View Slideshow
Appeared In
Special Issue
WWD California In Depth issue 03/19/2008

The California housing implosion and other woes mean trouble for the apparel sector and myriad industries.

This story first appeared in the March 19, 2008 issue of WWD. Subscribe Today.

It’s going to be a bumpy ride for the California economy.

That powerful engine, which includes the nation’s largest apparel industry and retail market, is being hit hard by the overall U.S. economic malaise.

Two years ago the nation’s most populous state was coming out of an economic slump. State revenue and jobs were on a growth track. The technology industry was reviving and agriculture, tourism and entertainment were solid.

Now the housing boom that propelled the gains has spiraled downward at high speed and the impact may be felt more in California than in any other state, particularly when compounded by the credit crisis, soaring fuel prices, falling consumer confidence, stock market convulsions and the potential for inflation.

“We now have a very good picture of the problems facing consumers,” said Chris Thornberg, a partner with Beacon Economics, who characterized California as being in a recession.

Thornberg expects retail spending in the state to keep falling through 2008 as consumers struggle to cope with the economic climate.

“From the manufacturing level, we will see a big problem for those who have to make a bulk of items, those who deal with Macy’s, Sears or J.C. Penney at a commodity level,” said Ilse Metchek, executive director of the California Fashion Association. “Retailers these days have the option of calling three weeks before delivery and saying, ‘Cut the order in half.’ That absolutely will happen if there’s a long-term [economic] dip.”

Jim Famalette, chairman and chief executive officer of Fresno, Calif.-based Gottschalks Inc., said the department store chain has seen the slowdown affect California operations since about the second quarter of 2007. The retailer has 63 department stores and 10 specialty stores in six Western states, and 80 percent of its business is in California. Last year, same-store sales fell 5.1 percent. In February, the chain reported sales were off 9.5 percent from a year earlier.

“I don’t see the economy picking up in the near term,” Famalette said.

To cope, inventories have been reduced to 5 percent below a year earlier. The company is also rolling out a new store format that is about half the size of its typical 120,000-square-foot stores. Tucked in smaller towns lacking fashion retail, the new Gottschalks emphasize women’s sportswear, accessories, shoes and cosmetics. The retailer expects to open three of the stores this year.

Single boutiques — where the profit margins are thin — may be hit even harder, and even large retailers are feeling the effects. Established retailers including Pacific Sunwear of California Inc., Talbots Inc. and AnnTaylor Stores Corp. have closed stores.

It’s a hard landing for a state that added 547,200 jobs from November 2003 to January 2006, ranked eighth among global economies and reported healthy home construction. Now California is losing jobs, consumer spending is shrinking and home sales are at their slowest pace in more than a decade. Single-family home prices have fallen below 2005 levels, and the number of unsold homes is the highest since 1999.

In fact, Southern California appears to be experiencing the steepest housing price drop in the U.S., a 17.9 percent decline compared with a year ago. The median home price in Southern California was $408,000, according to DataQuick figures released last week. That’s the lowest since October 2004, when it was $402,500 — 19.2 percent less than the peak of $505,000 last summer, and 1.7 percent below January’s median.

In the San Francisco Bay Area, the median price of a home has fallen 11.6 percent to $548,000 compared with the previous year, and a 17.6 percent decline from the top median price of $665,000 last summer.

“The housing industry will continue to slide in terms of prices and unit sales of both new and existing units,” said Jack Kyser, chief economist for the Los Angeles County Economic Development Corp. “The most distress will be in the Riverside-San Bernardino area and Orange County.”

The housing implosion and soaring foreclosure rates will be a drag on retail. The Los Angeles Economic Development Corp.’s 2008-2009 Economic Forecast & Industry Outlook projected a continued decline in taxable retail sales.

To make matters worse, gas prices continue to climb, and in a state with about 24 million licensed drivers and even more registered cars, those costs absorb a good chunk of consumer change.

Over the last two years, the average price of regular gasoline in California shot up from about $2.50 a gallon in March 2006 to $3.65 this month. Last week the Automobile Club of Southern California reported that gas prices set a record for a second consecutive week, jumping 46 cents over the previous month’s average.

The Consumer Confidence Index in February fell to its lowest level in five years, and expectations hit a 17-year low. Almost two-thirds of consumers plan to cut back indulgent spending in 2008, according to a survey by HSBC Bank USA, and four out of five want to increase the amount they save.

“It’s like a roller coaster, people are not spending as much and there’s so much uncertainly out there,” said Fraser Ross, owner of Los Angeles’ trendy Kitson boutiques. “It’ll get worse before it gets better. Right now we’re not laying anybody off, but in the future, who knows? Let’s hope for a lot of tourist dollars from Europe to get us through the hard times.”

The decreases in spending have contributed to a sharp drop in tax revenue. As a result, a state budget shortfall pegged at $14.5 billion in January has ballooned to $16 billion.

In Los Angeles, Mayor Antonio Villaraigosa said last week that projected budget deficits may force layoffs of city employees for the first time in 25 years. The city faces a $155 million shortfall in the fiscal year ending June 30, which may rise to $300 million to $500 million in 2008-2009.

Employment numbers look dismal. The U.S. economy lost 22,000 jobs in January — the first decline in four years — and 63,000 jobs in February, the fastest falloff in the labor market in five years. California has sustained significant job losses. According to the most recent Employment Development Department data for January, six of the state’s 11 major industry sectors cut jobs, and the jobless rate is 5.4 percent, 0.5 percent higher than last year.

Information technology hemorrhaged 25,100 positions, the most in any California sector and the industry’s biggest one-month job falloff ever, surpassing the 18,800 positions that were trimmed in April 2001.

Statewide, construction was among the hardest-hit areas, down 12,800 jobs in January, the 10th consecutive month of job losses, and its largest monthly drop since January 1995. The sector lost 69,300 for the year ended in January 2008, a 7.6 percent year-over-year job reduction that was more than twice the U.S. construction industry’s 3.6 percent loss. From February 2006 through January 2008, the California construction industry lost 105,800 jobs.

Motion picture and sound recording employment was down 13.5 percent of its workforce compared with the previous year, although the deep cuts were largely attributable to the writers’ strike. Leisure and hospitality lost 1,500 jobs in January. The sector had gained jobs in each of the four previous months, with gains totaling 9,800.

The finance sector lost 1,200 jobs in January, the 11th consecutive monthly job loss in finance and the 19th in the last 20 months. Year-over-year job losses totaled 3.8 percent in January. From its peak in May 2006 through January 2008, financial sector job losses reached 56,800.

The economy has dimmed Bay Area employer expectations for the year, according to a business confidence index released last week by the Bay Area Council, a group of chief executives from 275 of the largest companies in the area, including Macy’s West, the Gap, Nordstrom, Google, Safeway and Chevron.

The quarterly index, taken in February, fell 10 points to 38 on a scale of 100, where anything less than 50 translates into economic contraction. During the most recent Bay Area economic downturn after the 2001-2002 dot-com bust, a period worsened by the Sept. 11 attacks, confidence stood at 39.

The survey also found 22 percent of Bay Area ceo’s plan layoffs this year, while 22 percent are aiming to hire. Just a year ago 44 percent of the ceo’s polled were going to add employees and 6 percent planned layoffs.

National mall vacancies hover between 7 and 8 percent, up from 5 percent over the last six months, according to New Jersey-based commercial real estate services firm NAI Global. Executives at NAI Global’s retail division estimate the vacancy rate could hit 10 percent by the end of the year.

However, California is in a better position than much of the nation, with strong markets like Los Angeles, Orange County and San Francisco reporting vacancy rates of 2.1, 2.8 and 3.5 percent, respectively, at the end of 2007.

Nonetheless, a retail expansion trend that got under way at the height of the housing market means more space is coming to the market just as consumer demand is falling.

“We will start to see some small shop space fade away,” said Mark Klionsky of NAI Global. “National chains may close a few stores, but the most immediate effect will be on smaller stores and the malls they occupy.”

Many experts hope for a relatively short economic downturn for the state on the order or eight months, although there are complications ahead.

The entertainment industry faces labor negotiations with the Screen Actors Guild, and there is expected to be continued fallout from the recently settled 14-week Writers Guild of America strike. A contract for the longshoremen’s union will be up for renewal in June, and strife could cripple industries statewide.

Not everyone is pessimistic about the coming months, though.

While the loss of construction and financial services jobs have taken their toll, Kyser of the Los Angeles Economic Development Corp. said the state’s diversified economy includes major industries such as health care that are generally less vulnerable to an extended recession.

Off-price retailers like Ross Stores Inc., for example, are expected to fare well. The company gets most of its merchandise from manufacturers stuck with stock and, at times like these, there’s typically more to choose from as full-price retailers cancel orders, said Katie Loughnot, vice president of Ross Stores investor relations. Likewise, Ross, based in Pleasanton, Calif., in the Bay Area, is also benefiting from customers looking to save.

“The trade-down customer is one of the resilient aspects of our business,” Loughnot said. Ross Stores in February posted a 4 percent same-store sales gain from a year earlier, with sales in California increasing 2 percent, which exceeded expectations of sales being flat.

And the top end of the luxury retail market can benefit. “No retailer enjoys looking at a recession coming up but it’s a great opportunity…for true luxury brands to establish themselves,” said Emmanuel Perrin, president and ceo of Van Cleef and Arpels North America, during a recent luxury retailing summit in Beverly Hills.

California’s tourism industry may see growth trends, thanks to a declining U.S. dollar that could help fill some of the gap in U.S. consumer spending.

In the real estate market, affluent areas should escape the consequences of the credit crunch that is hammering secondary and tertiary markets in and near cities such as Riverside and Stockton, which have led the nation in home foreclosures.

“People in those areas have such wealth in such numbers that whether it’s getting hit at the gas pump, declining home value or a stock portfolio losing value — it doesn’t matter,” said Robert Cohen, executive vice president at Robert K. Futterman & Associates, a real estate brokerage firm with offices in Los Angeles and San Francisco. “It just won’t last long enough or be deep enough to hurt people at those levels.”

In the entertainment industry, the Screen Actors Guild and the American Federation of Television and Radio Artists plan to negotiate jointly on a new contract with the studios and networks, and talks could begin as soon as the end of March or early in April.

Though complaints of the cheaper-to-produce reality programming that currently abounds still linger in the industry, content provides for future opportunities, some say.

“If you think about the last six months, we saw an even bigger pipeline of programming developing that didn’t require a lot of top-level writing talent, and maybe some of the films being made wouldn’t have moved forward before the strike,” said Peter Winkler, Southern California/Phoenix Sales & Marketing Leader for PricewaterhouseCoopers.

Some reality shows are ratings hits and are also relatively cheap to produce.

“If media and entertainment companies

invested in cheaper reality [shows] they then have more to invest in other parts of their business moving forward, and that could shore things up,” in the overall economy, Winkler said.

Edward Leamer, director of the UCLA Anderson Forecast, released last week, said consumer spending would keep the economy out of a recession and that the current situation does not match those of the state’s 10 recessions since World War II, which all consisted of huge losses in manufacturing jobs followed by a quick rebound.

“California has challenges right now, but the best way a retailer can move through is to have new and innovative product, by remodeling, rejuvenating and focusing on customer service,” said New York-based retail analyst Dana Telsey, who said she believes consumer spending in the retail sector will bounce back. “It’s about how you manage through it.”