NEW YORK — After muddling through 2002, retailers have a lot to look forward to in 2003 — most of it not to be welcomed. There will be more deflation, rising unemployment, consolidation, global tensions, inventory excess and product sameness. Wal-Mart’s unending growth is a given, leaving less market share for everyone else except the most nimble.

“If you wake up today and say I have a problem, you are four or five years too late,” said Hans-Joachim Korber, chief executive officer of Kaufhof Warenhaus, based in Germany.

This story first appeared in the January 16, 2003 issue of WWD. Subscribe Today.

Historically, retailing has been “a bellwether and bedrock industry of creativity and innovation. If anything, I think it’s become dysfunctional,” said futurist Watts Wacker, chief executive of FirstMatter. His advice to retailers: “Learn to be uncomfortable and expect consumers to be unreasonable.”

“The retail box is a sarcophagus,” declared John Hockenberry, correspondent for Dateline NBC, in a rather dark depiction of the state of the industry.

These comments sprang out of “super sessions” at the National Retail Federation annual convention at the Jacob K. Javits Convention Center, Sunday through Wednesday. It was dubbed “the big show,” and as Ed Sullivan would have said, it was “a really big show” in terms of attendance, ideas and retail-bashing. There were 12,500 people registered, mostly retailers, along with about 300 exhibitors on the trade show floor. For an industry that’s hurting and under mounting pressure, the convention is the time for self-analysis, though much of the examination is from those not on the front lines, but from the periphery — the consultants, Wall Street analysts and futurists who feed off retailers for their own survival and take a high profile as panelists at the forum.

Then there’s the exhibition floor, where actual business is conducted. It saw steady traffic, but reportedly the technology suppliers weren’t getting the commensurate business. “Merchandise optimization” was a big buzz word, and companies ranging from Saks Fifth Avenue to J.C. Penney use such systems to varying degrees to help schedule markdowns for maximum sales. However, not everybody agrees that more data is what retailers need to climb out of their hole.

“Retailers are drowning in a sea of information,” declared Gil Harrison, chairman of Financo, during the financial forecast. “It’s not yielding better results. It really deprives them of releasing creativity into the organization. People have to be allowed to do their own thing.”

The need for creativity and the short-term (some would say short-sighted) demands of Wall Street stifling newness were major themes echoed at the conference. According to Angela Selden, managing partner at Accenture, retailers have to shift priorities, from expansion, to rethinking strategy and encouraging innovation.

Big news always seems to break during convention week. This time, Kmart announced 326 more store closings and 37,000 job cuts, Simon Properties stepped up its bid to take over Taubman Centers, and Wal-Mart disclosed its interest in buying the Safeway grocery business in the U.K. — yet another overseas acquisition.

The announcements fueled speculation that consolidations will accelerate, and that generally, retailers are in for another tough year, though speakers at the NRF projected an improving U.S. economy, primarily in the second half. But it’s a schizophrenic economy: Consumer spending is holding up, and there’s declining consumer debt due to refinancing, and possibly increased spending on apparel after a few seasons of holding back and more spending on cars and homes. On the downside, the labor markets are weak and consumers are tense.

Also, with some time since Christmas to reevaluate store results, several analysts and economists said the holiday season wasn’t as bad as originally thought in terms of margins and inventories, though sales were admittedly disappointing.

But it’s time for retailers to “Go to the edge and find out what’s so alluring,” said Wacker. Even venture further, to the “fringe.” It’s a place that’s scary, messy and hard to deal with, but one populated by people planting the seeds of new trends. From there, promising trends are snapped up by hip, trendy entrepreneurs in the “realm of the cool.” Then marketers make a larger market for the growing trend. As an example, Wacker cited Nike’s growth from a company that provided shoes for world-class distance runners to an industry giant making sneakers for almost any conceivable purpose, like middle-aged men mowing the lawn.

“You must learn to anticipate what the manifestations of each of these stages are as you go forward,” said Wacker. “This is what will bring the opportunity for innovation front and center within your organization. Innovation is not a one-time commitment…It’s a never-ending journey.”

Apparently, few take it, Wacker implied. “How come 70 percent of the goods in any department store are in every department store? That’s not using your gut,” he said.

According to Ken Walker, managing partner of Retail Options, there’s a good reason to innovate. “You guys have run out of options,” he said during the session “Innovate or Die,” which he moderated. “You have done everything to cut costs. Innovating, in all honesty, is your last chance.”

“There is no one right way” to define innovation, Walker said. “It can be a new look, a new idea, a new technique, the old revisited. At the end of the day, it’s about differentiation.”

The biggest hurdle in organizing a company for innovation is “fear of failure,” Walker noted, but much else is also required, including a chief executive officer “who really feels the need” a team that explores the market together, reviews products together, and is led by a “chief image officer” so the company is focused. “Communicate innovation to everyone in the organization.”

Target is one company with a predisposition to innovate, at least according to Michael Graves, president of Michael Graves & Associates, who has an exclusive product line at Target, including housewares and bedding. He said Target four and a half years ago wanted him to design the scaffolding for the Washington Monument, which Target paid for. That led to a lunch meeting with former Target hard goods executive Ron Johnson. Graves confessed he had never been to a Target, while Johnson said Target had been knocking Graves off for 15 years. Johnson got Graves to design about a half dozen original items, initially, and now Graves has about 600 bearing his signature at the mass retailer.

How does Graves see the process of innovation? “It’s about understanding who we are. What we do when we design stuff is to tell stories.” Graves also said that when designing, “I avoid the ‘wow factor’ as much I can. Wow will be old by tomorrow. I don’t think it’s what pays the bills.”

When it comes to designing product, it’s not simply about creativity. Denise Seegal, ceo of Sweetface Fashion, hammered home that point during a session entitled “Retail Profitability is a Seven Letter Word: Product,” when she discussed the importance of “intellectual designers” who understand the financial ramifications of what they design as opposed to just the creative ones. “They need to understand that everything they create has to be worth something,” said Seegal.

And product design can’t just emanate from those who sit in a studio all day and sketch. “We’ve added stylists to our design teams, young girls who live the life to help us develop a product that is appropriate,” Seegal said. Among the products where Sweetface is scoring with consumers: athletic pajama bottoms, french terry, athletic mesh, and velour bottoms.

Retailers have a lot of learning to do on how to capture more business and can learn from other industries, even casinos. Gary Loveman, ceo of Harrah’s Entertainment, said his firm is as much a retailer as an entertainer and has decided to build up its gaming business by building consumer loyalty, getting customers to return more often to Harrah’s, rather than relying on expansion.

Harrah’s has put together a marketing blitz involving television commercials highlighting the “feeling of anticipation” at the slot machines or crap tables, and has established tiered customer loyalty card systems, tagged as gold, platinum or diamond cards. The efforts have increased Harrah’s market share, measured by frequency of visits to a Harrah’s casino versus a competitor’s casino.

How much is a customer worth to Harrah’s? The answer, said Loveman, lies “not in terms of what they spend, but in what we think their potential to spend is.”

Aside from being market challenged, retailers are challenged operationally, particularly by deflation. Deflation is a new phenomenon in modern retailing, and forces retailers to sell more units to maintain revenue levels, as Carl Steidtmann, chief economist at Deloitte Research, said during his presentation. In a session entitled “Ideas Change the World: Managing Strategic Flexibility in a World of Retail Change,” Steidtmann described a new consumer shopping mentality from “buy now to wait now.” That means consumers are waiting longer to make the purchase, knowing the goods will go on sale. Deflationary cycles, he said, tend to be long-lasting.

So how do retailers cope? Steidtmann said companies must learn to be more flexible in their operations, because deflation rewards companies with cash, rather than those heavily laden with hard assets such as real estate and inventory. Real estate can be taken off the balance sheet through sale and leaseback agreements, while inventory can be decreased by requiring suppliers to take more ownership. Outsourcing is another way to take capital and human resource costs out of the business and increase flexibility.

Other considerations are “dynamic pricing” based on real-time information, having unique merchandise, format innovation and new products or brand extensions, Steidtmann added.

“Ideas really do transform the world,” he concluded.

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