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8/9/2019 paper_12995

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Despite the fact that the economy has yet to hit the official benchmark of a recession,historically defined as two consecutive quarters of declining GDP, the majority of Americansfeel the economy is in a recession. At the very least, we know there are sectors of theeconomy that are exhibiting strong recessionary indicators and the retail industry is at theforefront of those trends. With the rash of recent retail bankruptcies, store closings, andincreasingly vacant retail space it is apparent the retail industry is facing tough times.Because retail is the second largest sector in the U.S. in number of businesses and employeesand accounts for 8.3% of GDP, the implications of a retail recession are numerous and farreaching. Consumer spending also accounts for two-thirds of the national economy, giving usan indication of the relative strength of our economic times. As we have seen nationalretailers folding it is natural to wonder what the impacts will be of a slowing economy onIowa owned retail establishments and our overall retail landscape. This report presents dataand analysis for decision makers, retail business owners, and concerned residents to determinethe local impacts of tough economic times and offer solutions and means of adapting.

Introduction

CONSUMER CHOICES:SMOOTHING CONSUMPTION AND GOOD

2

BUSINESSS CHOICES:INVENTORY

3

BUSINESS CHOICES:PRICES

4

BUSINESS CHOICES:EMPLOYMENT AND LABOR COSTS

5

KEY STRATEGIES FOR CONSUMERS & RETAILERS

6

AUTHOR INFO AND DATA SOURCES & NOTES

7

Inside this Report:

September 2008

Retail Economics 101:

Lessons and Strategies of

a Recession

Current Economic Conditions

The current economic pictureis represented by a lot ofnegative headlines anddismal performance of theeconomy’s leading indicators.Some of the economic ills weare facing are rising prices,lower disposable incomes,lower savings rates, decliningconsumer spending, a housingslowdown, and risingunemployment. What theseindicators tell us about theoutlook for retailers is that therecord consumer spendingexpansion is over. Retail isthe proverbial end of theroad for a good so when itsdemand weakens the effectswill ripple though its supplychain. Now imagine its notjust the demand for a singlegood that is weakening, but

demand for most goods. Theretailer will struggle but sowill the manufacturers, theinput suppliers, the truckdrivers who transport thegoods and so on. This iswhere the concept of lag timeis important in our economicsystem. The phenomenon thatled to a decline in consumerspending and retail demandmay have been in progressfor months before we noticethe slowdown in spending.Thus the impacts onmanufacturing, distribution,and employment in otherindustries may be a yearremoved from the events thatactually triggered thedeclines. As economic forcesslow or stop altogether, retaildemand further weakens thus

exacerbating the decline. Inthe end, the retail industry asa whole takes a beating in arecession, with more losersthan winners.

Predictions for retail arenegative, with the NRFprojecting the weakestholiday season in six years. Itis not only possible, butprobable that the retail

sector will not even meet thelowered expectations of thisyears forecasts. This willmean significant hardship formany Iowa businesses andcommunities. Understandingwhat businesses can do tohelp weather the stormdepends on theirunderstanding of the uniqueattributes of their businessand environment.

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The basic economic conceptof consumption smoothing can

help us understand how thecurrent retail situation hasdeveloped and what we canexpect next. Consumptionsmoothing refers to anindividual’s preference tomaintain a certain standardof living over time. All thingsconstant this means anindividual will use savings asa tool to compensate whenincomes are low or save morewhen incomes are high thus

“smoothing” their consumptionpatterns. This doesn’t meanthat spending doesn’tincrease or decrease asincomes levels change, butrather that the peaks andvalley’s will be less dramatic.

The theory suggests thatpeople won’t spend one lessdollar for every one lessdollar that they earn, andvice versa. Evidence of thistrend can be found in the

proliferation of credit cardsand their increased use inrough economic patches.Because a certain amount ofpeople’s consumption is fixedand doesn’t vary with income,shortages are made up bydipping into savings or debtto maintain ones standard ofliving. Financing personalconsumption when income isdecreasing comes down to achoice between debt and

equity, and most recentlywith the historic rise in housingvalues we saw thisframework altered. Ashousing prices wereincreasing, individuals hadmore paper wealthtriggering spending increases

Consumption Smoothing and Good Substitution

Page 2

Retail Economics 101: Consumer Choices

“IN MANY CASES,

SAVINGS ARE

EXHAUSTED AND

CREDIT CARDS ARE

MAXED OUT

FORCING PEOPLETO ACCEPT LOWER

LEVELS OF

CONSUMPTION

AND A REDUCED

STANDARD OF

LIVING.”

as though that paper wealthwas a real stream of income.

People feeling wealthier,spent more money, fueling thetremendous consumerexpansion simultaneous withthe growth of the housingmarket. In the infancy of therecent growth in these twosectors, individuals paid offcredit card debt accumulatedin the prior recession byrefinancing their homes. Inthe infancy of the recentgrowth in these two sectors,

individuals paid off creditcard debt accumulated in theprior recession by refinancingtheir homes. Unfortunately,real incomes were not risingduring this period and manypeople smoothed their new“wealthier” consumptionlevels with more credit carddebt. Many householdsrefinanced their homes morethan once during thisexpansion, only to be faced

with the dismal reality thathome prices cannot continueto increase at the current rateand the equity in one’s homedoes not have the samewealth effect of a liquid assetsuch as traditional savings.

We are now in a periodwhere many people haveexhausted the safety nets thattypically sustain a minimallevel of consumer spending.In many cases, savings are

exhausted and credit cardsare maxed out forcingpeople to accept lower levelsof consumption and areduced standard of living.This response to economictimes furthers the downturn,and increases its duration.

While consumption smoothingexplains the fundamental

choices behind savings andspending for the consumer, itdoes not explain their specificspending decisions. During arecession, the typicalconsumer is forced to makedifficult decisions andeconomic tradeoffs. In termsof consumption, we often seethese choices manifested assubstitution between goods.When budgets areconstrained, the typical

consumer will substitute downor choose an inferior good.An example of trading downwould be substituting groundbeef for steak. Otherexamples might be buyingfrozen fruit instead of freshor purchasing the store brandrather than a name brand.This trading down is a type ofconsumption smoothingallowing the consumer to getthe same level of consumption

but at a lesser quality perunit. This theory of goodsubstitution holds when thereare inferior goods to tradedown to and they arereasonably good substitutesfor the more expensive good.

Another example of this goodsubstitution at work is in theconsumer’s choice of where toshop. While most retailersare experiencing salesdeclines, discount retailers

are thriving as people tradedown from expensivespecialty and departmentstores to shop at discount andwholesale stores. Thesetrends have great impacts ona retailer’s strategy to survivea recession or downturn.

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The art of maintain the profitmaximizing level of inventory

is difficult in the best ofeconomic times, during arecession it becomes bothmore critical to success andmore difficult. For smallretail businesses andindependent stores this task isincreasingly complicated dueto payment terms andminimum order sizes. It isnecessary to reduceinventories for most retailestablishments particularly

those specialty items thataren’t frequent sellers.Reducing existing inventory istypically done via in storesales and specials allowingthe retailer to convert someof their existing assets intocash. Converting inventory tocash is an important first stephowever, most retailerscannot sustain themselvesthrough a recession onexisting inventories and

therefore must place ordersfor new inventory under agreat deal of uncertainty.This reduction in demand fornew inventory sends ripplesthroughout the supply chainand coupled with high fuelprices results in largerminimum order sizes and lessfavorable terms for delayedpayment. The wisest retailstrategy under thesecircumstances is to order the

minimum necessary to sustainexisting demand. This is adifficult balancing act as noretailer wants to take thechance of being out of amainstay item and sending ashopper to another retailer ina competitive market. A wisestrategy is to have ample

supply of items that sell dailyor frequently, typically these

are the items that get peopleinto the store. Anotherstrategy is to vary selection,offering less high end itemsand more inexpensive tomoderately priced items forbudget conscious consumers.Additional consideration is inthe appearance of the storeas minimal inventories canconvey a negative impressionto customers. Often a wellstocked store implies a

certain success to customersand encourages a betterrelationship. One means inwhich to convey the samemessage to consumers withreduced inventories is tochange the appearance ofthe store and displays. Arestaging of the layout of thestore can be doneinexpensively and with greatresults and impact. Optimalmerchandising and use of

space is one non-pecuniarymeans retailers have toimprove their chances ofsuccess.

Suppliers facing their ownconstraints and recognizingretailers need to pull back oninventory spending will offerdeep discounts to retailerswho place large orders orpay their invoice quickly. Forthe majority of small and

independent retailers these“deals” are a bad idea andcan deepen the pain of adownturn. The discounts areintuitively appealing toretailers, however inventoryis only as useful to a retaileras its ability to be convertedto cash quickly. So while a

70% discount on a uniqueitem may come along once

every five years it will beuseless if the item is only soldonce a month and many mustbe ordered.

During tough financial timessmall retailers must put theirliquidity ahead ofconsiderations such as profitsand markups per unit. Oftenretailers are hesitant toliquidate or reduce inventoryat a loss per unit in toughtimes and therefore feel a

cash-flow crunch. With nocash safety net or reserves,any additional shock to theirdemand can makefundamental businessexpense payments difficult tomaintain. During a recession,many retailers wind up inbankruptcy for these reasons.Another common mistake is tonot anticipate the downturnor underestimate its severityand duration resulting in

changes being made too lateto be effective.

To withstand the tough timessmall retailers must be honestabout their sales prospectsand make difficult choices.The first step is to analyzethe inventory for the musthaves or staple items andthen actively reduce the stockof non-essential items. Nextretailers should set limits for

ordering new inventory andplan for its ongoingmanagement, presentationand marketing. Finally, thekey is to try and acquire asmany months of cash reservesas possible that would paybasic expenses such as rent,utilities, and wages.

Managing Inventories and Costs

Page 3

Retail Economics 101: Business Choices

“DURING TOUGH

FINANCIAL TIMES

SMALL RETAILERS

MUST PUT THEIR

LIQUIDITY AHEAD

OF

CONSIDERATIONSSUCH AS PROFITS

AND MARKUPS

PER UNIT.”

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Retailers from clothing storesto restaurants are

experiencing rapidly risinginput and inventory prices.Inflationary pressurescoupled with the recessionmake it even more difficultfor retailers to survive. Thereason is that these increasescannot simply or universallybe passed on to consumers,not when they aredramatically cutting back onspending. Additionally, formany retailers and business

owners there is an expense tochanging prices and withuncertainty about theduration of the downturnthese decisions are moredifficult.

The goal for many businessowners during a recession isto maintain their currentlevels of income or profit.Perhaps they don’t expect togrow but they certainly don’twant to lose money. This

motivation is why it seemsintuitive to raise prices whencosts increase, however thisstrategy may actually resultin less income for the businessowner. In principle a goodhas a price that is so high, thequantity demanded by theconsumer will be zero, andfor many goods if the pricewere zero demand would beinfinite. What happens inbetween? The answer

depends on the type ofgood, and its elasticity. Theprice elasticity of a gooddescribes how strong theresponse of the consumer is inthe quantity demanded of agood when the pricechanges. An inelastic goodexhibits little change in the

amount demanded by theconsumer when prices change

while an elastic good seesmore dramatic changes. It isunrealistic to think a retailerwill know the exact elasticityof a good, howeverunderstanding the nature ofdemand for a good enhancestheir decision making ability.

Pricing goods based on theirelasticity is a smart retailstrategy during a recession.Examples of inelastic goodsare gasoline (at least in the

short run), water, and goodsthat typically do not havegood substitutes. Elasticgoods such as dining out,luxury automobiles, andsugar have many substitutesand therefore price increasesresult in less quantitydemanded. The lesson for aretailer is to not raise priceson those goods that yourcustomer can live without orgo down the street and

purchase in a less expensiveform. A gourmet grocerraising the price on aimported spaghetti sauce byone dollar would befoolhardy when a lessexpensive substitute isreadily available.Conversely, daycareproviders may find that in theshort run they can increasetheir fees due to rising costsand not see a decline in

revenue.

Another reason some retailersmay find changing pricesdifficult is that the process ofchanging prices has a realcost. This economic concept isknown as menu costs and asthe name suggests is based

on the cost to restaurant ofhaving menus reprinted to

reflect new prices. Withoutknowing how long inputprices will be affected it isdifficult for some firms toincur the additional expenseto raise prices. Thistransaction cost theory hastruth to it but is lessapplicable when input pricesare rising due to long termeconomic trends and less inresponse to shocks. However,this theory does point to an

interesting dilemma forrestaurants. It is more costlyfor a restaurant to raiseprices due to menus andcompounding the problem isthat dining out is an elasticgood. When the economymoves into a recession,people cut back on dining outand substitute eating at homeor at less expensiverestaurants such as fast foodfranchises or the new quick-

service types. Raising pricesfor a restaurant candecrease revenue much morethan it would otherwisedecrease due to smallerprofit margins. In the shortrun, retailers and restaurantowners may not have theopportunity to change theirprice structure. However,businesses can prepare forthe long run by thinkingabout the choices consumers

will face and adjusting thetypes of goods they offerand the range of prices theycharge. For a restaurant thismay mean offering lowerprice options as specials,using less expensive fooditems, and offering some selfservice items.

Raising Prices in Times of Rising Costs

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According to National RetailFederation research, retail

and food and drinking placesemploy more workers than allother sectors of the U.S.economy. With one in fiveworkers occupying a job inthis sector, the impacts of aretail recession onemployment will besignificant. During the recentboom in consumer spending,the retail sector addedhundreds of thousands ofjobs. Data from the BEA and

BLS from 1980-2003illustrates that retailemployment exhibitedaverage annual growth ofmore than 1% despite tworecessions and one downturn.The fastest year to yeargrowth occurred in the1980’s following therecession lasting from 1980-1982 with average annualgrowth in retail employmentgaining 4% between 1983-

1985. During the recessionsbeginning in 1980, 1990 andthe slowdown in 2001 theretail industry saw declines in

employment. The averageannual employment declined

during these events at .8%.BEA data indicates thatIowa’s retail sectoremployment followednational trends over the longrun but has deviated in thetiming of adjustments. Duringthe recession 2001-2003retail employment declinednationally as well as in Iowa.Prior to 2001, Iowaemployed a largerpercentage of its 2001 retail

labor force than the nationdid and following therecession, Iowa reemployedits retail labor force at alower rate than the nationdid. Iowa’s retailemployment began decliningin 2007 while the nation’sretail employment was stillincreasing indicating Iowa’sadjustment to the recessionmight be more gradual.

The data illustrates that retailemployment responds quicklyto economic conditions, andcautions that the individual

retailer is currently facingdifficult decisions with respect

to levels of employment andoverall labor costs. Withinput costs rising andstructural rigidities affectinga retailer’s ability tomaximize revenue, laborbecomes an avenue forretailers to reduce costs.Some options businesses useto avoid laying offemployees is reducing hoursfrom full to part time, usingless employees per shift, and

reducing store hours. Noneof these are desirablesolutions as employees areoften family in smaller retailestablishments and reducinghours makes it more difficultto compete with discounters.Another option retailbusinesses often revert to isbecoming a non-employeeestablishment to weatherthese downturns. Again, thedecline in retail employment

has ripple effects throughoutthe economy and forces theindividual retailer to maketough decisions to survive.

Employment and Labor Costs

Page 5


IOWA’S RETAIL

EMPLOYMENT FELL

BY NEARLY 3%

DURING THE

MIDDLE OF THE

MOST RECENT

DOWNTURN

SOURCE:

COUNTY BUSINESS

PATTERNS, US CENSUS

BUREAU, 2001-2003

90.00%

92.00%

94.00%

96.00%

98.00%

100.00%

102.00%

104.00%

1998199920002001200220032004200520062007

Retail Employment Indexed to 2001 Levels

Iowa

National

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1. Now is a good time to be a consumer. You might have less money to spend but

retailers want your money more than anytime in recent history. Take some time to shoparound for the best prices, environment and service.

2. Your dollar is your vote. If you really enjoy shopping at a local retail store don’texpect it will be waiting for you to come back if you switch your shopping habits.Choose where you spend your dollars based on whom you would most like to continuedoing business with.

3. Be reasonable about where you travel to shop. Driving an additional ten miles to save$1.00 probably isn’t worthwhile, try and maximize your savings per trip.

4. Limit credit card use. Retailers may be running great specials but stocking up at 70%isn’t saving you money if the balance stays on your credit card for multiple billingperiods.

Tips for Consumers and Retail Shoppers

Tips for Retailers and Business Owners:

1. Just like consumers shouldn’t rely on debt to purchase items at a discount neither shouldyou. Financing unnecessary inventory with debt because it is being offered at reducedprices won’t make you money in the long run.

2. Offer consumers lower price substitutes in your store. Lower price point options maykeep a consumer in your store from shopping at a discounter.

3. Don’t be afraid to have sales or specials to move inventory. The downturn won’t lastforever and getting more people in your store or restaurant is the key to building longlasting customer relationships and repeat business. You might not make the same profitper item or entrée that you were prior to the downturn, but you are making sales andmeeting customers.

4. Don’t assume the raising prices will keep your revenue stream stable during adownturn. The price elasticity of the goods you sell will determine whether you canraise prices or not. Do not raise prices on highly elastic goods as this will reduce thequantity demanded dramatically.

5. Know your inventory. This might include keeping detailed records or journals of whatyou sell the most of and to whom. Pay attention to your competition and their prices.

Being in touch with the nature of your inventory can limit lost revenue with respect toprice changes and stocking of inventory.

6. Consider low to no cost options to revitalize your space. Changing the layout of yourstore can add instant appeal with little or no expense.

7. Be prepared to make some sacrifices and tough choices. Plan for the future and thinkstrategically about where you want to be when the down time ends.

8. Listen to your customers, they are your greatest asset.

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Retail Economics 101

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Author: Meghan O’BrienReCAP, Iowa State University

Department of Economics

Phone: 515-294-4095

[email protected]

www.recap.iastate.edu

For more information about retail trends and performance in Iowa’s communities please contact the

author or visit the ReCAP website to view online copies of retail reports for all 99 Iowa Counties

and over 700 Iowa cities. Data used in this report can be found at the following websites:

www.bls.gov

www.bea.gov

www.census.gov

Additional Websites of Interest:

National Retail Federation, www.nrf.org

Plunkett Research, www.plunkettresearch.com

Market Watch, www.marketwatch.com

The U.S. Department of Agriculture (USDA) prohibits discrimination in all its programs and activities on the basis of race, color, national origin, gender,

religion, age, disability, political beliefs, sexual orientation, and marital or family status. (Not all prohibited bases apply to all programs.) Many materials can bemade available in alternative formats for ADA clients. To file a complaint of discrimination, write USDA, Office of Civil Rights, Room 326-W, Whitten

Building, 14th and Independence Avenue, SW, Washington, DC 20250-9410 or call 202-720-5964.

Issued in furtherance of Cooperative Extension work, Acts of May 8 and June 30, 1914, in cooperation with the U.S. Department of Agriculture. Jack M. Payne,

director, Cooperative Extension Service, Iowa State University of Science and Technology, Ames, Iowa.

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