The recession is taking a toll on the business models of premium and luxury retailers.

According to the Los Angeles Times, faced with sales declines at their full-price stores, Neiman Marcus, Saks Fifth Avenue and Nordstrom are lavishing more dollars and devotion on their outlets which are performing better than their traditional stores.

According to Robert Wallstrom, president of Off 5th, Saks Inc.’s outlet division, “These days, customers are saying they want a brand, customer service and a deal.”

Outlets may just be the lifeboat needed by some of the brands to get through the current downturn, with the mix of the “real steal” deals to get the footfalls and the “just a little off the top” to get the margin. The current outlet stores are good enough to avoid severe damage to the brand.

However, a critical question does remain unanswered: once the consumer becomes used to shopping at a certain price level, might some brands struggle to move back up the curve?

‘Refrigerated and Frozen Food Retailer’ magazine wrote about price wars in food and grocery retail, between retailers, or between retailers’ private labels and national brands.  

The comments about the difference between retailers’ own brands and national supplier brands are particularly interesting. The question, whether retailers’ own brands necessarily need to be cheaper and whether they can catch up later, is also very acute.

To me, the price difference here is really reflected by the difference between whether you are creating a brand (albeit one that is available only in one chain of stores) or a lower-priced private label. 

A brand needs distinctiveness, a private label is mostly a me-too. A brand needs to build its own relationships and desirability beyond the store it is available in, while private label sells because there is an existing customer for something else that it is knocking-off. (Of course there are private labels that are not me-too and that are distinctive, but they are the exceptions proving the rule, so I would much rather go with the simplified view of the world for now.)

Finally, migrating up the price curve is difficult in the best of times. Believing that it can be done quickly after an introductory low price, in the current economic scenario, would be highly optimistic. 

Price-optimization solution providers believe that retailers can increase private label prices:

DemandTec’s Derek Smith is seeing smaller price gaps between national brands and private label, with private label also adding more tiers. This allows one tier to fulfill the opening price point in a category, with the other tier playing roughly on par with the national brand or even priced above it…

“You also have to understand what price gap is necessary to get the consumer to trade up or down,” depending on your strategy, he adds. For example, you might want to incent shoppers to trade down to your private label, so you get more margin. So… do you raise the price on the national brand, lower the price on the private label, or do a bit of both? Once again, it will depend on your customer set and their purchasing history…

Lyle Walker, VP of marketing, KSS Retail, has seen some of the retailers he has worked with raise prices on their private label without losing sales – thus significantly increasing category profits. “We build demand models with two years’ worth of POS history, and then dynamically adjust elasticity values based on weekly updates of POS data,” said Mr. Walker. 

Of course, Mr. Walker also qualifies the argument by saying that the increment may be “pennies here and pennies there,” implying that the discount for private label may still remain large enough for the customer not to notice the “pennies” being added on gradually.

Which sort of negates the whole question about whether retailers’ private label can really compete by pricing on par with national supplier brands, doesn’t it? 

(The original RFF article is available here.)

We touched upon food price inflation last month and – no surprises – it is still hogging the headlines. It is, after all, an emotive topic. We are terribly concerned not just as food and grocery professionals, but also as consumers and general public. After all, food and grocery are typically half of our monthly spend, give or take a few percentage points.

Inflation often brings with it swift (sometimes knee-jerkingly quick) reactions – price controls, export controls, subsidies to farmers and food producers, and various others. Some of these measures work but only in the short term, while others may have no immediate visible impact on the market at all but may be truly insidious because of that.

However, a significant set of questions has not really been touched yet: how the food supply chain is structured, how it is driving consumption, what impact that might have on food prices and several broader cost implications.

Thousands of years ago, when hunter-gatherer human beings stumbled upon agriculture, it was a breakthrough similar to the discovery of controlled fire. Hunter-gatherers were dependent on the natural availability of food, while agriculture created the opportunity to have some control over food supplies and reduce the natural feast-famine cycle. Thereafter, farming, processing and storage techniques kept evolving incrementally to ensure that more food could be produced for each unit of land and effort, and stored for longer – all moving towards ensuring “food security”. This led to the age of empire-building, where monarchs grew their wealth (essentially food territory) with the help of military-imperial complexes, and the greater wealth in turn supported the military-imperial complex.

This remained the trend for a few thousand years, until the age of industrialisation and the age of petroleum. Through the industrialisation and the world wars, the military-imperial complex gave way to a military-industrial complex, which essentially became the military-industrial-petroleum-agricultural complex. Suddenly, there were not just machines to plant, reap, thresh, sort, clean and process, but also petroleum-based substances to dramatically increase output and to keep the produce fresher for longer.

As US farms and then European farms industrialised, the parameters that began to be applied were the same as in any factory – how to produce more while spending less – and every year the target was to grow more for less. Underlying this was the principle of “efficiency from larger scale”. The same philosophy played out further down in the supply chain – from processing to extend the shelf-life of the product as it was (such as chilling, cleaning, sorting) to processing and packing in order to change the nature of the product itself and gain additional value (such as tomatoes to paste or potatoes to chips).

Standardisation became a vital link in industrialisation – if you can standardise produce, you can cut down human handling – while you may lose product variety (including flavour and colour) you gain in terms of driving down the cost of production. By reducing unpredictability you can also concentrate on building the scale of business, because it becomes more repetitive.

The interesting side-effect of this is that, gradually, we are converting ourselves (and people in many industrialised economies already have) into petroleum-burning machines rather than those running on solar energy, because increasingly the agricultural supply chain is dependent on non-renewable petroleum and its products, rather than by the natural energy of the sun being converted into food by the plants.

And the important thing to keep in mind is that, in this switch-over, the energy efficiency is actually going down rather than up – we are using more calories of fuel source to produce each calorie of food energy.

The issue is more acute now than ever before, because now the growth markets of choice for industrial agriculture companies are China and India. If these two countries move through the exactly same path as have the western economies in terms of agriculture and food processing, given the population base itself, clearly the impact will be 5-7 times (or more) on the demand for petroleum as well as the fall-out on the ecosystem.

You may ask, why should retailers worry about this?

Firstly, pure cost considerations – clearly, the costs of petroleum are not coming down, and explosive demand through industrialised agriculture will only serve to push them up. How far can you push the food bill every month, before people start buying less? What impact would that have on large retail supply chains and farmers whose processes are increasingly built around products of industrial agriculture?

Secondly, what consumers are already beginning to express in western markets will possibly happen in India in the next few years as well: concern about where and how the product has been produced, what has been the fall-out on the environment and on the overall health of people involved with that supply chain as well as the health of consumers.

Carbon footprint, food miles & locavores (people who only consume food that is produced within 100 miles of where they live) are terms that retailers are increasingly hearing.

And an alternative set of questions is also being raised. Is it ok to burn non-sustainable fossil fuel if you get “carbon credits” by planting trees somewhere else – have all the carbon costs been accounted for from the start to the finish of the production process? Is it better to reduce the food miles and have food produced locally in a high-cost economy’s industrial agricultural model, or to have naturally grown foods from a more primitive farm in Africa or Asia where the environmental impact is only the “carbon debit” of the air-freight. And, even if the produce is carbon-friendly, what about the nitrogen footprint (from the fixation of nitrogen into fertilisers) and the methane footprint (from large scale animal farming)?

This one page is surely not enough to present any in-depth analysis, but I hope it will serve to kick-start the process of questioning how India (and China) should take the lead in creating an alternative and more sustainable model for food security for large populations. There is a lot of research being done, and much yet to be done, to quantify the true cost of blindly pushing for scale in the food chain. Truly “progressive grocers” need to take an active role in supporting this.

April has opened eventfully around the world, when it comes to food prices.

A leading Indian business daily opened the first week of April 2008 with a story saying that chain-stores may be as much as 15-40% cheaper than street vendors for staple vegetables and fruits. When we put this against the backdrop of concerns at skyrocketing global prices of rice and fuel, as consumers we may have a reason to thank the chains for helping to balance our monthly budgets.

But is this really a victory for proponents of organized retail, or a blow against retail chains?

The same article went on to state that chain stores were offsetting the hit they were taking on food by selling other products that offered them more margin, “an option not available to hawkers”, and also quoted leading Indian retailers.

The very same day, media in Hong Kong were covering a survey that stated that supermarket prices in the city were on average 12% higher than independent grocers, with some branded products being sold for as much as 20% higher. The Democratic Alliance for Betterment and Progress of Hong Kong, which carried out the survey, cautioned consumers that they should not be misled by supermarket ads for big discounts and advised them to compare prices frequently between chains and independent retailers.

(The study did not compare price differences now to what they might have been 20-25 years ago, when the market was not so consolidated. Such a study may provide some other interesting insights.)

During the same week, the government of Ivory Coast in Africa also responded to protests by women and youth in Abidjan against rising living costs with an emergency meeting and lower import duties on key food items.

Obviously inflation, especially in food prices, is a global concern right now, so this simultaneous appearance of news across countries is hardly a coincidence.

They, however, do raise concerns about how the chain of food supply and retail is structured, and also some important questions about competitive strategy.

Let’s deal with competitive strategy first. Obviously, the terms “loss leader” or “key value item” have been coined in the last few decades, but the strategy itself has been well-known and widely used since the time humans started trading thousands of years ago. 

The foundation of the strategy is built on items that are a staple, usually widely compared by consumers or used as a benchmark when comparing different merchants.  A merchant may place a very low margin on such a product, or sell it at cost (or even at a loss).

The concept is simple: attract a customer into the store with an irresistible offer, but make sure that consumer also buys other products that provide enough profit to the retailer. 

As a consumer you may feel outraged that someone is “cheating” you, but in our “sensible” and rationally-aware moments we as customers know that this happens frequently, and know how to avoid it. However, we are not always rational – if shopping were purely a rational exercise then automated comparative software would be fulfilling all our shopping needs by now.

Stepping beyond the retailer-consumer relationship, there is also question whether this can be classified as free or fair competition when cash-rich organizations with a wide basket of goods, take the strategy to the doorstep of the small individual trader whose product offering is much narrower and usually concentrated on the staple goods that are being discounted.

There is no really easy or quick answer to this question. 

On the one hand, large retailers such as Wal-Mart, Carrefour, Tesco, Metro and others, have been widely credited for achieving cost-efficiencies from scale, and then passing on these efficiencies to the consumer in the form of lower prices (and, apparently, higher standards of living).  That is a good thing and definitely of benefit to the population at large, especially in inflationary times such as these. Rather than keeping prices high due to inefficient sourcing, wasteful and expensive handling, and non-value-adding costs in the supply chain, it is surely a good to push for lower costs.

On the other hand, there is no simple way to draw a line when competitive benefit to the consumer becomes predatory pricing within the trade. 

If a retailer took price reduction as a “strategic investment” to grow a market (as happens in markets and product categories around the world), when do you start calling it “unfair”? And should you even attempt to label it unfair? What is the cost to the market, when it could eventually concentrate and consolidate market share in few hands? Is the cost to society more in supporting small inefficient retailers, or more if these retailers lose their independence and become employees? (If you’re looking to me for the answers…sorry, I don’t have them yet!)

Value judgements are almost always subjective rather than objective. ‘Large versus small’ conflicts are frequently emotive rather than rational. And even though there are no easy answers, I believe we should think about these questions, as businesspeople, as consumers and as social individuals.

There are some rather interesting (and by no means conclusive) studies, opinion papers and books that have looked at the structure and economics of the food supply chain, but constraints of space force me to postpone that aspect to another column. The questions and competitive strategy will not be disappearing quickly, so I’m sure these will still be relevant then. 

Meanwhile, I’m sure we have enough food for thought!

A discount outlet store sells merchandise that is off-season (such as summer merchandise in winter or vice versa) or out-of-fashion (hence possibly two-three seasons old) or comprising of manufacturing over-runs.

However, in India discounts are prolific even in the high street market. In clothing as an example, a large chunk (estimates vary from 40% to 70%) of ready-to-wear stock is sold under discount. Some of it is sold in factory outlets, but a significantly larger proportion is sold throughout the year in regular high street stores under offers that run throughout the year.

There are also discount streets within the city (such as Fashion Street in Mumbai or Sarojini Nagar in Delhi) operating the year round. This reduces the benefit that a discount outlet specifically provides to the consumer.

Second, discount stores typically are based “off-locations” away from regular customer traffic. In markets such as the US and the UK, an “outlet village” may be located 50-100 km from the nearest suburban or urban centre but quite close in terms of drive time. In India currently, due to poor road conditions, the stores have to be in higher cost locations.

Most critically, a sustainable and sizeable discount outlet also needs a base of many brands that have built up high profile and that operate consistent price premium at full-price levels. The brands must have enough scale so a discounting outlet cannot damage its brand image. This enables not just standalone discount outlets, but entire “outlet villages” to be set up. These clusters can generate a much bigger and sustainable customer footfall, much like a shopping mall. That ecosystem of brands has been weak in the past in India but has recently accelerated, and we are likely to see critical mass emerging in future, which may allow the discount business to grow.

In the coming years, expect more action, with clustering of stores and brands, specialist discount malls, and possibly even innovative and India-specific models to come up. How about air-conditioned haats with proprietary bus connectivity to town centres?

Let the good, discounted, times roll.