WHAT'S NEW

Anatomy of a Sale: Xmas Season Irrationality

"Even if markdowns are more aggressive than usual, it will still be a cheaper markdown now than if you have to take it later in the season." Brendan Hoffman, CEO Lord & Taylor, as quoted in the Wall Street Journal, 12/4/2008, "Holiday Shoppers Lured Only by Big Bargains"

It's become axiomatic by now that when Christmas approaches, retailers pull out all the stops to drive revenue. 'Tis the season for deep discounts, and as a retailer who cares as much about gross profit margin as I do revenue dollars, I often wonder what does it mean? What are the motivating factors for the discounting frenzy?

According to the WSJ article cited above, "the Christmas season typically accounts for at least a third of retailers' annual sales, and is the time of year when companies fatten up to survive the comparatively meager sales months to come."

Do you believe that? It's too much of a blanket statement for my taste. I can guarantee you that no bike retailer earns 33%+ of its revenues in December, and I suspect that few if any specialty retailers (regardless of category) do. Why is it, then, that the discounting pandemic has spread beyond department stores and mall stores and seems to be everywhere now? Is it a simple act of flushing inventory overstock, since current inventory levels are based on sales forecasts set during happier economic times many months ago? Or is it an act of mutually-assured-destruction between retailers who use their only real weapon --retail price discounts -- to earn traffic?

I don't have the answer. I only know one business: Competitive Cyclist. And decisions about inventory and pricing aren't made with the flippancy of a Lord & Taylor. They're tough choices to make; they don't necessarily make rational sense; and -- like many things in a closely-held business -- they're driven by personal idiosyncrasies as much as the larger economic landscape. So today I'll explain why -- despite all of the good reasons for not discounting -- you'll find promotions, incentives, etc at Competitive Cyclist during December 2008.

Typically you'll only find discounted pricing at Competitive Cyclist for 1 of 3 reasons:

(1) Seasonal inventory elimination, scenario 1. Most common is apparel. There's no need to carry winter clothing past March. There's no need to carry summer clothing past August. Holding out-of-season apparel in inventory is financial suicide. It's best to cut margin by putting it sale, and then re-investing the cash in relevant inventory. This phenomenon isn't just specific to seasonal apparel. The same holds true with framesets (which get new paint jobs, etc, on an annual basis) and on components (which functionally change on a near-annual basis.) Seasonality & model year considerations cause the majority of the discounting we'll do where willingly take a hit to our gross margin %.

(2) Seasonal inventory elimination, scenario 2. No one wants to get stuck with out of season inventory. It's not just retailers, but the same holds true for wholesalers. So we get a steady stream of communication from manufacturers, distributors and importers trying to tempt us to buy their soon-to-be-obsolete goods. In these situations, their pricing is aggressive, and it allows us sell it at deeply discounted retail prices while still making our desired gross margin %. A great example is our current sale on Shimano Dura Ace 7800. It's as though a reverse auction is going on: With Dura Ace 7900 now available, it casts 7800 in the dark light of obsolescence. Distributors are dying to get rid of 7800, and we're eager to let them bid against each other -- lowest price wins. This provides fantastic value for our customers, and it benefits our bottom line.

(3) Wholesale overstock in extremis Some stuff just doesn't sell. You can never predict it, and it's often impossible to diagnose the causes why. But sometimes seemingly good products never gain traction. While we occasionally fall victim to it here at Competitive Cyclist, we take great pride in our inventory controls so the problem is normally easy to resolve: Ridding ourselves, for example, of 20 slow-moving saddles is quick work, and it has little tangible financial impact on us when we mark them down. But on the wholesale level, it's a different story. A wholesaler who makes a saddle mistake will end up with 500 or 1,000 unwanted units on hand, and that is painful. Which leads them to go for the nuclear option: selling them at a loss to someone -- anyone -- willing to take them all.

A combination of factors 2 and 3 above is the fuel for success of Sierra Trading Post and the new kid on the block, chainlove.com. We get in on the action, too, since it's profitable, and it's great for the customer. Sell somebody something for 40% off and it earns you some serious loyalty.

So, to go back to the original question -- Why is Competitive Cyclist engaging in Xmas season discount activity? We'll share an anecdote pertinent to factor 3 above. In the fall of 2007, the US Colnago distributor was in a bit of a pickle. They were drowning in 2007 Colnago CLX framesets and complete bikes -- a nice carbon fiber model that never got marketed well because Colnago seemed uncomfortable in giving too much exposure to their first-ever Asian-made bike. They had hundreds upon hundreds of units in stock, and unfortunately they just took delivery on…hundreds of units of the 2008 CLX. A true inventory nightmare, especially since importers must pre-pay for their inventory.

Without going into gory details, we'll sum things up by saying that we ended up with all of the '07 CLX's, and we made more than our standard Colnago gross margin % while selling them at retail prices of 40-50% off. From a sales standpoint, it was ducks in a barrel, and it led to a Gordon Gekko-like revenue total for November 2007 here. It was awesome.

Here's the problem: We monitor a lot of metrics on a regular basis, some rational and some less rational. The rational ones include gross margin %, revenue dollars, inventory turns, and net profit. The less rational ones include year-on-year revenue growth. It'd be smarter, of course, to fixate on year-on-year net profit dollar growth. But for whatever reason people like saying "Company X is a $25 million/year company" not "Company X is a $4 million/year-in-net-profits company." We can't explain why that is, but we're infected with the same idiocy here, and so going into November 2008 we faced an impossibly lofty sales goal since it was based, naturally, on growth over our ridiculous, CLX-fueled numbers in November 2007. Combine this absurd goal with the detonation of the US economy, and it led to month that felt like utter failure. Not only did we not achieve our sales goal, but we fell into line with the widely-reported super-grim November retail statistics.

What's curious is that if it weren't for that CLX frenzy in 2007, our YOY revenue would've been up for November 2008. That should be a silver lining, no? We were victims of our own success, right? Yes, I should've be smarter about our definition of success for November 2008. Yes, in those dark nights of November when every dollar felt like an alley fight and my main solace came via a wine refrigerator, I should've taken refuge instead in all the YTD successes of 2008. We exceeded all goals for YTD gross profit %, revenue, inventory turns, revenue growth, and net profit. But rather than considering & celebrating all of the good, instead I'm trying to qualify for the Olympic OCD team. My brain is shackled to November's negative YOY revenue totals and -- despite the wealth of evidence that confirms that the situation is macro-economic, and not specific to Competitive Cyclist in the least -- I see November as a utter condemnation of me as a business owner, a manager, and as a man. I'm pissed. I'm frightened. I'm in full recognition that these feelings are not rational but it doesn't matter. I'm super-charged by the business equivalent of fight-or-flight.

What unnerves me? Plenty.

• The shift in consumer expectations about pricing.
• The apparent requirement of retailers to fixate strictly on revenue numbers, not profits.
• The fact that our experience with marketing expense is consistent with the retail sector as a whole: We're having to spend significantly more with Google to maintain the volume of sales referred from it.
• The fact that our best strategy at Competitive Cyclist to battle the recession is to exercise careful inventory control, which leads to strained vendor relationships. Despite the historic circumstances, vendors expect us to match or exceed previous year spending. They stick to a laughable company line about sales expectations. They don't like it when I laugh at them. This does not lead to warm and fuzzy relationships.

So, to answer the original question, why are we playing the discount game? We've had a great year and a sustained track record for success. We have the lack of debt and the cash cushion on our balance sheet to affirm it. We have loyal customers, awesome brands, an excellent staff. We could shrug off the next 3 weeks of madness, and just focus on 2009. The current situation in retail is untenable, and won't last much past December. So WHY WHY WHY after 11 months of being militant about gross margin % are we now chasing gross margin dollars however they'll come? It feels like weakness because it is weakness. I'll admit it: I'd rather have the momentary glory of a ringing register -- cash flow irrespective of margin -- because November was so nerve-racking to endure. We're discounting not because we need to financially, but because we need to emotionally. The theme for the retail sector in 2008 is "Revenue without profits." It's a fantasy. It's the drug that keeps you from facing the problem. It's a half-real pleasure, and it's exactly what I need to shake off November.

Once the Xmas season passes, the carnage will be frightful. Retailers will report earnings, and they'll be bailing the blood out of Wall St. And our beloved bike industry, what'll happen in the first few months of the year? We expect widespread LBS closures. Why? Because vendors strongarm retailers into committing to "preseason" sales programs at Interbike in October. These programs load LBS' up on inventory at a slow time of year, and it provides vendors the receivables they need to collateralize credit from the bank.

Payment for these pre-season purchases comes due around March. Inevitably, the LBS will sell this inventory at discount prices to fund operating expenses between October-March. They'll end up paying their pre-season bills late. Vendor credit departments are sure to be working with a zero-tolerance policy. Because of this starting in March LBS' will lose access to vendor credit and inventory. Without these two lifelines, they'll go bankrupt and/or shut down. It will be widespread and it will be ugly. Mark my words. The spring will bring destruction to the LBS landscape. Your average LBS showed an inability to pay bills within 60 days of their due dates when the Dow was at 13,500. Talk to anyone who works wholesale -- they'll chuckle and assure you that it's an indisputable fact: Creditworthiness is the #1 headache in maintaining happy relationships with LBS'. In 2009, the average LBS is a ticking time bomb.

What can you expect from Competitive Cyclist? Not unlike now, we'll surely be nervous and come March we'll be fit as hell since the best cure for anxiety is a 300-mile training week. But, in all probability, we'll be well-positioned since, as LBS' die, we inevitably gain market share. And as LBS' slow down their buying, wholesale overstock in extremis opportunities will increase, which is great for us AND for our customers. So expect awesome values on awesome products.

For now, though, we'll play the Xmas discount game. Like Orange County housing values in 2006, the laws of economic physics make it impossible for this to last much longer. The current zero-profit discount madness can't go on past the holiday season. And as far as we're concerned, it can't be over too soon.