Luxury brands get Sak’ed …

Excerpted from WSJ, “Saks Upends Luxury Market With Strategy to Slash Prices” By V. O’Connell and R. Dodes, Feb 9, 2009

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When Saks Fifth Avenue slashed prices by 70% on designer clothes before the holiday season even began, shoppers stampeded …
Saks’s deep, mid-November markdowns were the first tug on a thread that’s now unraveling long-established rules of the luxury-goods industry. The changes are bankrupting some firms, toppling longstanding agreements on pricing and distribution, and destroying the very air of exclusivity that designers are trying to sell.

The problem Saks faced last November is one that haunts the U.S. economy as a whole: From car makers to home builders, companies are stuck with inventories that are far too fat.  Saks’s risky price-cut strategy was to be one of the first to discount deeply, rather than one of the last. Managing high-fashion inventory is tricky. Clothing can go out of style in just months, so stores don’t want to keep it around. But cut prices too soon or too deeply, and shoppers start to expect it …

Pressured by Saks, and hit by the worst holiday season in almost 40 years, rivals including Neiman Marcus Group Inc. and Barneys New York slashed prices, too. They cut much more deeply and aggressively than usual … That, in turn, clobbered smaller boutiques …

Saks’s maneuver marked an open abandonment of the longstanding unwritten pact between retailers and designers over when, and to what extent, to cut prices. Those old rules boiled down to this: Leave the goods at full price at least two months, and don’t do markdowns until the very end of the season.

That worked fine in the good times. Demand was high, and so were everyone’s profit margins. But Saks’s surprise discounting forced companies and brands that have their own retail operations … to follow suit or forfeit sales. Giving designers a heads-up wasn’t an option, Saks says, without risking that rival department stores get wind of its strategy …

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Perhaps the biggest consequence is that customers are now questioning the entire premise of luxury goods: Why pay top dollar today if big markdowns could be coming tomorrow? … Designers are starting to fight back … Some are thinking about splitting their product lines or withholding some top items from department stores in order to feature them in their own stores … Diane von Furstenberg says another solution might involve producers leasing space in department stores

Mr. Sadove [Sak’s CEO] says he’s working on damage control with designers … Still, he and Mr. Frasch, defend their actions, saying they needed to swiftly fix a big problem that no one saw coming … The change happened “over as short a period of time as you can possibly imagine” … The result: a huge disconnect between Saks’s inventory and shoppers’ appetite …

So [Sadove] floated the idea of deep price cuts. Some colleagues urged drawing the line at 50%. But Mr. Frasch felt strongly that wouldn’t be enough … Their decision: A 70%-off sale would be used, but only in a worst-case scenario, if sales kept declining and shoppers remained bored by less eye-popping 40% rollbacks.

Extreme discounting of luxury goods is perilous. Not only does it potentially leave your best customers feeling duped for paying full price, it also erases fat profit margins of 50% or more … Part of the problem is the designers’ own fault. Over the past 15 years, their products have become so ubiquitous — Gucci is sold in airport, Hermes has mall shops — it’s undermining the image of exclusivity. In a January survey of rich shoppers … roughly half of high-net-worth consumers said luxury brands are becoming commoditized; 64% said they were overpriced …

In hindsight, Saks executives say they may have cut too much in some areas. “We didn’t need to do what we did in accessories” … High-end shoes and handbags would probably have sold out, even at higher prices, because shoppers see them as more practical wardrobe updates than another new outfit …

This year, Saks is spending about 20% less on merchandise to keep inventories lower, but Mr. Frasch acknowledges the number is only a guess. The luxury-goods business is “absolutely flying blind,” … Mr. Sadove, agrees. “One of the big questions that people are asking,” he says, is: “Will people ever buy at full price again?”

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