Biting to the Core: The Future of Mom-and-Pops, the Majors, and Brand Labels in the Evolving Retail Landscape

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In a rapid and rather remarkable convergence of four key trends, a lot is changing for core retailers and for retail in general. The accelerating push of large brands into retail, their reduced dependence on core shops, the decline in the number of true core shops, and the financial/management model required in our new economic environment pose many challenges but also many opportunities for those still standing. I’ve written about some of these issues before, but it’s time to pull them all together. There’s a lot to cover, so let’s get started.

Evolution of the Core Shop
Once upon a time, 20, 30 years ago (pick the timing for the sport that interests you most), a true core shop was the place you dropped in on to get your fix of whatever subculture sport you were in to. You were an active participant part of a tight community, the products were niche and exclusive, and the few other places to turn to for the goods you were looking for took some effort. The folks in the shop had thorough knowledge and the best product service not to mention they were participants themselves who really lived the lifestyle and were driving forces in the progression of the time. They were the first to see new trends and introduce innovative products.
            There was a certain interdependency between brands and shops. A bigger percentage of a brand’s sales went through the core shops, there were fewer other distribution channels, and there was more of a risk to consumer brand perception if they went outside the core shops. Further, the cost structure of the time made it easier for the small retailer to succeed. There was one land phone line. No computer and internet expenses. Insurance was a lot less. Stores weren’t open as many hours. Consumers had fewer options in terms of getting their hands on product and product information. Bottom line: It was considerably easier to be a destination shop.
            Then some time after 1980 began the great economic melt-up. At some point even further down the road, “shops” started to pop up like mushrooms on damp, warm, manure. If they carried a collection of hardgoods and stood alone as single brick-and-mortar storefronts or even small independent chains, we labelled them as “core.” Eventually, large numbers of doors emerged. But the cost of operating a shop grew. Competition exploded and put pressure on margins, distribution expanded, consumers had more choices and easier access to products and information, internet sales took off creating a space of zero travel distance between product and consumers, brands moved into the retail space, and lifestyle customers became increasingly more important than participants. Brands, as they grew, inevitably became less dependent on core shops.
            None of these emerging trends mattered so much as long as sales and cash flow grew and the economy was throwing a wild party. But like always happens, the bash ended and there were some terminal hangovers involved. All of the issues that growth and cash flow had let us work around came home to roost. Many core shops have had to scramble for cover or, worse, literally close up shop.
            Thing is, though some may have been independent of any significant financial source, many of them were never really the core shops outlined above in the first place. We called them that because we didn’t have a better term and it didn’t really seem to matter. What were they then? I don’t know. Aberrations of a hot economy? Symptoms of unsustainable consumer spending?
            Now, the overall number of shops has declined. The real core shops—the kind that were around a couple of decades back—will get a little breathing room if only because there are no longer five shops in a 10 block area. But not, in all cases, enough breathing room because the trending issues touched on above that economic prosperity allowed us to push to the side are still very much alive. And, as we’ll see below, big brands are getting very serious about retail.
 
The New Economic Model
Sales growth, though improving over last year, doesn’t seem likely to return to 2006 or 2007 levels. Credit is tougher to obtain and that issue is likely to stick around for a whiile. Being aware of risk and actually managing it is back in vogue.
            Inventory is being vigilantly managed and expenses carefully controlled. The focus should now be on generating more gross margin dollars. You can’t get anywhere without a strong balance sheet. Systems, which are pretty bad in a lot of smaller retailers and brands, are a strategic advantage and a place you need to spend money. Issues of the cost of doing business, distribution, and the internet are not going away even when the recession completely ends. And consumers, though they seem to be spending more than they were a year or so ago, haven’t reopened their wallets with the same giddy abandon we enjoyed for so long.
            What’s been really interesting are the conversations with shops and brands that have had to cut spending pretty dramatically and manage their businesses more closely. Almost universally, they tend to say, Damn! If only I’d done this 10 years ago, I’d be in great shape and have a whole lot more money in the bank. Turns out that, in many cases, these necessary actions the economic downturn required of retail to stay afloat were just smart business moves. Just because there was a long period where it wasn’t absolutely crucial to run your business well doesn’t mean there wasn’t a lot to gain by doing it. Oh, by the way, now you have to or you won’t be around.
The Eight Hundred Pound Gorillas
The conventional wisdom on why core stores are important to our industry says that they’re an early warning system for trends coming and going, they are builders of community, they provide better margins for both the shop and the brands sold in them because of who the customers are, they are incubators of brands, and they help keep the sport and culture a bit edgy and, well, special.
            Obviously, some of that isn’t as true as it used to be, but I still think core shops are important. I’m not certain some larger companies feel as strongly about that as they once did. Or, at least, they have other priorities that make them less sensitive to the role of the core shop than they once were. Among these priorities is growth. It’s a public company thing and the growth, mathematically, just can’t come from small shops.
            I’ve been pretty surprised over the last couple of months to hear what some of these major companies are saying in their Security and Exchange Commission filings and in the company conference calls where they discuss their results publically, meaning anyone can listen. All the quotes compiled below are from one of those two sources. Overall, they seem unclear about growth opportunities in core stores and, moreover, about the survival of some of those stores.
            Billabong CEO Derek O’Neill says, “I can’t sit here at all and say that all the accounts that we’re currently dealing with will still be there in three months time.” He also says his company may have to tighten credit by the end of the next six months.
            Genesco CEO Robert Dennis (Genesco owns U.S. shoe chain Journeys) notes that when, for example, a five-store chain has a lease coming up for renewal, it will find Genesco on their landlord’s doorstep taking over that space. The other thing that’s happening, as Dennis describes in discussing Genesco’s hat, uniform and sport apparel business, is that they “…are consolidating the industry,” he says. “The mom and pops are going out of business or they are credit constrained and can’t stay fresh.” I’m not so sure that’s any different than in action sports.
            It’s interesting to note how U.S. retail giant Zumiez characterizes its stores in a recent 10-Q report. Except for being in malls, it’s typical of the description a traditional core store might use: “Our stores bring the look and feel of an independent specialty shop to the mall by emphasizing the action sports lifestyle through a distinctive store environment and high-energy sales personnel. We seek to staff our stores with associates who are knowledgeable users of our products, which we believe provides our customers with enhanced customer service and supplements our ability to identify and react quickly to emerging trends and fashions. We design our stores to appeal to teenagers and young adults and to serve as a destination for our customers. Most of our stores, which average approximately 2,900 square feet, feature couches and action sports oriented video game stations that are intended to encourage our customers to shop for longer periods of time and to interact with each other and our store associates.”
            The big companies are also coming around to the idea that they can potentially merchandise their own brands in their own stores better than through core stores.
            Nike: “We will continue to invest in bringing world-class solutions to consumers who are hungry for new retail experiences. Nowhere is this more important than online. The digital lifestyle is driving dramatic change in our industry and significant potential to our company. We are attacking that in every dimension; online shopping, customization, immersing our brands in consumer cultures and telling inspiring and entertaining stories.”
            Billabong: “If you look at the wholesale level, most of the business going on, the buyers are focused on your price point category and up to your mid price print category. …In our own retail, which has definitely outperformed our wholesale side in this period, in our own retail we can showcase and merchandise a product across all the price points and we’re doing really well right across the board.”
            Billabong continues: “…we are beginning to drop product into our own retail even faster than wholesale channel. We are beginning to, on certain key styles… build product that may go into our own retail before even the wholesale consumer sees it in an indent process.”
            They see systems and operations as key. Operating well is a key advantage that can put a lot of money to their bottom lines.
            Zumiez: “We have developed a disciplined approach to buying and a dynamic inventory planning and allocation process to support our merchandise strategy. We utilize a broad vendor base that allows us to shift our merchandise purchases as required to react quickly to changing market conditions. We manage the purchasing and allocation process by reviewing branded merchandise lines from new and existing vendors, identifying emerging fashion trends and selecting branded merchandise styles in quantities, colors and sizes to meet inventory levels established by management… Our management information systems provide us with current inventory levels at each store and for our company as a whole, as well as current selling history within each store by merchandise classification and by style.”
            Nike: “To do that we committed to building our retail capabilities, smoother product flow, surgical assortment planning that focuses on key items, more compelling merchandising, stronger brand stories and more efficient back-of-house systems.”
            Billabong: “If you look at the big retail brands out there, they don’t have a buyer to get past, they just decide what they’re going to make and they put it in their own stores and therefore they could have a very short cycle.…we are looking more and more at some of our own retail stores where we can looking at touching on a more vertical model. And not having that delay with going out and having an eight week ordering pattern and then go away and ordering product, we’ll just go straight to retail.”
            PacSun talked about doing the same thing in their conference call last week. Genesco’s CEO characterized small retailers systems as being “from the dark ages.” The current overall consensus from these big brands and major retailers is that they’re looking at the vertical integration and fast fashion models of retailers like H&M and American Apparel. Essentially offering on-trend, in-season apparel at lower prices. What’s more, these retailers stock stores more frequently, but with limited quantities of merchandise, giving shoppers a reason to visit stores more often. As you can see, there’s a lot going on in the retailing world. So what’s a smaller retailer to do?
The Road Ahead
The first thing to recognize is that only you as a shop operator can change your own behavior. These big companies are going to do what they’re going to do. As the saying goes, it’s just business, and developing outward is the natural progression of economic growth. The good news is that there’s a role for specialty shops based on the original model, that is to say, a store that properly services the core participants of the sport and lifestyle. But you’re going to have to run your shop like a business. Location and community will be your key attributes, and a credible online presence is now a requirement. Running it like a business is just the price of admission.
            Another piece of good news is that there are some natural limits on just how big big chains can get while still being credible. In his first conference call as Pac Sun CEO, Gary Schoenfeld said, “Nobody needs 900 Pac Sun stores.” The company is trimming back and reducing its number. Journeys store numbers will be almost static over this year. Genesco expects to open only 50 stores over five years across the whole company. Meanwhile, Footlocker, The Gap and Starbucks are other big retailers who we’ve seen that have learned this lesson and had to close storefronts.
            Next, some of your suppliers—skate comes to mind—are able to supply you with new product regularly and quickly. Take advantage of that to the fullest extent possible. Another important element, and something that has been lost in recent years, but goes back to the historical specialty shop model, is finding and featureing new brands—even when it looks risky. It’s a point of differentiation you can’t afford to give up, and what’s even riskier is not taking chances on smaller, emerging brands. It’s always been the case that new brands grow up in the core shops and then move on into broader distribution. It’s true that it may be happening faster than in the past but that comes under the heading of something you can’t fix. That doesn’t mean you’re helpless. Favour brands that offer product exclusively for specialty shops. Do some private label (but not too much, you don’t want to completely bite off the hand that feeds you) that gives you a better margin.
            Recognize the bigger brands’ concerns with the price points you’re buying and your ability to merchandise across their line well in the space you have available (see the quotes above). You’re never going to be in a position to carry everything by Quiksilver or Burton, but sit down and work with your brands to achieve a mix you’re both happy with. I mean, what’s wrong with saying to Brand XYZ, “Look, I’ve only got x-number of square feet in the whole store and can’t do what you’d like without turning myself into a Brand XYZ store. But I’d love to sell more expensive, faster-turn product that puts more gross margin dollars towards the bottom line. How can you help me do that?” Recognize their legitimate concern and interests in this area. If they don’t have a good answer, you’ve learned something and at least your conscience is clear. And if they do have a good answer, you might make a few more bucks. Finally, remember that the best shops give credibility to the brands they carry—not the other way around. I can’t believe how much mileage I’ve gotten out of saying that.
            Okay, let’s talk systems. A lot of retailers, perhaps more than half in action sports, have point of sale systems that they don’t use as anything but glorified cash registers. That’s got to end. If you agree that your focus has to be on capturing gross margin dollars and that you can no longer rely on big sales increases, then what choice do you have? You probably already own most of the hardware and software you need. If not, it’s cheap enough to get. Yes, the training will be a pain in the ass and this management accounting stuff kind of sucks, but if you don’t know which inventory is moving (and which isn’t), how quickly, and at what margins, then you are simply screwed. At best, you’re leaving a pile of money on the table. Good for you if you can afford that. At worst, poor systems will guarantee you go out of business.
            Conceptually, the whole analysis above isn’t that hard to get your head around. Do you agree with the evolution and role of core shops I’ve described? Does the financial model make sense given the current economic conditions? You can’t argue with what big brands are doing in retail. They are doing it and they are transparently telling you they’re doing it. But don’t despair. You’ve got tools and you can compete, even prosper, if you just remember the values of what the core shop really consists of and apply these to your own retail environment.

 

 

A Medium to Long Term Perspective on the Job Market

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The chart below is something you need to see to have some medium to long term perspective on the economy and the job market.  It comes under the heading of something you won’t see in the mainstream media.  I have finally been doing this long enough to know that people don’t always like it when I present something that’s troubling and I actually thought about not posting it.  But I reminded myself that my job is to give you the best information I can that will help you run your business, even if it’s not cheery, or maybe especially then since nobody else seems anxious to do it.

The purpose of posting this is to give you some perspective on the possible duration of our current economic conditions.   Remember we need something like 100,000 to 125,000 new jobs a month just to keep up with population growth.   Eventually, new jobs and new industries will be created and the country will prosper if only because of its massive natural advantages.  But financially caused recessions are historically always the worse, and the deleveraging process we are going through has to be measured in years.

 

 

I Wonder if PacSun Might Carry Hard Goods; And What Would Zumiez Think?

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Just for a moment, hypothetically, let’s think about PacSun’s turnaround strategy, whether it might make sense for them to start carrying hard goods, and how other companies might react.

PacSun’s Strategy

That PacSun is in the middle of a turnaround is hardly disputable, if only because their management has characterized it that way. And in my judgment, they are pretty much doing the right things. First and foremost, they acknowledged that their stores had stopped being a destination for their target customers, and they are working to fix that. They want to “Reestablish PacSun as a destination for great brands.” What does that mean exactly?
 
First, it means completely revamping their management team- to the point where at their last conference call they said they had cut back their juniors inventory because they did not have the right leadership or strategy in place. The management changes are well under way and, when we listen to their next conference call (okay, when I listen to it), probably within a couple of weeks, we may find it’s complete.
 
That impresses me. While there’s absolutely nothing as disruptive to a company as a total makeover of top management, there’s also no way for a company to succeed if the team isn’t aligned and in agreement as to the company’s strategy. Those of you who were at the Group Y Action Sports Conference a couple of weeks ago heard exactly the same thing from Van’s Vice President of Marketing Doug Palladini as he explained Van’s success.
 
Second, they’ve recognized they can’t have the same merchandise selection in all stores, regardless of location, and are working to localize their inventory. Third they are starting, like a lot of other brands, to emphasize speed and freshness in product. “The days of shopping in Europe for trends and then delivering a whole new collection are pretty much behind us,” was how they put it. We may all bemoan fast fashion, but there’s no choice but to react to it if it’s what the customer wants.
 
Fourth, they are going to be more cautious with private label and have eliminated private label board shorts. Fifth, they’ve rolled out a new advertising and promotion campaign that has a more appropriate focus. Last, they’ve recognized that more stores isn’t the answer and are focusing on making the ones they have better places to shop.
 
The Hard Goods Issue
All good stuff. If I were a hard goods brand and PacSun asked me to sell them some hard goods I’d get excited by the fact that Pac Sun could buy a whole lot of product from me (though I doubt any hard goods brand can expect to be in all their stores). On the other hand, I’d need to feel good about their chances for making their stores an attractive destination for my customers again. If they were lame, I wouldn’t want to be there because the lameness might rub off on my brand.   I would, in other words, need to feel good about PacSun’s ability to implement the strategy I’ve described above.
 
I’d get to feel good by spending some time with the people in charge of implementing the hard goods strategy for PacSun.    Assuming there was such a strategy, that is.
 
I’d want to roll out the product in, say, 10 or 20 stores initially. And I’d want those to be stores that already reflected PacSun’s revised strategy- ones that were remodeled to reflect the new focus, had a reduced reliance on house brand product, and had inventory specifically selected for the location. I’d want to have some involvement in how my product was merchandised and I’d like to know where PacSun was going to get sales people who could represent and sell hard goods. And while all these discussions were going on, I’d be chatting with my friendly competitors who also make hard goods to try and find out if they were selling to PacSun.
 
Some level of hard goods can make sense for PacSun as part of a strategy of regaining credibility with their target customer.   It’s certainly part of what has differentiated Zumiez among mall stores and made them successful, and that brings us to an interesting part of the discussion.
 
Though both are mall based chains with an overlapping focus, Zumiez is not PacSun and PacSun is not Zumiez. They have different ambiances, and different, though obviously overlapping, target customers. Zumiez has always carried hard goods and has prided itself on having employees at all levels that are in touch with the action sports culture. Though PacSun may have originally been closer to the “core” than it is now, it was never as close as Zumiez and it drifted even further away with growth and some of the decisions it made.   Zumiez has always been closer.   That has been important in how it has kept its credibility with customers even as it has grown.
 
PacSun wants some of that credibility back. I have to assume Zumiez would rather not share that market space with a nine hundred store gorilla. Even though Zumiez is only more or less one third the size of PacSun by number of stores and their geography doesn’t completely overlap( PacSun is in all 50 states, Zumiez in 35) I have to believe that PacSun’s problems made life easier for Zumiez in some ways and in some locations.
 
How might things go if PacSun starts carrying hard goods? A couple of years ago, I might have said that if they represent the brands well it would be good for everybody. But economic times are different and I think that’s less likely. It will also depend on what hard goods, exactly, they carry. I don’t imagine it will be snowboards (though of course I don’t know that). I can certainly imagine skate and while surf fits PacSun (and not really Zumiez) it’s generally difficult to imagine selling surf boards in mall stores.
 
I’m sure Pac Sun expects to make money on any hard goods it sells, but that wouldn’t be the primary motivation. They want to rebuilt credibility with their target market and get that customer back in the store. It’s a component of their overall strategy.   Superficially at least, a PacSun with hard goods will have moved a bit towards Zumiez’s in its positioning. Will the customers see that? Will Zumiez’s customers be more likely to shop at PacSun? Or will customers who chose PacSun over Zumiez be disappointed? Depends on just how much actual customer overlap there is I guess. But unless they subscribe to the “a rising tide raises all boats” theory, I can’t see Zumiez as thrilled.
 
Other brands, not hard goods, are currently sold at both Zumiez and PacSun. Wonder how they would see this if it happened. Would PacSun pick up some apparel or other products from the hard goods brands they decided to carry? 
 
 A PacSun who carries hard goods and uses that to revive their credibility with the action sport oriented consumer is a stronger competitor to Zumiez.   A PacSun who carries hard goods and does it badly damages the idea of such stores in malls, and that could reflect on Zumiez. It’s not that PacSun will be the same as Zumiez, or even that they will necessarily target exactly the same customer group. But some of those customers may only see the superficial similarities. Think how consumer looked at Hollister.
 
As Zumiez, PacSun, and any hard goods brands that might consider selling to PacSun know, having hard goods doesn’t instantly give you credibility and attract customers. You have to do it just right and the devil is in the details.

 

 

How is Our Customers Buying Power? A Chart That Should Make You Think

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I stole the chart below from Clusterstock (It’s not stealing if you confess, is it?) and wanted to share it with you. Look at the unemployment rate for our prime customers; the young workers aged 16-24. It’s close to 20% as of May. Now, if you’re in skate you go younger than 16 and if you’re in apparel, you’ve got some customers over 24 but it’s still relevant information.

The good news is that you’ll notice that this group has only for one period of time had an unemployment rate of less than 10% since 1974 so the baseline employment rate you should compare this with isn’t as low, thank god, as for the other groups of workers shown.

But my reading of the chart is that, as an industry, we tend to do well when that unemployment rate in this group is falling and to do, well, not so well when it’s rising. Not much of a surprise.
 
The other thing I wonder about is the extent to which this group, in our industry at least, is supported by their parents. As usual, wealthier, professional people are been less impacted by the recession and their kids are often our customers.
 
How can you make use of this information? Maybe by watching it on the Bureau of Labor Statistics web site. I’m pretty sure that a drop in the unemployment rate for 16 to 24 year olds would be good news for us- and for the younger people who got jobs.
 
 

 

 

Jeff’s First Book Report (at least since the 10th grade)

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Somewhere in the area of 75 AD the silver content of the Roman Denarius was about 100%. It was solid silver. Somewhere before 300 AD that content had fallen to around 10% or less. The value of the currency fell and the empire’s debt rose as Rome fell apart.

I thought that was an interesting fact, so I decided to tie it in to my suggestion to you that you find and read a book that came out last year called This Time is Different; Eight Centuries of Financial Folly by Reinhart and Rogoff.

The point of the book, of course, is that it never has been different. Not in the Roman Empire and not in the global financial crisis and resulting and ongoing Great Recession of 2007. The book is full of charts and tables but I guarantee you that not a single equation will rear its ugly head. Look at it this way; the time it takes to figure out the charts is probably the same amount of time you’d take to read the page.
 
“And this has what to do with action sports exactly?” you might ask. Well, nothing. Everything. We can’t make all our business judgments based on what we read in the popular media (I’ve pretty much given up on them by the way). If you listened to them, you heard that we created 88,000 new private sector jobs last month. You didn’t hear that we need close to 125,000 just to keep up with population growth. You may get told that the unemployment rate has gone down, but not that it went down only because the Bureau of Labor Statistics doesn’t, for some reason I can’t fathom, count people who have given up looking
.
 We certainly can’t rely exclusively on the discussions we have with our peers in our somewhat incestuous industry (like any industry I guess). And you can’t, especially now, take a short term perspective.
 
From around 1980 to 2000 we had what is simply the longest and strongest period of low inflation, growth, investment returns and employment we’ve ever seen. It was great wasn’t it? And we all kind of took it for granted. The cycle started to reverse itself in 2000 when the internet market crashed. The “recovery” was driven by the Federal Reserve’s decision to flood the market with liquidity and reduce interest rates, the breaking of the perceived relationship between risk and return, and tax cuts it appears we couldn’t afford.
I honestly think we would have been better off if we’d been allowed to have a bit more of a recession in the early 2000s. Maybe we wouldn’t have to be enduring our current one.
 
Anyway, we take for granted our 20 year up cycle, but are incredulous that there might be a long down cycle. I have never figured out why that is. The good news I suppose is that we’re ten years into the down cycle, however long it’s going to last. Don’t believe me? Go look at your overall stock market returns and  the change in average wages since 2000.
 
Here’s what This Time is Different teaches us.  I’m quoting at some length, because they just say this better than I can.
 
"If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government’s policies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly."
 
"We show that in the run-up to the subprime crisis, standard indicators for the United States, such as asset price inflation, rising leverage, large sustained current account deficits and a slowing trajectory of economic growth, exhibited virtually all the signs of a country on the verge of a financial crisis- indeed, a severe one. This view of the way into a crisis is sobering; we show that the way out can be quite perilous as well. The aftermath of systemic banking crisis involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources."
 
They don’t do this with stories (though there a few good ones), nor with suppositions, nor with opinions. The analysis is based on 800 years of rigorously gathered data that goes back as far as 12th century China and medieval Europe. As they admit, it’s not perfect. But it’s as objective as they can make it.
 
You need to convince yourself, as you figure out how to position and run your business, that this time isn’t different, that’s it’s happened before, and will happen again. Human nature, as the authors point out, doesn’t change. Financially caused recessions are the worst, and they last the longest.  That’s not my opinion.  That what their data shows.  Hoping things get better won’t do. As I think a sailor once said, “Call on God, but row away from the rocks.”
 
Read the book please.

 

 

What’s Going on in Greece and Why You Might Care

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The concept of the European Community and a common currency worked okay (though with massive misallocation of capital) as long as long as there was lots of growth and lots of money and lots of subsidies for poorer countries and low interest rates. For a long time, what you could earn on a German bond wasn’t that much lower than what you could earn on a Greek bond of similar duration (as little 20 basis points- one fifth of one percent- in 2007), implying a similar risk. The idea was that they were both parts of the Community, had a common currency, and that the rich would continue to take care of the not so rich.

Then, a few weeks ago, the bond market, which tends to have a mind of its own and doesn’t much care what speeches government officials make, decided that support wasn’t going to be there and that Greece, to use the technical financial term, was going in the crapper. Rates on five year Greek bonds soared to 15%.

Normally, when a country screws up financially like Greece has, a big part of the solution is to devalue the currency. That makes exports grow as they become more competitive, imports fall as they become more expensive, and it’s cheaper to pay off debt denominated in local currency. And of course, the tourists flock to the suddenly inexpensive country (assuming the people aren’t rioting in the street over austerity measures).
 
This has been doing on ever since there’s been money. Well, maybe not the tourist part. Go read This Time is Different; Eight Centuries of Financial Folly by Reinhart and Rogoff. One of the things they note is that Greece has been in some form of default for half of the last 200 years.
 
The Greeks should just crank up the printing press and turn out a whole bunch of Drachmas. It wouldn’t be easy, but over time would work.  Oh wait- there aren’t any Drachmas any more. There’s only these Euros and Greece can’t devalue them. Well, that’s an inconvenience.
 
As Greece’s cost of financing its debt goes through the roof (even ignoring that they are going to have to issue more debt that somebody is suppose to buy- no idea who) the austerity measures will have to become even tougher. This of course slows the economy further and reduces tax collections, making the problem worse.
 
I should note the Greeks are already notorious for managing to not pay taxes. In the last year for which figures are available, there were only 6 (yes SIX) Greeks out of a population of 10 million who reported income of a million Euros or more. Damn clever those Greeks. Maybe a bit too clever.
 
So I suspect that Greece is heading for an even deeper recession (I won’t use the “D” word though that’s what I really think will happen). I won’t even be surprised to see them default on some of their debt. That may take the form of a rescheduling which stretches out the term, reduces the interest rates or some other manipulation. As far as I’m concerned, that’s as much a default as just not paying.
 
The Europeans are making a whole lot of noise about injecting liquidity and bailout packages and backup lines of credit. But at the end of the day this is not longer about liquidity. It’s about a national balance stuffed with liabilities they can’t pay. Somebody is going to take a loss. The argument is just over whom. We are, by the way, having the same argument in the United States.
   
But what the hell. Our industry doesn’t sell much to Greece and we don’t buy much from them so why should we care? In the first place, the somebody who may take the loss is all the European banks who hold most of this Greek government debt. When banks lose money, their capital declines. Banks make loans based on some multiple of their capital. If they lose money, they either have to raise more capital or cut lending. If they lose 100 Euros and are leveraged ten to one, that’s 1,000 Euros of lending they can’t do. You may have noticed that has had a bit of an impact over here.
 
In the second place, there’s the little matter of Portugal, Spain and Ireland which are in none too good a shape themselves (though nowhere near as bad as Greece). Where’s the money going to come from to bail them out and which banks hold their debt? They use the Euro as well, so devaluation isn’t an option for them either.
 
Again, if each country still had their own currency, the Greek Drachma, Irish Punt, Italian Lira, and Spanish Peseta would all be devaluing, the German Mark would be rising, and the usual adjustment mechanisms would be working. They aren’t and they can’t while the currency union exists.
 
The financial markets see this and are concerned that either the currency union comes apart (very messy in the short term, though perhaps a good results in terms of resource allocation in the longer term) or there’s a potential for default on sovereign debt. The result is a lot of pressure on the Euro.
 
I expect that Europe will have a double dip recession and won’t be surprised if the Euro goes to parity with the dollar. I’m actually putting my money where my mouth is in this case and have started the process of pulling some Euros we have back into dollars. Wish I’d started two months ago.
 
I’m hopeful it’s clear by now why you care about Greece and the mess in Europe in general. Tougher economic times there mean less consumer spending. A weaker Euro means our exports become more expensive. The good news, I suppose, is that imports from Europe become less expensive. Maybe all those snowboards being made in China will be made in Austria again.
 
Remember when the subprime crisis started? “It will be contained,” said Fed Chairman Bernanke. And in Europe they couldn’t figure out why they should possibly care about a bunch of bad residential housing loans in the US. Then Lehman Brothers blew up and we went from “It will be okay” to global economic recession in about 20 minutes. 
 
That’s how these things have always happened (go read that book I mention!). It’s okay until it isn’t and everybody gets caught by surprise. Maybe, if you think my analysis is reasonable, there are some things you should be looking at now just in case so you don’t get “caught by surprise?” 

 

 

What Are Big Brands Doing in Retail? It’s a Bit Scary

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Below is the handout I distributed at IASC’s Skateboard Industry Summit at the end of April where I talked about the evolving retail environment.  These are quotes from recent fillings and conference calls by Billabong, Genesco (owners of Journeys), Nike and Zumiez about how they see the retail environment and their involvement in it.  Except for Nike, you’ve seen these if you’ve read in detaill my most recent analysis of these company’s results.

These quotes aren’t my opinion or interpretation; they are what the senior executives actually believe and are doing.  In general, they are unclear about their growth opportunities in core stores and the survivability of those stores.  They think they can merchandise their own brands in their own stores better than in the core shops.  They like the higher margins.  You really need to read these comments.  Draw your own conclusions.

Billabong

 There is still “…a little bit of an apprehension to actually placing forward orders, and some customers preferring to do a little bit of business in season.” “I’d say that’s a trend that’s probably going to be there for a little while,” he continues.
 
Jeff’s Comment: I’d be curious to know just what he means by “a little while.”
 
“I can’t sit here at all and say that all the accounts that we are currently dealing with will still be there in three months time,” is how he puts it. He also thinks they may have to tighten credit by the end of the current six months.
 
“If you look at the wholesale level, most of the business going on, the buyers are focused on your price point category and up to your mid price print category.” “…in our own retail, which has definitely outperformed our wholesale side in this period, in our own retail we can showcase and merchandise a product across all the price points and we’re doing really well right across the board.”
 
“The cycles with our own retailers, we are beginning to drop product into our own retail even faster than wholesale channel. We are beginning to, on certain key styles…build product that may go into our own retail before even the wholesale consumer sees it in an indent (sic) process. But we’re beginning to utilize our own retail to test product a lot more and we’re just becoming a little more focused on that shortening of the whole supply side.”
 
“If you look at the big retail brands out there, they don’t have a buyer to get past, they just decide what they’re going to make and they put it in their own stores and therefore they could have a very short cycle.…we are looking more and more at some of our own retail stores where we can looking at touching on a more vertical model. And not having that delay with going out and having an eight week ordering pattern and then go away and ordering product, we’ll just go straight to retail.”
 
What percentage of total revenues could retail represent?” somebody asked. “It’s probably going to depend on what happens with the wholesale account base,” O’Neill responded.
 
Genesco
Genesco is looking at “very modest” store growth in Journeys. They say they don’t want to have happen to them what has happened to other retailers who have over extended themselves on their store count. They mention Footlocker, The Gap, and Starbucks as retailers who are closing stores because they got a bit overextended. They plan to open only 50 net new stores over the next five years across the whole company.
 
They also note that they have another wave of store leases coming up for renewal. They expect to get lower costs and more favorable terms when those leases are renegotiated. Overall, they expect that with very modest store growth and comparable store sales growing by only two to three percent, they can expand operating margins from the current five to eight percent and grow earnings per share by 15% to 20% annually. Obviously, they see a lot of opportunity in reducing costs and operating efficiently.
 
He notes that when, for example, a five store chain has a lease coming up for renewal, it will find Genesco on their landlord’s doorstep taking over that space. 
 
The other thing that’s happening, as they describe in discussing their hat, uniform and sport apparel business, is that they “…are consolidating the industry. The mom and pops are going out of business or they are credit constrained and can’t stay fresh.” 
 
President and CEO Robert Dennis talked about how the economics of their hat and hat related business has changed as they have gone from 150 to 800 stores. The difference, he says, “is enormous.” There is tremendous leverage with landlords, the companies from whom you license product, vendors, and infrastructure.
 
He also characterizes most of these small players’ systems as being “from the dark ages.” 
 
Nike
“We’re also starting to realize the broader benefits of becoming a better retailer. Over the past few years, we’ve spoken about expanding our direct-to-consumer business. We saw a huge upside to bringing innovation and excitement into the marketplace in our own stores, with our wholesale partners and online.”
 
“To do that we committed to building our retail capabilities, smoother product flow, surgical assortment planning that focuses on key items, more compelling merchandising, stronger brand stories and more efficient back-of-house systems. All balanced to produce greater consumer experiences and strong profitability. It’s a powerful mix that helped NIKE Brand Retail deliver 11% revenue growth and 140 basis points of gross margin expansion year-to-date.”
 
“We will continue to invest in bringing world-class solutions to consumers who are hungry for new retail experiences. Nowhere is this more important than online. The digital lifestyle is driving dramatic change in our industry and significant potential to our company. We are attacking that in every dimension; online shopping, customization, immersing our brands in consumer cultures and telling inspiring and entertaining stories.”
 
“Comparable sales for brick and mortar Nike-owned retail stores increased 17%, and online sales grew 25%. Profitability for the businesses grew even faster as better merchandising, lower promotions and more surgical mark downs drove gross margins up 550 basis points versus last year.”
 
Zumiez
 “Our stores bring the look and feel of an independent specialty shop to the mall by emphasizing the action sports lifestyle through a distinctive store environment and high-energy sales personnel. We seek to staff our stores with store associates who are knowledgeable users of our products, which we believe provides our customers with enhanced customer service and supplements our ability to identify and react quickly to emerging trends and fashions. We design our stores to appeal to teenagers and young adults and to serve as a destination for our customers.  Most of our stores, which average approximately 2,900 square feet, feature couches and action sports oriented video game stations that are intended to encourage our customers to shop for longer periods of time and to interact with each other and our store associates.”
 
 Jeff’s Comment: Except for the mall location, how is this different from any other core shop?
 
Zumiez pursues, on a national scale, the same branding strategy the best independent retailers pursue.  “We seek to build relationships with our customers through a multi-faceted marketing approach that is designed to integrate our brand image with the action sports lifestyle.” They spent $822,000 on advertising in fiscal 2009.
 
 “We have developed a disciplined approach to buying and a dynamic inventory planning and allocation process to support our merchandise strategy. We utilize a broad vendor base that allows us to shift our merchandise purchases as required to react quickly to changing market conditions. We manage the purchasing and allocation process by reviewing branded merchandise lines from new and existing vendors, identifying emerging fashion trends and selecting branded merchandise styles in quantities, colors and sizes to meet inventory levels established by management. We also coordinate inventory levels in connection with our promotions and seasonality. Our management information systems provide us with current inventory levels at each store and for our Company as a whole, as well as current selling history within each store by merchandise classification and by style.”

 

 

Notes from the Skateboard Industry Conference

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It was, by any measure, a successful conference and IASC did a great job putting it on. Attendance, at around 95, was up over last year, which was also up over the first year of the conference the previous year. The attendees were the senior people from the right companies. The food continues to improve (breakfast still needs work) and the skating at Woodward West is outstanding. Getting there from Seattle is a bit of an effort and I made the drive from Burbank this time without getting lost (the first year, the sign that said “Paved road ends in two miles” sort of threw me.

IASC kept us busy for two full days on interesting topics that included a key note address by George Powell, social media and action sports, why athletes go broke (I’m still sorry I missed the chance to invest in the rafts that inflate under furniture to protect them from flood waters), ethical sourcing, Shop- Eat- Surf’s Tiffany Montgomery’s interview with former DC Shoes CEO Nick Adcock, and a retail discussion.

Angelo Ponzi from Board Trac was given the thankless task of making the last presentation that summed up everything that had been discussed during the whole conference. Word is he pulled it off and people wanted more time with him, but I had to leave for the airport and didn’t see it. That’s representative of why it can suck to be the last presenter.
 
I talked before Angelo, focusing on the action of some major brands (see my most recent articles on Billabong, Zumiez and Genesco on my web site) with regards to their efforts in retail and relationships with core shops.   I suggested that the decline in the number of core shops, the financial model that needs to be pursued given the economic conditions (lower sales growth, focus on gross margin dollars), and the evolving retail environment suggested some pretty obvious steps that skate companies needed to take to be competitive. I spent a few minutes discussing those steps.
 
I guess if I’d been planning the agenda I would have scheduled discussions that focused more on those steps. They include effective use of your management information systems, focusing on inventory turns- not just gross margin percentages, distribution (“The Industry” is not going to “fix” distribution, but most companies can manage their distribution better if they have better information), and the role of the existing skate distributors. Those topics are clearly not as much fun, but they might be more important to the long term health of the industry.
 
Skateboarding as a sport/activity/lifestyle- whatever you want to call it- seems to be doing just fine, though the individual companies have challenges. I thought skate’s problems and strengths were best framed by a brief exchange between an executive from a major retailer and a hard goods brand owner. The retailer bemoaned team riders showing up drunk,  showing up late or not at all, and not interacting with the kids. The owner said, more or less, “That’s the way it is. If you don’t like it, don’t invite them back.”
 
I’ve never managed skateboard team riders, but I have had some dealing with snowboard team riders. What I’ve always said is that I’d rather have the kid who was personable, professional, and showed up on time (sober) even if he wasn’t quite as good as some other rider so I probably tend to come down on the retailer’s side on this one. Yet the brand owner (a former pro skater like most of them) was defending something that is important about skateboarding and that has allowed it to maintain its edge and underground image even as it has mainstreamed.
 
That edge and image were also handily maintained by something called “hall bowling” the first night and by a report of somebody riding a rollaway bed down the driveway the second. That the bed was ridden was denied in the morning (but there was a mattress under a tree). But as I was printing out my boarding pass I did hear the lodge staff discussing how much to charge for a rollaway and wondering why anybody would allow this group an open bar. I of course, being the sober serious fellow I am, had nothing to do with any of this. Except for the part where I woke up at 4:30 to find that somebody had turned off the power to my room (and to others) and it was about 45 degrees. It’s cold at this camp at 4,000 feet elevation.
 
I can’t wait for next year!

 

 

An Interesting Advertising Observation; What Does it Mean?

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I was recently paging through a couple of Transworld consumer mags (Surf and Skate I think) and something caught my attention. I don’t know what made me notice it, but I suddenly realized there was not one non-endemic advertisement in either mag. Okay, maybe I missed one, but there was no Ford Trucks, Mountain Dew, AT&T or any other of the major brands that had previously graced their pages. There was Nike. I’ll get back to that.

Talking about coming full cycle. I remember when there use to be none of these big advertisers in Transworld’s magazines at all and we thought that was a good thing. I had conversations with various Transworld people years ago about their efforts to work with these major brands. The brand, having exactly no understanding of the industry or the demographic they wanted to reach, would submit ads that were, well, not specifically too good. Transworld would try to work with the company to get it to change its ad, but that meant working through the advertising agency who could hardly go back to their client and say, “Actually, our ad sucked and we didn’t know what we were doing.”

And Transworld, no matter how much they wanted the money (and they charged these companies more than they charged industry brands) wouldn’t take the ads that sucked. Those ads made Transworld’s magazines look bad and inevitably generated irate phone calls from industry advertisers who found their ads next to the sucky ads of the companies that didn’t know what they were doing.
The economy has led brands in all industries to cut back on their advertising. But I can guarantee that Ford, Mountain Dew and AT&T have not stopped advertising everywhere. They have stopped advertising, however, in what I still consider the leading action sports consumer publications and have decided their dollars are better allocated somewhere else. Why?
I should note that if I had other action sports publications in front of me, I bet I’d find the same trend so this is not about Transworld.
You advertise through a particular channel because you believe that channel is the best way to reach and influence customers and potential customers. I can guarantee that action sports publications do not take up a big chunk of Ford’s advertising budget. Even though it’s a relatively small number, they found it expendable. Aside from the economy, there are a couple of possible reasons for that decision.
First are the changes in distribution that have occurred in the industry. Recent attempts to control certain distribution channels not withstanding, our products are all over the place. I suppose we could be critical of that (Hell- we are! All the time!), but it’s pretty much inevitable industry evolution.  In general (some brands are exceptions), we have sent the message that we’re not as exclusive as we use to be. And more and more of our customers are non participants so I’m guessing that the big non endemic companies no longer think it’s quite as necessary to be in the core publications to reach most of the action sports customers.
There’s also a certain decline in the panic that big non endemic companies felt when surf/skate/snow were growing like weeds and generating all kinds of publicity and excitement. Big brands were worried they were missing something, even if they weren’t exactly sure what it was.
Finally, there’s the recognition that the disposable income of the core magazine consumer has declined. Obviously, this has been made worse by the recession, but the decline in middle class real income is a long term trend that started before 2007.
Then there’s Nike, still advertising away in Transworld. The difference is that Ford, whoever they want to sell them to, still wants to sell pickup trucks. Nike wants to sell skate/surf/snow products and, in the process, build brand credibility across our demographic to sell the other related products they make.
So you can see why Nike is still in action sports magazines, but other big companies aren’t. The same analysis applies to Quik, Billabong, Volcom and other large action sports brands (if we can call them large in the same breath with Nike). They’ll be advertising in action sports magazines, but will spread their dollars to other advertising platforms as well. Because just like Nike, they want credibility in action sports to translate into sales in a broader market.
Only it’s not quite like Nike. Nike already has credibility and consumer recognition in the broader market and now wants to build that credibility in a small subset of that market. If they should fail (and it doesn’t look like they are going to), Nike will be just fine. Action sports industry brands are trying to go the other way- from a smaller, defined market to a much larger one. They focus every day on how to gain credibility in the larger market while keeping it in the smaller. They believe that without the later they can’t develop the former. And yet, ultimately, if they want to keep growing, they have to be able to keep larger market credibility even if they lose it in the market where they have their roots.
I think that, as much as anything, explains why our industry has evolved the way it has.

 

 

The BRA/IASC Roundtable at ASR

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As they do every ASR, IASC and BRA hosted a round table meeting by invitation only to discuss issues of mutual interest and, as usual, I attended. The meeting was well attended and the exchange lively.

The first issue on the table was Manufacturers’ Suggested Retail Pricing (MSRP) and Minimum Advertised Pricing (MAP). I’ll assume you know what those things are. People in the room were generally in favor of both and I’d have to admit that I’m not necessarily against them. Though as I mentioned in the meeting, managing distribution well is perhaps more important in keeping prices up.
What concerns me about both MAP and MSRP is that they feel like potential excuses not to manage your business well. I was impressed with the retailer in the meeting who said, more or less, “We got some belts with price tags on them but we ripped them off and priced those belts $5.00 higher because we knew that’s what we could sell them for. MAP? MSRP? How about knowing your customer, your market, and your inventory? Don’t let these kinds of tools, which may have their uses, have too much influence on your thinking.
Honestly, I’m not quite sure what the second issue was, but it ended up with the usual hand ringing about margins on skate hard goods needing to be higher.
I worked up some righteous anger, but then Don Brown ended the meeting before I could get a word in. Probably just as well.
But after the meeting I reminded everybody who would listen that the previous ASR, IASC had sponsored a seminar where a major topic of discussion was Gross Margin Return on Inventory Investment (GMROII). Cary Allington from Action Watch had presented some very interesting numbers showing that if you took inventory turns into account, the margins on skate decks were not nearly as bad as people thought.
I had been arguing for a while that our new economic circumstances required a focus on gross margin dollars- not just gross margin percentages. Actually, I first suggested that years ago.   Cary brought GMROII to me attention and I wrote an article about it. I knew that inventory turns and inventory dollars were important, but GMROII gave me an elegant and effective way to put them together and compare how profitable it to sell a skate deck compared to, say, a pair of skate shoes.
So the source of my pissedoffness was that here we were again lobbying for higher margins, while ignoring turns and margin dollars and data suggesting that on a GMROII basis, margins on skate decks weren’t half bad. And I’m sure we’ll have the same discussion at the next ASR.
The article is on my web site and has a date of August 15, 2009 on it.  Cary’s numbers are in there and I think they will surprise some of you.