Article

Luxury retail at a crossroads

Shattered by heavy discounting, luxury retailers now need to focus on two distinct customer types - those looking for branded items at a lower price, and the shrinking number who are not price-sensitive.

August 24, 2009

If you are the CEO of Neiman Marcus or Saks Fifth Avenue, you have every reason to believe that the current economic recession has fundamentally changed how your business works forever - or at least the next decade. Although the retail sector has suffered as a whole through 2008 and 2009, with hundreds of bankruptcies across all categories and sizes, the future of luxury retail in a post-crisis economy looks extremely dicey.

Forced to adopt deep discounting strategies and aggressive promotions to salvage last year's holiday season, luxury retailers have most likely diluted their brand image and hurt future cash flows for short-term results.

Saks starts the stampede

Before the holiday season got underway last year, a combination of factors including Saks' failing strategy leading into the recession, accumulating inventory and reduced consumer spending forced the retailer into announcing unprecedented discounts of up to 70 percent to kick-start the shopping season.

The rest had to toe the line or risk losing precious customers in an extremely challenging environment. Predictably, announcements from Neiman Marcus, Nordstrom, Barney's etc. followed, even though they were in better shape than Saks, financially and inventory-wise.

Another related development was the spike in the number of discount/outlet stores operated by the luxury brands. Originally intended to extend their product reach to new locations and aspiring customers without affecting their high-end image, the discount stores began to attract clients who used to frequent full-time stores. Despite the steeply marked-down merchandise, the volumes driven were below expectations and most retailers (including Saks) continue to face the nightmare of aligning mounting inventory levels with reduced consumer demand.

On a slippery slope

Once you embark on a high-risk strategy involving deep price-cuts, you are forced to stay the course till things turn around. For Saks and other upscale brands, this implies discounted merchandise at their stores until the end of 2009 (at the least) which will continue to erode margins without necessarily clearing inventory.

In this context, it's no surprise that discount stores operated by these brands are popping up all over the place while the growth in regular store square footage has dropped drastically. Take Nordstrom, for instance. It has announced plans to expand its outlet stores by a dozen a year for the next four years. Given that same-store sales at Nordstrom Rack stores have been much more encouraging than full-line stores, there is every possibility that the expansion could be even more aggressive. Saks has plans to open more Off Fifth stores to channel excess inventory and tap into the expanded base of customers looking for steep bargains.

But that begs the question: Will their customers return to full-line stores when the economy rebounds? Well, it depends. There is no doubt that retailers will not be able to command marked-up prices on merchandise their customer base is, by now, used to purchasing at generous discounts. In the post-recession economy, every category of consumer will continue to expect "value-priced" products and resist any dramatic (or even moderate) jumps in pricing from the current levels.

Customer mindsets and purchasing behavior have undergone a fundamental change and the emphasis on value over price is a trend that's here to stay.

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Looking into the unknown

Despite companies slashing orders, closing stores and pushing layoffs, the discounts were inevitable. This, unfortunately, has led to the partial commoditization of the luxury market where price competition is ubiquitous. Until the demand and supply forces balance out, brands must divide their energies and inventories to focus on two distinct categories of customers - the growing percentage looking for branded items at lower price points and the shrinking population of high-end affluent consumers who are not as price-sensitive.

Exemplary customer service and a highly enjoyable in-store experience were two factors that luxury retailers hitherto differentiated themselves with. They should not lose sight of these values during tough times - especially during tough times. The surest way to erode customer loyalty is by communicating mixed messages to them by diluting the exclusivity of your brand.

Overall, there is very little consensus in the market about what the future holds for luxury retail. What everyone can agree on is that new business models need to evolve that take into account the not-so-subtle shifts in customer purchasing power and can sustain themselves on the lower margins and volumes of business in the foreseeable future. Whether luxury brands can understand and adapt to the new market realities without destroying their niche in the process is anybody's guess.

Aravindh Vanchesan is a Program Manager with the Frost & Sullivan North American ICT Practice. He focuses on monitoring and analyzing emerging trends, technologies and dynamics in retail markets worldwide.