Already having been hit hard in recent years due to changing shopper preferences, the apparel industry ―particularly department stores and specialty apparel retailers―are now facing the fallout from the COVID-19 pandemic. As stay-home measures continue across regions of the globe, the challenges for retailers to turn things around becomes greater. Couple that with an unemployment rate that’s spiked to 14.7 percent as of mid-May, and the challenge will likely prove insurmountable for some.
U.S. Federal Reserve Chair Jerome Powell has warned of the threat of a prolonged recession. Already, apparel prices are in free fall with a year-on-year decline of 5.7 percent from April and the same period last year, according to Consumer Price Index (CPI) released. Further, the bankruptcies of J.C. Penney, J.Crew, Neiman Marcus, Stage Stores and the scuttled Victoria’s Secret deal could be just the start.
This isn’t the first time the industry has had to adapt to rough economic conditions. The 18-month-long Great Recession throughout 2008 and 2009 claimed many retail casualties but it also spawned some lessons on how to handle a lengthy crisis.
“The reality from the Great Recession was that many companies didn’t survive,” said Murali Gokki, a managing director in the retail practice at consulting firm AlixPartners LLP. “The recovery was much longer than anticipated for companies that did manage to survive in terms of getting their top line back to what it was pre-recession. It took three to five years to do that.”
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Current estimates say 5 percent to 10 percent of pre-COVID-19 apparel demand could be wiped out, as “lost store volume can’t entirely be made up online,” Wells Fargo retail analyst Ike Boruchow said in a note to clients on May 13. Boruchow estimated that it could take at least nine months for sales levels to reach their “new normal” following this year’s holiday season.
Promotional pitfall
The Great Recession, which was spurred on more by systemic financial issues than any consumer-driven changes, saw the bankruptcy and demise of department stores such as Mervyn’s and Filene’s Basement and apparel chain Steve & Barry’s, among others.
A major lesson to take away in the wake of the recession of the late 2000s is that retailers—particularly legacy retailers—must reevaluate their cost structures and overall liquidity level, if they have any intentions of operating long term.
“The companies that are positioned well have a more amplified focus on cash preservation and are working harder to improve their liquidity position and being able to use that liquidity to set them up for success in this present crisis,” Gokki said. “Companies that were successful in the last recession and most likely will be in this one are also taking initiative to have meaningful cost reduction. This reduction can’t be for the sake of cutting costs. It must go hand-in-hand with productivity and improvement, and that’s where I think this current crisis needs to be addressed. Apparel companies especially need to rethink their entire operating model around product and marketing.”
They should avoid the trap of being overly promotional, or they’ll find it difficult to pull back on these expectations, which is exactly what happened as economic conditions improved the last time.
“The reaction of the cost structure caused retailers to flip into promoting a retail shopping culture of forever on sale,” said Michael Felice, a principal in the consumer practice of Kearney. “We used to think 20 percent to 30 percent off was a big deal―you’d run to a store for that. Everything now is 20 percent to 30 percent off every day. They’ve gotten themselves into a downward spiral and some of that was liquidating off inventory in the past. That is a parallel that will relate to today. How do shoppers go back into a store that’s been shut down for eight weeks if 80 percent of the products should no longer be in the store?”
Felice noted that retailers are going to have to figure out cause-based ways to productively remove that inventory from the store first, then reposition that store towards profitability.
Susan Anderson, senior equity research analyst at B. Riley FBR, indicated that the apparel retailers that are best positioned to succeed have been able to fortify their supply chain and quickly pivot to the new environment due to an expected change in how the shopper would spend. While the magnitude of COVID-19 may have been difficult to predict, it was arguably an easier environment to make drastic changes in, as there was no warning for the financial crisis.
“Now versus back then, retailers have a much greater ability to pull back on inventory. Compared to then, the lead times are much shorter, with some retailers getting them down to a month. That gives them much greater flexibility so they’re just not left with as much inventory as they were back then,” Anderson told Sourcing Journal. “[Store closures] led to early actions like pack away for next year or early canceled orders that you normally wouldn’t do in a regular environment where you stick it out and see if the consumer will buy it.”
Anderson noted that apparel retailers are cutting as much as 20 percent of their orders from their manufacturers, which they likely wouldn’t have been able to cut a decade ago.
Contraction ahead
The good news is the concentration of weak players has actually improved since the last financial crisis, Moody’s indicated in March. Just 27 percent, or 20 out of 73 retailers, had a speculative “B3/B-” rating or lower (including J.Crew, Neiman Marcus, J. C. Penney and Ascena Retail Group) compared to 35 percent in March 2009.
However, these numbers are poised to increase as the economic stress caused by the COVID-19 pandemic potentially weakens companies in the “B2/B3” rated categories, according to Christina Boni, a vice president and senior credit officer at financial services firm Moody’s.
“There is a sharpening divide between those who have the capacity to weather the challenging operating environment and those who do not. The majority of companies that defaulted in 2019 and year-to-date 2020, such as Charlotte Russe, David’s Bridal, 99 Cents Only and Pier 1, did not have the scale, the pricing power or the deep pockets that their competitors had,” she said.
The reality is that many more stores are likely to close for good once the pandemic subsides, with estimates of up to 100,000 total by 2025, including 24,000 alone in apparel, according to UBS. With that potential, retailers that already have been struggling are likely going to have to start prioritizing where they should be focusing within their store base.
“It’s going to be about getting the most out of the stores that I have and finding which ones I really want to double down on as my winners. Shoppers will be looking at regionalized, localized more and more,” Felice said, meaning consumers will be more community-oriented after stay-at-home orders lift. “Doubling down on those supply chain capabilities to the store and home will be big. During this time where you have a lot of stores shut down, there’s also an opportunity to rethink how I use my store network. I don’t foresee that every store manager goes back to the same store, so I really want to look at who my top talent is and what my top locations are.”
Given the ongoing battles between retailers and their landlords over rent payments, store closures could be an immediate consequence once malls begin to open up throughout the U.S. Luckily for apparel retailers today, most have a growing online base that they can continue investing in that maximizes the value of their stores, even when they’re closed, a luxury they likely didn’t have coming out of the Great Recession.
“There’s just going to be a lot more leverage,” Anderson said. “If you’re a retailer that has a lot of stores, or even some of these brand manufacturers had stores too that they wanted to close anyway, I think we’re going to see a lot of that. If you do have a more robust online business, you feel more comfortable doing that now because you basically already have the consumer online. You don’t have to now do the work that you would have normally when you shed a store to bring that consumer online.”
David Swartz, an equity analyst in the consumer sector research group for financial services firm Morningstar, said that retailers that want to be successful coming out of this slump must not only focus on stores that are profitable, but brands that generate profit as well. This may not bode well for smaller brands that retailers feel they aren’t able to take a chance on.
“They need to promote categories and brands that are popular and were doing well before the crisis,” Swartz told Sourcing Journal. “I think that we’re going to see a lot of smaller brands disappear because they weren’t strong sellers to begin with and then with this crisis going on, I don’t think these retailers can afford to carry brands that are not strong sellers. We’re going to see that retailers are going to be even more focused on trying to stock the popular brands… They will continue to promote brands that will sell well no matter what the economy looks like.”