BrainTrust Query: OK, it's official - deflation is a real threat. What now?
The consumer price index had its largest decline since World War II in October. Regulators are pondering whether they need to step in to prevent a long period of price declines. How should retailers react?
The dirty little secret about inflation is that it actually enables retailers to make money on inventory as prices rise faster than acquisition costs and they sell low cost inventory at higher retail prices. Now retailers are facing falling acquisition costs and consumers who are willing to postpone purchases in the expectation of even lower prices. Retailers must meet these lower price expectations in order to get consumers to buy, regardless of what the inventory acquisition cost may have been. Earlier negotiated wage and rental rates now seem inflated when compared to current commodity costs. So you have strapped retailers facing lower margins and outsized labor and rent costs. Not a real pretty picture.
At this point it is still uncertain whether October was a blip or if we're headed for a protracted period of declining prices. But for retailers facing the current economic climate, there are some key steps that can be taken to reduce exposure. Inventories must be reduced; it is no longer economical to carry slow moving items or over allocate shelf space to accommodate excessive case packs. Carrying safety stock has now become more expensive, so greater tolerance of out of stocks may make sense in some categories. Retailers must consider negotiating more aggressive terms for "stock protection" in order to reduce the impact of cost declines on previous purchases.
Wages are the classic example of a "sticky downward variable." It is very difficult to reduce wages; instead the general reaction is to lay off workers or reduce employee hours. I have read about past efforts to avoid layoffs by getting the workforce to accept wage reductions. Those situations are rare but non-union (and possibly union also) retailers need to start considering how they are going to handle this. A lot of human resource departments are going to be busy trying to explain this to employees.
Finally, rents may be a factor. To some extent, rents based on sales or other performance requirements may be self-correcting but others will require some negotiation with owners. The good news is that maintenance costs and possibly tax rates should be declining. This will provide room for the landlord to make adjustments.
Discussion Questions: So, is deflation here to stay? What are some other things retailers can be doing now to cope? Could wages ever be reduced?
[Author's commentary] I tended to emphasize the cost reduction aspects for responding to deflation, but there is also a revenue aspect. Retailers must do more to get reluctant shoppers into the store by offering incentives for them to visit. These could involve emphasizing a few loss-leaders or some other "too good to miss" opportunities that attract consumers. It is going to be difficult to get consumers to make a purchase, so retailers with their own credit card program may do better. But the credit card carries its own risks as laid off consumers are unable to keep up with payments. Layaway plans reduce loss exposure because the merchandise serves as collateral, but layaways face the same issues as declining inventory values.
Let's hope October was a blip.