Wednesday, Sep. 03, 2008

Heavy discounts called a costly move

Analysts wary of long-term problems with the strategy

In a bid to pull hesitant shoppers into their stores, retailers are slashing prices on everything from jeans to dinnerware. But those fat discounts will likely come at a big cost for the companies.

At teen retailer American Eagle Outfitters Inc., shoppers who buy jeans get a second pair at half off. Jewelry chain Zale Corp. is offering an extra 20 percent off on a slew of items like gold earrings that were already slashed up to 70 percent. Pottery Barn has discounts of up to 75 percent.

"There's a fine line between aggressive promotions and panic, and we are seeing a little bit of both right now," said Dan Hess, founder and chief executive of research firm Merchant Forecast.

Though retailers entered the fall season with inventories well below last year's, analysts said many were still a little too hopeful. August sales are turning out to be even weaker than expected, which analysts fear could lead to more piles of marked-down merchandise on the floor. That could in turn hurt third-quarter profits as the industry prepares for the critical holiday season.

Major retailers, including Wal-Mart Stores Inc., J.C. Penney Co. and Gap Inc., which also operates Banana Republic and Old Navy stores, are slated to announce final August sales results Thursday.

Hess estimated that discounts are 10 percent deeper at mall-based apparel stores than a year ago, despite a drop of 10 percent to 15 percent in inventories.

"Even though retailers are entering the season conservatively, they still have been too optimistic about the consumer," he added.

Stifel Nicholas analyst Richard Jaffe noted that the weak sales trend suggests a downturn that more closely resembles the one of the mid-1970s than more recent difficult periods.

"It's a more prolonged consumer spending downturn," he said. "It's going to be tough. There's no quick way out of it."

Offering such deep discounts can cost high-end retailers such as Nordstrom Inc. and Saks Inc. in ways beyond lower margins or falling profits. By doing so, analysts said, they risk hurting the cachet of their brands.

Retailers also could lose the power to raise prices once the economy improves. The longer stores offer generous discounts, the more used to them buyers will get and resist buying items at regular prices later on.

Many economists predict that the economy is unlikely to improve until at least well into next year. The latest economic reports show consumers are still struggling to keep up with soaring living expenses. The Commerce Department reported Friday that personal incomes plunged in July, and consumer spending slowed significantly as the impact of billions of dollars in government rebate checks began to fade.

Despite a slight improvement in consumer confidence in August according to The Conference Board, helped in part by lower gas prices, the level is still near historic lows as shoppers worry about the job market and the housing slump.

The malaise is hurting all income levels, including more recently the affluent shoppers.

Retailers overall are expected to report a 2 percent increase in same-stores sales for August on Thursday, with discounters expected to keep faring much better than the slumping apparel-based stores, according to the International Council of Shopping Centers-UBS index. Same-store sales are those at stores open at least a year, and are a key indicator of a retailer's health.