How Off-Price Retail Innovated A New Business Model For Sustainable Growth

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Code red, code red!

Business is suddenly declining rapidly and somehow the executive team missed the signs to mitigate the revenue miss. This sparked an across-the-board layoff. If you were one of the lucky ones remaining, likely you were asked to pick up the slack from one of your former colleagues and absorb another 40 hours of work.

A hiring freeze was initiated. Travel is reduced to a bare minimum and when you do travel there is a feeling of guilt. Marketing expenses are slashed, reducing the air cover you once relied on to drive sales. The culture has been compromised and the company that once referred to you “family” now feels like a stranger in your own house.

This is a cyclical and sad scenario in corporate america. During strong economic times hiring and spending rise out of control and when the economy shrinks the other way companies callously reduce overhead, often drawing a straight line through the organization chart to achieve a projected break-even number.

It’s naive to think that companies will never have to reduce their workforce and economic pressures are indeed real and must be addressed. However, how can these extreme reductions be mitigated? And how can you continue to grow your business in a down market?

3 ways to reduce costs without cutting growth:

 1. Elevate your leadership gaps with new hires by outsourcing to Fractional Executives to gain fresh ideas for a fraction of the cost.

2. R&D – a good way to reduce research and development costs is to partner with an Ingredient Technology who can accelerate your growth in a number of different ways (e.g. expand your customer reach, increase your average unit retail etc).

3. Benchmark marketing budgets to 3% of sales during growth and decline cycles of business. Reducing marketing to zero is not a strategy as you cannot cut your way to growth but you should re-allocate it based on ROI.

Now, let’s take a deeper dive into the consumer products industry and how the off-price channel of business innovated a new business model to lead a paradigm shift in the retail industry.

Did you know that retail buyers are investors?

In order to understand the consumer products industry It’s important to understand what a retail buyer does and how they operate. These executives are investors. Instead of investing into stocks, they invest into a particular product category (e.g. shoes, luggage or sportswear) and analyze how they invested a retailer’s money at the end of each season; their jobs and bonuses are tied to gross margin earnings.  Buyers are given an investment budget commonly known as “open-to-buy” to search for products in the market and purchase a collection of merchandise from various brands to sell in their stores.

While buyers are experts in their respective categories and have an “eye for product” there are macro economic factors that affect the product investment performance. For example, when gas prices surge it increases the cost of airfare which in turn reduces travel and, therefore, tourism.

A stock broker would not sell airline stocks when tourism is downtrending; the idea, of course, is to buy low and sell high to make a profit. So why would a retail buyer invest more into the luggage category during this same period of downtrending travel only to sell the product at a discount?

The answer is because buyers are allotted a finite space within a retail store and they have to fill this space with product. Secondly, they are given an investment budget based on the previous year’s performance without much consideration for future economic factors, whether good or bad.

Does that business model make sense?

No, it doesn’t!

Traditional department stores have operated this way for decades essentially setting up their buyers (and company) for cyclical failure given the lack of flexibility.

What is “closeout” merchandise?

The off price market used to be a dirty secret in the retail industry where aged inventory completed its life cycle. These retailers were perceived to be the underbelly of ill fitting products and manufacturing defects. I speak with investors and analysts who still believe this and it couldn’t be further from the truth.

Off-price retailers have grown larger than full price retailers so they cannot rely solely on closeout merchandise to sustain their sales. For instance, Macy’s and TJX Companies share the same customer and are indeed competitors in the United States. There was a time when TJX was much smaller than Macy’s but the tables have turned. In comparison, TJX has over 3,200 stores (TX Maxx, Marshalls, and Home Goods combined) with over $32B in revenue while Macy’s currently has 546 stores with $18B in revenue (fiscal year ending 2021).

Closeout merchandise are current products that have either been discontinued or excess inventory that a brand owns. This is “dead inventory” on a brand’s balance sheet and they are challenged to turn it into cash as quickly as possible while balancing the perception of the brand in the marketplace. When a brand floods the off-price market with merchandise they risk diluting their brand image with full price retailers who demand exclusivity; it’s a tough balancing act to keep all points of distribution happy.

Closeouts are often considered an “opportunistic buy” because off-price buyers have leverage and can negotiate great prices because they know the wholesale brand is desperate to ship this inventory, especially if it’s at the end of a quarter. However, closeout merchandise are only a fraction of an off-price retailer’s merchandise mix for the largest players in the industry.

What is a “special makeup”?

The majority of an off price retailers product assortment are in the form of “special makeups”, a process by which a wholesale brand develops and produces product specifically for an off-price retailer (e.g. Nordstrom Rack) to ship in the future, similar to how they would for a full price retailer (e.g. Nordstrom). The difference is the pricing structure and margin expectations vary widely between the two channels. Special makeup merchandise does not necessarily mean it’s an inferior product although, at times, a brand will slightly reduce the quality to make the math work. There is an art-and-science to this process; the art is the product creation and the science is the financial engineering to ensure profit margins are acceptable to both parties for a win-win partnership.

An example would be using less expensive packaging or using a less expensive lining in a shoe such as canvas versus leather. The end-use customer rarely knows, or quite frankly cares, about these slight quality adjustments. The off-price customer is very savvy and is driven more by price-to-quality value and the thrill of discovering a deal rather than by superior service, optimal quality and exclusivity experienced in the full price channel.

How innovative business models drive growth in good and bad economic cycles

Enter TJX Companies to flip this old way of thinking on its head. They discovered that consumer preferences change quickly, largely driven by macroeconomic factors that shift the demand for certain products. Thus they created “modular” selling floors within their stores. Instead of forcing products into predetermined 20×20 selling areas, they created store floor plans that allow new fixtures to replace old fixtures (i.e. hanging racks to replace shelves or vice versa) based on what consumers actually want.

Secondly, TJ Maxx rewards buyers who willingly give their open-to-buy investment budgets to another buyer whose product category is in higher demand. Imagine a luggage buyer transferring $15M in investment dollars to the footwear buyer and being rewarded for it! This concept is so foreign to traditional department store buyers who cling on to every open-to-buy dollar they can, and with all good intentions, invest it the best they can even in downtrending product categories.

What a brilliant strategy to hedge against macro economic trends that creates a true team culture and maximizes every investment dollar; a win-win-win for employees, customers, and investors.

Now let’s apply this business model to the opening scenario of a company downsizing their team due to an unforeseen downtrending business. Theoretically, this could have been avoided with a modular business model to adjust to macro economic trends. A business plan should be a living document with the ability to shift economic levers. TJ Maxx is the epitome of this evolution enabling the company to outperform the competition while achieving a $84B market cap as of this writing.

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