The squeeze is definitely coming.
Retail apparel prices may have fallen last month, according to the U.S. Labor Department’s Consumer Price Index, but that’s only a temporary lull. The real crunch is expected to begin in back-to-school and fall merchandise, when the pressure from rising raw material and fuel costs is expected to become too much to bear and retailers will at last have to pass on some of those increases to consumers.
But retailers aren’t taking those inflationary pressures lying down.
According to a study by AlixPartners, stores can mitigate the effects of higher prices for everything from cotton to gasoline by increasing long-range booking of materials and reducing product complexity, among other tools, as they look to minimize the negative impact of sticker shock when consumers start looking to spruce up their wardrobes for fall.
According to the AlixPartners study, apparel inflation is averaging 17.4 percent for most retailers, with some seeing increases as high as 30 percent. Even employing some of the strategies available, more than 40 percent of firms could put themselves at a competitive disadvantage later this year.
Of the nine strategies offered by the consulting firm on cost control (see box), 95 percent of retailers said they tried to force suppliers to hold or reduce costs, but it was the least successful tactic. Strategically managing raw materials through long-range booking was one of the more successful approaches. And while only 59 percent choose to simplify product complexity or quality, AlixPartners believes this strategy will supply differentiation in the fall.
Those that did had a high rate of success, but there were still 49 percent who elected not to simplify product and “they will face intense pressure and will be way behind this fall,” said David Bassuk, head of the global retail practice at AlixPartners.
Many retailers will test the waters of consumer resistance with prices that could be up by 10 percent or more in the fall, so first indications of who is and isn’t making the adjustment to the return of inflation could come as early as July, when b-t-s floorsets are introduced.
Bassuk said more than 50 percent of the rise in cost pressures are likely to be felt in fall 2011 and beyond, particularly during the all-important holiday selling season.
While retailers are expecting to pass along “one-third of the cost increases on lower-priced product and commodities, [they are] hoping to pass on nearly 50 percent of the cost increases on higher-priced product,” he said.
The companies hurt more by the increases are those in the moderate business.
“We are definitely seeing more issues with the moderates where you have more cotton-based fashion brands, such as some teen retailers who are heavily focused on T-shirts and denim. There’s more flexibility in the luxury end to add some costs, or even incur some of the expenses because its easier to do so when you have a $50 T-shirt than a $19 T-shirt,” he said.
Of the more than 30 retailers surveyed, one-third — 33 percent — said costs have risen 15 percent to 20 percent, 29 percent pegged increases at 10 percent to 15 percent, 13 percent reported hikes of 35 percent or more and 4 percent put the increases at 5 percent.
While cotton has been a major factor so far, labor and fuel are also having an impact. And Bassuk said that while labor costs began to rise significantly in China last year, they are now increasing in other key manufacturing countries.
“Material is about 40 percent of the overall costs, trims add one-third to the price of the garment, and then labor and finishing and transportation become more impactful as they go up,” he said.
Mark Montagna, analyst at Avondale Partners, believes that even the luxury sector is not immune to the impact of rising prices. He noted that when the economy declined in 2000 with the bursting of the dot-com bubble and in 2008 when the recession hit, luxury retailers and brands saw massive declines in sales and share prices.
“Some of the luxury retailers have begun introducing a lower price point for their merchandise lines to bring back the aspirational customer. For that end of the market, some of those shoppers may again pull back on their spending,” he said.
Montagna expects to see more luxury brands offer merchandise at their own outlet concepts, or through online sites such as Gilt Groupe’s Gilt.com or Nordstrom’s Hautelook.com as another channel of distribution as younger customers and aspirational shoppers begin to explore options for buying designer goods at lower price points.
He also expects retailers who sell core basics to offer value-added options such as embellishments for both uniqueness and a reason to raise prices to make up for rising costs.
Richard Hastings, macro and consumer strategist at Global Hunter Securities, said, “The impact of inflation in the U.S. is focused on the lower-income household. There’s not much of an effect anywhere else in the other income groups.”
While food inflation overseas is an issue, Hastings said those increases are going to be felt less in the U.S. since there are greater transportation efficiencies, as well as big-box options. Again, lower income consumers will feel it most, but that’s because they’re already pressured from reduced income levels.
“The real story is about those with annual household incomes of less than $75,000,” Hastings said. “That’s a huge number, and it all will depend on other variables such as debt, demographics, age, condition of one’s health or age of children. After that, you’ll see a lot more pressure for those whose annual household incomes are less than $50,000.”
He said lower-income consumers will likely change the number of shopping trips to adjust for the price increases. Retailers in that sector will adapt to the pricing pressures by, for example, featuring a lower weight fabrication or fewer embellishments on the pockets of skinny jeans. There even may be a narrowing of variety on the sales floor.
“The big question will be the margins. Can retailers and vendors create something with enough markup to pay for the higher freight costs and other increases? An item selling for $39.99 can have a 3.5 percent pass-along increase to $41.39. That’s not that much, but a 10 percent increase will raise the price to $43.99. The lower-income shopper may balk at that increase, especially if gas prices stay elevated during July and August,” the strategist said.
He also believes the problem will get worse in 2012 with local governments raising taxes to make up for persistent budget deficits.
“The state level burden will creep up in 2012 and 2013. The higher taxes will impact discretionary income. What you’ll eventually see is a severe bifurcation between those having higher and [those with] lower incomes,” Hastings concluded.