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July 24, 2008 - Price Inflation and Retailers

I recently had the misfortune of owning stock in a financial company called Bank of America.  Listening to Jim Cramer on CNBC, I heard Jim state that trying to buy a financial stock at the bottom is like trying to catch a knife in freefall by the blade without getting cut.  So after taking a financial beating I am left to wonder; what was I thinking? 

This is the second article in a three part series on the increase of component and shipping input cost of fitness equipment and what it means to manufacturers, retailers and consumers of fitness equipment.  This article covers fitness equipment retailers.

Recently, I wrote an article detailing the cost of inputs into manufacturing fitness equipment both inside and outside the US.  I have received a lot of comments regarding this article.  Most of these individuals really don’t get what I am saying.  They understand that the cost of shipping is going up but dispute that a factory can make their product cheaper in the US.  They boil their argument down to points that address that shipping is only one component of many and they are correct.  The problem is that it has become a very large component.  The real problem is that many factories have outsourced all or some of their manufacturing overseas and, having made the bet, are riding the bet for the long term.  Time will tell if they are right.  Where our critics miss the boat is the effects of onshore productivity when combined with the inordinately large increase in the cost of shipping.

Back to the issue at hand regarding retail, and the reason that I brought up the manufacturers’ comments at all is that they are absolutely right about one issue – shipping cost is only one component.  For retailers, cost and quality are only two factors.  Any retailer knows that individuals buy on more than just cost and quality.  We know this because any purchase decision at its essence is an emotional decision for a consumer.  They may have rational reasons to justify their purchase, but the decision to pull the trigger for many people is all emotion.  The problem for retailers is that in the current economy – fear has become a big motivational factor.

Many people believe that we are in a recession.  Not withstanding the rebound in the stock market in the last few days, we are officially in a bear market.  Reading an article detailing the thoughts of investor Warren Buffett, I am convinced that we will see continuing consumer weakness though the end of the year and probably a good portion of next.  The reason is that regardless of what happens in the stock market, daily notices of large layoffs, plant closings, and other cuts by companies fuel the fear that prevents people from making that emotional choice to purchase a big ticket item.  What does this mean for fitness equipment retailers?  Pain!

Fitness equipment specialty retailers have to look at their market segments to determine their ability to effectively ride out this turn in the economy.  Whether the turn will prove to be an official recession or if it is a simple slowdown, we do know one certainty and that certainty is that people have drastically reduced their spending on many big ticket items including fitness equipment.  We have heard this from both the big box and the specialty retailers.  Many of the more successful specialty retailers that we have spoken with are riding the storm out by strengthening their commercial sales.  While many consumers have stopped spending, many retailers have reported to us that their commercial sales remain strong.  Combine that with using their comparative advantage with big box retailers and we believe that many will be safe in the long run but it may be a painful journey.

Big box retailers have also reported weak demand in fitness equipment sales.  We believe that in addition to economic forces, the reason for weak demand has been the requirement that retailers raise the price of their fitness equipment on the sales floor just to cover cost increases passed along by the manufacturers.  For instance if a retailer has a cost increase of $35 on one treadmill, the retail cost of the treadmill will have to rise $50 in a big box store or nearly $60 in a specialty store just to maintain margins and those margin estimates are on the low end of the scale.  Many of the price increases that we have heard about make the $35 number look small.  Most that have had that minimal of a price increase are sold in the very low price range.  Although on a percentage basis the price increases are smaller for the very high end of the market, it is still a price increase and many times this price increase is harder to pass along to the consumer which squeezes profit margins further in the face of declining sales.

What this means is that unlike years in the past where retailers have had some pricing power, the consumer is now in the driver’s seat.  This will continue until the economic downturn improves or some retailers cease to exist.  Consumers will be able to drive harder bargains simply by leveraging one retailer against the other and only those who have comparative advantages over other retailers will be able to maintain margins at an acceptable level.  In other words it is good news for the consumer but bad news for the retailers.
Any time we have wild fluctuations in the economy we always have winners and losers but in this case, it could be especially painful for specialty fitness.  The reason is that most retailers realize that more and more sales of fitness equipment have been moving to other sales channels.  Online, big box, and warehouse clubs have been grabbing a larger portion of the market and when you combine that with the economic downturn, it will be devastating to many specialty companies.

Last year, I received a great number of complaints because I predicted that four manufacturers would quit the treadmill business and although I aimed too low, the prediction for this year is the failure of many specialty retail locations.  Although I am not averse to be the bearer of bad news it doesn’t bring me any great joy making this prediction either.  Let’s face it, I got my start in specialty fitness retail so I would like nothing more to see this segment do well but that simply isn’t going to be the case.

What we are going to see is the market of specialty retailers shrink to fit the declining market they were already experiencing.  For the surviving retailers that will mean that they will be stronger in the long run but also have to face a considerable amount of pain in the interim until everything shakes out.  How do you survive this without asking God for a miracle to see your stores reopen tomorrow in a market like Houston that has been immune to the recent downturn?  The answer is very simple.  Get very aggressive in your marketing efforts, question every cost, and maximize every sale.

Some retailers like to spend money but that is not necessarily the case with marketing.  I’ve been a big believer in Jay Levinson’s book Guerilla Marketing for years and if you’ve never read it, he explains how to market effectively for little or no money.  The second point is to question every cost.  Before spending money, ask yourself if you must purchase and when you do buy anything, read the invoices carefully and make sure you are buying from the best source.  Finally, make sure you are effectively covering your market including the commercial sector.  My mentor had us call and visit commercial prospects every summer when the retail portion of our business slowed down and it resulted in sales every time we did it.  Also make certain to meet all the needs of the customer with all the accessories that they will need to maximize their ownership experience.

All of this has been said before but it doesn’t hurt to hear it again and sometimes concentrating on the basics is the best way to get through a downturn.  Realize that the consumer is more than the boss right now and also that there are going to be significant downward pressures on retail prices when others go out of business but be assured that Darwin’s Laws will rule this year in retail.