Retailers and fashion vendors are taking cues from their models.

While top-line growth has been a rarity, firms have turned to reducing expenses to drive profits, and moved the slender look from the runway to their financial statements and expense allotments.

Lean and mean hasn’t been so in fashion since the days of heroin chic.

Decreased selling, general and administrative expenses, workforce cuts and consolidations all point to fashion’s belt tightening. It’s also reflected in the advertising slump that’s plagued the publishing world.

No doubt, “post” economics (post-bubble, post-Sept. 11, post-Enron) have also had a hand in the financial dieting. The evidence is everywhere, as some serious calorie counting in recent quarters has effectively done away with much of fashion’s expense fat.

Even Wal-Mart Stores, the world’s largest company, which hasn’t had difficulties driving sales with its discount concept, has struggled to manage expenses. Commenting on the second quarter, president and chief executive Lee Scott told Wall Street, “While pleased with our results, we are not satisfied. This quarter again, we did not leverage expenses. Controllable expenses showed improvement, but higher insurance, benefits and legal costs resulted in a consolidated increase of 16 basis points.”

All of the cutting, though, has not come without its price, and some now worry about the overall effects on retailing as well as where fashion retailers go next time fiscal dieting is needed. Technology and other means of improving efficiency have their limits.

“There’s a lack of excitement that really permeates everything,” said retail consultant Walter Loeb.

Retailers during the recently ornery economy have increasingly resorted to lower prices rather than innovation to keep customers coming through the doors, but that’s only put more pressure on them to meet their revenue goals.

As long as the economy continues to flail, stores will do everything they can to maintain profitability and to avoid the ire of their shareholders by focusing spending on productivity-driving areas.

May Department Stores Co. this month completed the process of merging its Kaufmann’s and Filene’s divisions in the Northeast and Robinsons-May and Meier & Frank units in the West and Northeast. Without affecting sales help, that cost 1,200 jobs at Kaufmann’s headquarters in Pittsburgh and another 600 jobs at Meier & Frank in Portland, Ore. St. Louis-based May Co. projected the move would help it save about $60 million before taxes, or 13 cents a share, annually.

In the most basic sense, cutting expenses, through consolidation or otherwise, drives bottom-line growth by allowing companies to spend less for each sales dollar. With sales growth sluggish, improved margins are necessary to even maintain profitability. This is especially important for public companies caught between shareholders’ need for growth in a stagnant sales environment—a particularly pressing issue for most department store operators. The tap may be running dry on saving through consolidation, though.

“There are probably not any more big cuts companies can make,” observed Philip Zahn, fixed-income analyst at Fitch Ratings, who rates mostly broadline retailers. One of the dangers of divisional consolidations, though, is a lack of regional or local influences offered by different buying offices, he said.

While many retailers may not have the opportunity to consolidate their way to better returns, most can pinch away at advertising dollars.

On the advertising front, retailers can often afford to cut back for a while on image campaigns or catalog drops, but decreased spending in other marketing areas can be deadly for the market share that’s a critical measure of competitiveness.

According to the Publishers Information Bureau, magazine advertising revenue from retailers during the first half fell 2.9 percent against a year ago to $385.2 million. This bought retailers 6,506 pages of magazine advertising, an 11.6 percent drop.

For apparel vendors and accessories firms, the drop was even greater with a 13.7 percent decline in dollars (to $511.8 million) and a 19.3 percent slump in pages (to 9,793) during the half.

Can payroll be cut? Not without great risk, according to Ladenburg, Thalmann & Co. equity analyst Eric Beder.

“At the store level it’s probably very tight,” he said. “I just don’t believe you can cut more people and not really hurt customer service. Customers are close to the breaking point in the lack of service they’ll take.”

Fattening margins and sharpening productivity, though, can be done with more finesse than simple cuts.

A font of efficiency just not being tapped across much of retail is better management of inventory. “The productivity gains you’ve seen elsewhere in software and systems have not been seen in retail, but that’s definitely changing,” said Beder.

Ultimately, retailers are slinking toward an approximation of a just-in-time inventory system that delivers merchandise to the locations where it’s needed as efficiently as possible through the benefits of new technologies.

The words “tighter inventories” have been on the lips of most retail executives as they described their often slumping sales and improving margins. Last week, during the first spate of retail earnings, proclamations of better stock management and more efficient buying came from companies including Wal-Mart Stores, J.C. Penney, Federated Department Stores, May and Abercrombie & Fitch. The second quarter won’t be remembered for impressive sales gains, but it will go down as a period in which net income improved more rapidly than sales, or in some cases deteriorated more slowly.

Among those leading the charge for greater retail efficiency is Angela Selden, North American managing partner for Accenture’s retail industry group. “If retailers could more precisely figure out exactly where their inventory should go, they could double the amount of money they are earning on the same inventory investment,” she asserted.

Seasonality and geographic specificity of assortments — in short, having more cowboy hats in Texas and fewer sweaters in Florida — provide opportunities for greater productivity as well.

“It’s a no-brainer. It lets retailers maximize their sales and margins. It’s a no-brainer,” said Ladenburg’s Beder, summing up the consensus among analysts and consultants contacted.

Greater pricing integrity also presents opportunities for growth, with more realistic, possibly less greedy initial markups paving the way for better maintained markups in the long run. Pulling prices slightly down in some cases will drive unit sales up enough to more than compensate for the reduced price while, in other cases, raising prices will hardly affect volume. Obviously, fashion plays an important role in this area.

Selden described initial pricing as one of the “richest areas” for retailers looking to improve margins. This price elasticity is “absolutely appropriate for retailers to be focusing on right now and not many of them are implementing it across their whole base of business,” said Selden.

As times have made retailers cut back, vendors, who in some cases have faced drastic reductions in sales as stores sought to prevent stock surpluses since Sept. 11, have been under even greater pressure to do so, and most have fewer options than their retail accounts do.

“This is a challenging business even in a relatively good retail environment,” observed J.P. Morgan Securities equity analyst Noelle Grainger of the apparel manufacturers she follows.

Accordingly, vendors have long focused on cost.

More mature vendors like Liz Claiborne and Jones Apparel Group have been coping with moderate growth rates for some time while Kenneth Cole or Quiksilver, smaller firms with higher growth rates, are adjusting to a new world, noted Grainger.

While the manufactures have made most of the cuts they will in the area of headcounts and salary freezes, she said, they will reap more cost benefits going forward from falling sourcing costs, partially from excess capacity in Asia due to the downturn in demand.

Over the next two to five years, Grainger said, vendors will be paying less for their goods. This lets them charge less for merchandise or up the quality while, as Grainger noted, “hopefully keeping a little bit for themselves on the margin line.”

Having tightened up their businesses and their balance sheets, the vendors, especially Claiborne and Jones, are in a position to be aggressive in acquiring or investing in new businesses, Grainger said.

“They are not retrenching from growth strategies as a result of the current environment,” she said. “None of the vendors are really assuming that the environment is going to be getting all that much better anytime soon.”

Going forward, Dan Butler, vice president of retail operations for the National Retail Federation, noted retailers will probably keep expense spending down in the third quarter and ease up for the final quarter of the year. “The fourth quarter is always too important to cut any more than they have to — they are going to look at it as an opportunity to make up some lost ground,” said Butler.

Loeb advised retailers, “We’re at the bottom of things. It’s going to improve. I would take the initiative and be more fashion orientated and have more innovative merchandise, things people will talk about that identify me as a leader.”

Accenture’s Selden agreed, “Now’s the time to be bold and creative rather than to hunker down and try to manage costs. There are a lot of neat opportunities in the marketplace for a lot of the retailers that they’re choosing not to take on.”