Inflation Rears Its Ugly Head

Discussion
Apr 21, 2008

By Tom Ryan

Another retro trend from the seventies is working its way back to retail. Unfortunately, it’s inflation.

Retail prices are expected to rise in many categories – e.g., apparel, footwear, toys and electronics – that have largely enjoyed a deflationary cycle over the last two decades. For retailers, many will be challenged to raise prices without irritating customers who have grown used to bargains.

Writing for Slate.com, Alexandra Harney, a former Financial Times correspondent and the author of The China Price: The True Cost of Chinese Competitive Advantage, says some prices are already rising, but it should become more evident in the second half of 2008 and even more in 2009.

The reason for the price gains are mainly due to higher manufacturing costs coming from China. Among the factors driving up the gains: rising wages in China, the devaluation of the dollar against the (RMB), escalating raw material costs such as steel, and rising fuel costs that are increasing freight costs and the cost of plastic. And many of these drivers – particular the weakening dollar against the yuan – are expected to get worse before getting any better. According to an article on Slate.com, some Chinese factories are now asking their American customers for price increases of as much as 20 percent to 30 percent.

“This is only the beginning: We’ll be paying higher prices for Chinese goods for years to come,” she writes.

That leaves American retailers to devise new pricing strategies to avoid overwhelming consumers hooked on $3 T-shirts and $30 DVD players. A manager of several discount stores confided to Slate.com that his company has started raising prices of certain goods while putting others on sale. Others are considering bringing in lesser quality goods to meet price points expected by consumers, or being more aggressive around opportunistic buys.

Longer term, suppliers will be challenged to find a manufacturing hub as cheap as China. Other countries seen as possible replacements, such as Vietnam and India, don’t have infrastructure to handle the volume production that the world depends on for cheap goods. Other countries expected to gain a stronger look include Indonesia, Mexico, Malaysia, as well as Brazil or Kenya.

“Every country, however, offers its own special risks: strong labor unions in one, political instability in another. None offers the one-stop shop appeal of China, where factories make everything under the sun,” writes Ms. Harney. “For the time being, then, we will all still be buying a lot of ‘Made in China’ products – and paying ever more for them.”

Discussion Question: How can a retailer maintain its value proposition to consumers in industries facing inflationary pressures? Should they be raising prices sooner rather than later?

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7 Comments on "Inflation Rears Its Ugly Head"


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Max Goldberg
Guest
14 years 1 month ago

There are many ways for a retailer to differentiate itself from its competition. Price is only one factor. A retailer’s pricing policy is one decision. Quality of goods is another. Customer service is a third. Consumers might be willing to pay more if they know that they will be treated with respect from knowledgeable sales associates and the customer service staff. Retailers must return to the core attributes of their brand and position their offerings in line with those attributes.

Bill Bittner
Guest
Bill Bittner
14 years 1 month ago

There is actually a silver lining in the whole inflation scenario. As consumers grow to expect price increases generated by higher energy costs, the retailer sees the value of inventory in storage and on the shelf go up. Retailers also begin to see higher nominal dollar profits as the same gross margin generates more dollars. As long as wages stay down, the ultimate bottom line increases.

While the cost of heat and electric are both rising, I don’t think either commercial rents or labor costs are going to increase much. Combine this with smart retailers generating more revenues from the virtual market (i.e. the Internet), and you have a real opportunity for savvy retailers to profit in the near term environment.

Now let’s just hope the consumer can continue to afford to participate.

David Livingston
Guest
14 years 1 month ago

Prices are determined by the market and not simply a retailer making a decision based on inflation. Retailers can only raise prices if their competitors are raising prices. Look at gas stations. How do they maintain their value proposition? You maintain your value proposition by simply having competitive pricing.

Warren Thayer
Guest
14 years 1 month ago
According to IRI, on average, a 10% price increase in 2008 will reduce volume by 13.7%, vs. only 12.1% prior to 2006. Private label and lower-end lines can be expected to outperform their counterparts in inflationary times, but–all else being equal–this shouldn’t lead retailers to significantly change their product mix or dive into deep promotions. The temptation is to try to make up for slower sales by abandoning an EDLP program in favor of a hi-low or hybrid program to bring more shoppers into the store. Recently, I was speaking with Hoss Tabrizi, senior VP of advanced analytics at IRI, and he points out that you may succeed in getting more transactions but eventually this strategy will lead to reduced profitability. Some vendors–afraid of the share impact of a price hike–put through aggressive deal discounts at the same time to ease the pain, he notes. “They may be afraid of losing share right after a base price increase and therefore they try to do a BOGO immediately after a price increase to gain back some… Read more »
Ryan Mathews
Guest
14 years 1 month ago

Amen Warren. Put me in the camp that says a modest real increase in cost is more palatable long-term than “now you see it, now you don’t” discounts that actually erode retail margins and, in the end, increase consumer costs.

Mike Osorio
Guest
Mike Osorio
14 years 1 month ago

I predict the silver lining in the current situation will be the failure of several so-called retailers which are really private equity owned financial instruments (some of which has already started). When a retailer’s strategies are based on the basis of short-term financial results needed by short-term financial owners, a sustained downturn will frequently crush that retailer. The ability of a retailer to raise prices appropriately based on real market conditions depends on the level of trust built with their customers over time. Trust comes from strategies based on the customer and the brand vision. Retailers who have built trust can phase in price increases because their customers will trust that this is appropriate given the market realities.

Prices must be raised now vs. later to ensure the continued financial health of the enterprise. Those retailers with strong trust-based relationships with their customers will continue to thrive, and those that don’t, won’t.

Mark Lilien
Guest
14 years 1 month ago

Inflation isn’t always ugly. It’s often a sign of vitality. Recently oil prices declined because investors anticipated weak demand. Then oil prices increased because it seemed that demand would be strong. Retailers often assume that more units sold = greater success. Profitless volume isn’t a reasonable goal.

And increased Chinese costs might help some marginal American manufacturers. Furthermore, the world becomes a more stable place when desperately poor people gain some income. So if cheap labor sourcing shifts from China to other places, won’t that make the world a better place?

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