Holiday retail: Forget rock-bottom markdowns
As retailers reduce inventory, an unexpected uptick in demand sends them scrambling.
NEW YORK (Fortune) -- Recently a friend was shopping for boots at Saks, only to be told the store was out of her size. "You're the sixth person I've had to turn away," the sales clerk said. My friend is not alone. But at a time of slumping sales, shouldn't it be easier to find what you want?
Not necessarily. It looks as if some retailers ordering merchandise in the depths of the credit crisis overestimated just how bad things would get. Now certain stores appear at risk of running short of inventory heading into the crucial holiday shopping season.
What does all this mean for consumers? While there will still be plenty of discounts this season, the markdowns probably won't approach last year's rock-bottom level. And hot items -- like Netpal laptop or Sony's e-reader -- will sell out fast. "You're not going to see merchandise piled high like you did last year," says Stevan Buxbaum, a consultant.
The cost of inventory is one of the biggest expenses for retailers, and therefore a natural place to cut when sales are falling, as they have been for most of this year. Retailers typically try to order slightly less goods than they expect to sell. It's a fine balancing act: Not cutting enough results in markdowns to clear unsold goods, while cutting too much risks turning customers away empty handed.
The former scenario played out last Christmas. Caught unprepared by the sharp slowdown in sales following the collapse of Lehman Brothers and other financial institutions, retailers were awash in extra goods. That resulted in lots of great deals for consumers, but those discounts ate into store profits.
This year, the opposite situation appears to be playing out. Retailers were extremely cautious heading into the holiday season, and some may not have ordered enough goods.
During the second quarter, for example, Abercrombie & Fitch's (ANF) inventory was down 42%, compared with a 28% decline in sales. Ann Taylor (ANN) and Talbots (TLB) both shrank inventory 30% in the period. "These are some of the biggest declines in inventory we have seen since we started tracking the measure in 1992," says Lazard analyst Todd Slater.
These retailers may have miscalculated. Suddenly, the doom and gloom of the past year has been replaced by a slight optimism. Sales at stores open at least a year in September rose for the first time since August 2008. The October figures, due to be released Thursday, are also expected to show strength.
Third quarter GDP grew at a surprisingly strong 3.5%, marking an official end to the Great Recession, although most of that growth was the result of government stimulus programs such as the Car Allowance Rebate System (popularly "Cash for Clunkers). The National Retail Federation predicts holiday sales will decline 1% to $438 billion -- less than last year's 3.4% drop.
Some analysts are predicting an even stronger turnout. Customer Growth Partners, a consulting firm, released a report last week that estimated holiday sales would rise 2.4%, compared with a year ago.
Retailers that try to reorder goods to meet this small but promising uptick in demand may run out of time. For instance, American Eagle Outfitters (AEO) has one of the more nimble supply chains, but it still takes the retailer 45 days to restock merchandise that is made in China. "Many of the companies that I cover have cut inventory too much," says Richard Jaffe, a retail analyst with Stifel Nicolaus. "What do you do Dec. 15 when you're out of goods?"
Time isn't the only problem. Dozens of Asian factories have gone bust during the financial crisis, which will restrict supply when demand picks up, says James Lawton, a senior vice president with Dun & Bradstreet, a research and credit-monitoring firm. "A lot of capacity is coming out of the system permanently," he says.
That problem is not just restricted to apparel. Lawton says he knows of one retailer forced to delay store openings because the company that made its shopping carts went bankrupt. "They literally didn't have enough carts," he says.
The lesson: If you can't live without those Christian Louboutin booties, you'd better buy them now. 
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