Off-price retailers sell clothing and accessories from major-label brands at a significant discount. These companies take advantage of overruns, canceled orders, and forecasting mistakes made by their counter-parts in the full-price retail sector. When a major designer produces more clothing than it can sell through specialty retailers or department stores, or a store can't move all of the items in a particular line, the excess inventory is sold at a 20%-60% discount to an off-price retailer. The company passes these savings onto consumers, marking up goods by a lower percentage than full-price stores and instead building their operating margins by moving a high volume of inventory quickly, at rock-bottom prices.
Off-price companies serve a special niche in the retail industry, capitalizing on volatility in consumer demand and mistakes made by designers and full-price retail outlets to keep their stores stocked with new low-price products. It is the unpredictability of the market, and the inability of designers and retail stores to perfectly predict consumer demand, that create excess inventories for off-price consumption. While a specialty retail or department store must rely on fashion trends and innovative product designs to drive profits, an off-price retailer depends instead on its ability to move high volumes of goods quickly, and on its relationships with designers and distributors who provide the low-cost inventory on which its stores depend. Off-price companies rely on extremely lean cost structures, using their scale along with sophisticated systems and distribution infrastructure to maximize productivity while maintaining the lowest possible prices for consumers.
Fashion trends are a key driver of profits in the full-price retail industry; a designer often compensates for several poorly selling products with one hot, fast-selling line. The off-price sector does not have this luxury - firms in this industry must make the right decisions about what products to buy and sell, because they operate at such small margins on each individual product. Three key factors in off-price retail profits are:
Imperfection in the retail industry is what makes the off-price model possible. When a major label like Polo Ralph Lauren (RL) miscalculates consumer preferences and over-produces a product, it will send the excess inventory to T.J. Maxx at a huge discount. The margin that RL earns on this excess inventory is dramatically less than what it earns in specialty retail and department stores, so the company looks to avoid this situation whenever possible. If companies like Ralph Lauren could predict consumer preference perfectly, off-price retailers would no longer have an economic niche - but as long as buyers remain fickle and selective in their spending habits, off-price companies will continue to fill a need in the marketplace.
The two largest firms in the off-price sector, TJX and Ross, have combined to grow sales at a Compounded annual growth rate - CAGR of greater than 10% over the past five years, well above the average annual growth rate in the apparel industry of ~4%. The numbers indicate that more consumers are looking for value-shopping options, and off-price firms are predicting similar growth in the next five years and looking to expand into new markets.
The rise in Commodities Prices, and especially the price of oil, puts pressure on the off-price industry's already lean margins. Passing these costs onto the consumer is a major risk for an off-price company that depends on its steep discounts to attract business. High commodities prices also lead to inflation, and higher worker wages, which could further constrict off-price margins. On the flip side, when consumers have to spend more on basic commodities they will look for cheaper alternatives when they buy non-essential goods like clothing and footwear, which could benefit the off-price sector.
Many analysts and investors are predicting a recession in 2008, with some arguing that it has already begun. This is due to the effects of the subprime lending crisis, which has thrown the financial services industry into a tailspin and restricted the amount of money lent and borrowed by large institutions. This has created a lack of liquidity and a Credit crunch that has slowed consumer spending and affected retail sales. Most retailers are reporting lower sales numbers in the first quarter 2008.
But the off-price sector is affected by a recession somewhat differently than its counterparts in the full-price business. Consumers are likely to become more cost-conscious in a recession, motivating them to turn to off-price stores, while large department stores and designers will have a difficult time moving products, resulting in greater excess inventories for the off-price firms.
Nonetheless, the products that off-price retailers sell depend on discretionary income. Clothing, footwear, home products, and the other items that off-price retailers offer are not necessities, for the most part. So consumers must have some disposable income to spend on retail, even at an off-price store. The advantages that an off-price retailer holds in a recession are unlikely to create higher sales numbers; but they could help off-price firms fare better than their specialty counterparts who will struggle to sell high-end products in a depressed spending environment.