Factory shutdowns and order cancellations due to the coronavirus pandemic forced fashion brands and retailers to manage lower inventory levels, and they in turn learned that they can do more with less and still be profitable.
In the most recent round of retail earnings reports late last year, the majority of retailers posted strong quarterly profits, owing mostly to higher margins due to leaner inventories and a reduction in markdowns.
What retailers are doing
Fran Horowitz, Abercrombie & Fitch Co. Inc. CEO, during a company conference call in August, said that “over the past several months, we proactively bought inventory conservatively.”
“Our inventory is very balanced,” Horowitz said, noting that the company’s “agile” sourcing team has been able to “chase into what we need.” The leaner inventory has resulted in lower promotions and clearance and improved average unit retail, she said, referencing the metric used for pricing and sales comparison that gauges an item’s average cost over time. The company plans to remain conservative with inventory levels going forward. “In retail, chasing is a good way to go,” Horowitz said.
Staying laser focused on that strategy gave the specialty retailer its best third quarter operating income since 2012. The company reported third-quarter results in November.
“As we’ve done since the start of the pandemic, we are focused on controlling what we can control and stopped responding to what we cannot. We have remained conservative with our inventory commitments and that key move to maximize digital throughput while increasing omni capabilities, including curbside, ship from store, and pop-in capacity…. I firmly believe that our company is better positioned today than it was coming into this pandemic,” Horowitz said during a third-quarter conference call with Wall Street analysts.
More specifically, Abercrombie’s chief financial officer Scott Lipesky noted that the company’s gross profit rate was 64 percent, up 390 basis points from the year-ago quarter. “Results benefited from higher AUR, with promotions and clearance below last year and lower AUC (average unit costs),” adding that the company ended the quarter with inventories down 8 percent from last year.
American Eagle Outfitters Inc., which reported third-quarter earnings on Nov. 24, saw its intimates brand Aerie post its 24th consecutive quarter of double-digit sales growth. Chief operating officer Mike Rempell told investors on a conference call: “Our go-forward thinking on inventory continues to be that we want sales to outpace inventory.” That strategy gives the company its “best margin results and opens up inventory for us to chase,” Rempell explained.
The reduction in inventory levels also helped Macy’s post third-quarter results that were better than Wall Street’s consensus estimates, although in its case the improvement was not about profits but losses that were narrower than expectations. CEO Jeff Gennette said during an earnings call that the company managed the “channel shift” and was able to draw shoppers to its digital operations. He added that the retailer was also able to “flex categories and price points as customers’ needs change.”
Inventory levels were down 29 percent from the year-ago quarter. A continued focus on cleaner inventory levels allowed the chain to garner gross margins of 35.6 percent for the third quarter, lower than the year-ago gross margin rate of 40 percent, but up sequentially from the 23.6 percent in the second quarter.
Apparel firms are learning, too
It wasn’t just the retailers that benefited from the reduction in inventory levels. Apparel firms were also benefiting.
“From what I’m hearing in apparel, inventory is in better shape. They did a pretty good job during the pandemic in cutting back. Many companies have said they’d rather be out of stock than have more [than they need],” Mike Zuccaro, apparel credit analyst at Moody’s Investors Service, said.
Zuccaro said fashion companies have restructured operations post-Covid-19 by cutting costs. In addition to pulling back where they can on operational costs, many also reduced inventory levels through a cutting of their stock-keeping unit (SKU) counts. “Holding less is the way to go. Companies learned from the pandemic that this has become critically important because too much inventory can make you sick. It’s far easier to maneuver when you are cleaner and have less to deal with,” the apparel analyst said.
Cutting SKUs allowed companies to focus on a particular group of merchandise options, resulting in a curated offering with better quality items. “It’s really about having good product. Companies pull back on some items to save on costs, they then take their savings to put elsewhere, such as marketing or digital,” he explained.
Zuccaro added that investing in digital is another move companies are making to help with speed-to-market. Digital via technology in design allows companies to do swatches online instead of sending physical pieces of fabric shipped around the world. They’re also using digital processes to link inventory levels with those of their customers to create a whole ecosystem that can “talk” better with each other.
Doing the math
Companies have also been taking a good, hard look at margins and targeting where they want to be and how to get there, with the help of lower inventory levels.
One example is Capri Holdings Ltd. When the company reported second-quarter results on Nov. 5, Capri said net inventory at the end of the quarter was $930 million, representing a 13 percent decline from the same year-ago period. Executives on the company conference call also said they’ve raised prices, and found that consumers have shown “no resistence” to the increases.
While that’s one way to make up for fewer sales, it’s a strategy that also gives companies what they call better quality sales that translate to higher margins and greater profits.
BMO Capital Markets retail analyst Simeon Siegel has been advocating for a price paradigm reset since May to help fashion firms improve their margins, and he believes the key is inventory management.
“We saw that Victoria’s Secret sold less, but their profits went up…. And [recent] third-quarter reports show retailers have had their best gross margins despite revenue declines,” the retail analyst said. He noted that it’s never been easy to tell companies they need to shrink in order to grow, pointing out that even if executives hear what’s said, how well they can execute a pullback can be another issue to contend with.
“This year, the factory shutdowns saved companies from themselves. They didn’t have sales and there was no [new] inventory available. So, companies had to build back up from their roots and regrow their businesses,” he said.
Siegel has what he calls a simplistic math calculation based on the economics of supply and demand to drive healthier profits. “We know that if retailers are willing to give up 40 percent of their units, there will be 60 percent of people willing to spend more,” Siegel said. Taking that a step further, companies that keep lean inventories—meaning that they’ve already strategically figured out how many unit sales they’re willing to lose—are in the best position possible to hold the line on promotions, even if they also up the price points because fewer units create scarcity for those items.
“Their power lies in inventory and access. It’s about their ability to see the bottom line [and] figuring out what the right balance is,” Siegel said.
Editor’s Note: This article was originally published in the Sourcing Report 2021. Click here to read the full report.