Prices Fall To Match A New Frugality
Retailers Respond To Shopping Habits Forged in Recession

By Ylan Q. Mui
Washington Post Staff Writer
Tuesday, May 12, 2009

The nation's retailers have begun to embrace the new cost-conscious consumer, developing products they can sell at lower prices without driving themselves out of business in the post-splurge era.

Starbucks dropped the price of a medium iced coffee last week to just under $2. American Eagle cut out the ribbon from the inside waistband of its khakis and lowered the cost. Pottery Barn launched a new "Comfort Collection" sofa that starts at $999.99, which is $300 less than the "Basic Collection" sofa. Even Rock & Republic, whose trendy denim has graced the backsides of celebrities such as Victoria Beckham, recently unveiled a line of recessionista jeans selling for $128, a 29 percent reduction.

Retailers have absorbed the lessons of a ruinous holiday season. Caught with shelves full of unsold merchandise, they slashed prices to draw in shoppers. But the strategy was unsustainable: It decimated profits and resulted in massive layoffs, killing off a number of chains, including Circuit City. Serving recession-era shoppers, retailers realized, would require a long-term strategy featuring lower prices.

"What we have is retailers reacting to a very low-appetite consumer and a consumer that has been now taught to wait," said Michael Silverstein, senior partner at Boston Consulting Group.

The new consumer has curtailed spending and increased savings to 10-year highs. Smaller houses are newly coveted, bringing the average size of a new home down in 2008 for the first time in 35 years, according to the National Association of Home Builders. Fancy dinners out have been scaled back, prompting restaurants to reconfigure their menus. (Clyde's created a cheaper entree by offering one crabcake instead of two last month.) A recent survey by Boston Consulting Group found that 48 percent of consumers said they traded down on products last year, an increase from 41 percent in 2007. The number of shoppers trading up fell by six percentage points.

Retailers reassess their prices and their assortment of products every season. But this year, they are being particularly conservative. They are less willing to take risks on trendy, unproven merchandise and are stocking tried-and-true customer favorites. They have been reducing inventories; import cargo fell to the lowest level in seven years in February, according to an industry trade group. Many are putting more emphasis on lowering prices on the cheapest version of their products.

Consumer prices fell on a year-over-year basis in March for the first time in more than half a century, driven primarily by plummeting energy and transportation prices. Apparel and food prices increased during that period but fell on a monthly basis. Some economists have worried that falling prices could result in deflation, but Hemant Sangwan, a consultant with IHS Global Insight, said he doesn't think that is a danger in the retail sector. He considered the price cuts more of a marketing strategy to win over reluctant shoppers.

"Prices, especially in the retail sector, are very easy to change," Sangwan said. "As soon as the nature of consumers will change, prices will respond in the same way."

Some price reductions have come from stripping out fancy details for which retailers once charged a premium. Production costs have also dropped, allowing sellers to pass on the savings. Retailers are streamlining supply chains and creating new merchandise with cheaper components and lower prices. In some cases, they are sacrificing profits and hoping to make up the difference in volume.

Gretchen Hitchner sent back the $400 cocktail dresses she ordered from a vendor in favor of stocking up on a more versatile minidress that sells for $98 at her Bethesda boutique, Ginger. She cut her purchases for the fall by roughly 20 percent and is trying to offer more clothing for less than $200.

"You take a chance every season with every style," she said. "It's a whole different story this year."

Starbucks chief executive Howard Schultz said the company is tweaking pricing on its coffees after closing hundreds of stores over the past year. "Grande" iced coffee began selling for $1.95 last week, down from $2.25 in the Washington area. The company is also lowering prices on popular beverages such as tall lattes in some markets, though it is also raising the price of larger, more complex drinks.

"Consumers want to feel good about every hard-earned dollar they spend, and we certainly understand that," Schultz told analysts.

Profit at the accessories manufacturer Coach fell 29 percent to $115 million, during the most recent quarter, compared with the previous year. The company responded by repricing its merchandise 10 to 15 percent lower and offering more styles for less than $300. Next fiscal year, it plans for nearly half of the merchandise in its stores to cost $200 to $300, compared with 30 percent selling in that range this year.

J. Crew, meantime, now sells a new, more basic version of its popular ballet flat for $98. The cheapest ballet flat previously cost $118. This fall, the retailer plans to lower the price of its entry-level jeans by about $20 from $92.50.

"We do know for sure that there is an enormous price sensitivity out there," chief executive Millard S. Drexler said in a recent conference call with analysts. "We're just being real conservative now."

Williams-Sonoma, which owns the eponymous cooking store, said it is working to sell key items for less than $100 and lower prices on glassware and cutlery. Its home furnishings chain Pottery Barn was able to control costs on its new $999 sofa by manufacturing the frame in its factory in western North Carolina, Pottery Barn President Sandra Stangl said.

"It's comfortable, it's easy and relaxed, and I can afford it," Stangl said of the sofa. "Pricing, especially during these really tough economic times, is extremely important to our customers."

Getting shoppers to spend without resorting to discounting is crucial to retailers' bottom lines. According to Silverstein, gross profit margin on "first delivery" merchandise can reach 60 percent or more. After the first markdown, the profit margin shrinks to 40 percent. The second price cut slashes the margin to 20 percent.

But it remains unclear whether consumers are willing to open their wallets. Retail sales were down 10.7 percent in March from the same month last year, according to government data. Unemployment is near 9 percent, wage growth has stalled, and home prices continue to fall.

"I'm seeing it kind of sucks," Drexler said. "I wish I had a better answer. I wish we could see the road map more clearly. It's just not the case."

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