The Impact of Market Consolidation

We’re all watching the continuing rationalization of our retail space.  I suppose “rationalization” is a way too benign sounding word for a process that includes bankruptcies, store closings, job losses, margin hits, too much inventory, and struggles to increase sales and even to stay in business.

As ugly as this continues to be, there are going to be opportunities for the brands and retailers who get through it.  I’m going to take some comments from Dick’s Sporting Goods most recent conference call to help us think about the upside and downside of the process.  Dick’s, I suspect, will do just fine over the medium to long term because with the demise of The Sports Authority, there just aren’t that many larger, national big box competitors left (Academy has like 200 stores in 15 mostly southern states.  Who else?).  Dick’s ended their most recent quarter with 647 Dick’s stores.  They also own Golf Galaxy and have some Field and Stream stores I guess.

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Retail and Brand Strategy: Cycles or Long Term Trends?

Could this time really be different?

Recently, a couple of retail CEOs have been pointing out, or maybe bemoaning, the lack of a strong retail trend. They’ve noted how in the past they’ve been able to rely on such trends for big sales boosts and have explained their worse than expected performance partly by the lack of it.

They say, “But that will change.” I’m sure they are right. It will change.   Their implication, however, is that this is a traditional retail cycle of relatively short term duration. I’m not so sure about the “short term” part.

It’s a bit awkward for me to be asking, “Could it be different this time?” because I’m very aware of the cycles of history over decades and centuries. I know that in retail cycles, not to mention social, economic, and financial cycles, it has mostly turned out to not be different.

I’m going to compromise with myself and say it’s probably not different, but the time frame during which that becomes clear is going to be longer than we’re used to. The factors that are coming together guarantee a long, strange trip as the tidal wave of divergences works through our retail market. I’m going to look at what those are and try to reach some conclusions about succeeding in our industry.

Let’s start with overall economic conditions and debt then move on to customer behavior and how we sell to them. Next, I want to take a look at technology and what that means to the competitive environment. Based on that, I’ve got some ideas about how retailers and brands have to operate.

It IS the Economy, Stupid

I don’t think I need to spend much time trying to convince you that this economic recovery has been weaker than any since the 2nd World War. You are certainly aware that wage growth has been low to nonexistent and that job growth, especially for our primary customer group, has tended to be in lower paying jobs and often involve multiple jobs. Let’s call that group the millennials, though you’ll see below I think that’s an over simplification. When can we expect improvement?

Not for a while, and the reason is debt. I’ve recommended a book called This Time Is Different: Eight Centuries of Financial Folly by Reinhart and Rogoff. It’s so well researched that it’s hard to dispute their findings, but they are hardly the only ones acknowledging the problem debt is causing. Basically, they show that debt over a certain point leads to lower growth in an economy.

They suggest that growth starts to be impacted when total private and public debt as a percentage of GDP reaches around 90%. As of the start of 2015, by way of some examples, Canada is the cleanest dirty shirt at a bit less than 300%. The U.S. is about 375%, the Eurozone about 475%, the U.K. 500% and Japan, the hands down winner, is north of 650%. What probably won’t surprise, but should disturb you, is that total debt has continued to rise since the Great Recession.

I’ve always found the idea of fixing a debt problem with more debt perplexing.

Meanwhile, take a look at this chart showing real GDP growth in selected periods in the U.S. 2000 is the year the stock market bubble first burst. To my way of thinking, though the Fed stepped in and “saved” us, that’s when things started to go south in a noticeable way.

GDP chart for Retail and Brand Strategy article for TWB 1-16

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

I borrowed” this chart and the data in the previous paragraph from Hoisington Investment Management’s review and outlook for the third quarter of 2015. You can get your own copy at http://www.hoisingtonmgt.com/hoisington_economic_overview.html. I highly recommend it.

I’ve studied enough statistics to understand that correlation does not necessarily equal causation, but I’m convinced that there’s a relationship between GDP growth and debt. It is kind of logical. If you owe money, then you have less to spend while you pay it back and pay the interest. If you choose not to pay it back, then the people you owe it to have less to spend.

I think we’re in a low growth period until we do something about our overall level of debt. Solving the problems will be unpleasant and, if avoided long enough, draconian. Please, please, please, email me and tell me why I’m wrong.

So the first thing we have to deal with is continued slow economic growth caused by over indebtedness. Let’s move on. I don’t have room for a good rant on the damage the Federal Reserve is doing with continued low interest rates.

Our Customers

Our customers are, uh, wait a minute. Who are they anyway? Seems like we, as an industry, are trying to sell to everybody from six year olds to baby boomers. A couple of individual brands seem to succeed with that, but mostly you can’t. I’ll spare you my oft repeated speech about the dangers of expanded distribution except to remind you that 1) growth requirements make it hard to be a successful public company in this space because of the requirement for regular, quarterly growth and once you get into broader distribution 2) they may know your brand but not your story and your competitive advantage goes away and 3) we’re way over retailed with too much indistinguishable product.

I also wondered a while ago if maybe distribution didn’t matter due to online and because good merchandising could overcome wider distribution. To summarize, I thought that once a product was ubiquitous in the online world and a click away, customer’s reaction to broader distribution might change. I’ve decided the answer is “no.” It turns out that getting retailers who’ve never been great at merchandising specialty product to do it well is expensive, challenging and time consuming. There’s also our continuing problem of a lack of product differentiation which poor merchandising just highlights.

Meanwhile, back to our customers. If we have to characterize them as a demographic, we’d say, “the millennials.” This is the group (much like my mom’s generation who’s formative years were in the Great Depression) that got slammed by the Great Recession. They are financially conservative (and will be for life), are having a hard time making a wage that allows them to live independently, are not particularly brand loyal (though if you can get them, you can keep them), are most influenced by their community (not your advertising), and are more interested in experiences. A product is something they seek in order to have an experience, rather than buy for the hell of it. They have the data to find exactly the right product with exactly the right attributes because they don’t want to screw up the experience. Don’t try and bullshit them.

Okay, now that I’ve defined our customers as a demographic, I have to tell you not to do that. In the days of instant, endless, information about anything, groups, trends, styles, points of view can come and go pretty damned quickly. And anybody who’s interested in them can find out about them and be part of the community they represent. It’s easier to say your customer is of a certain age, and it may be true. But it’s not an adequate description of who they are.

Notice how the term “fast fashion” seems to have disappeared? It’s like it’s no longer an aberration, but a permanent condition. This seems to require that companies be a bit reactive after all those years where being proactive was a virtue.

To go with a soft economy, then, we’ve got customers that are harder to get and keep and in general have less money to spend. I am just a font of good news today.

Technology

 Let me remind you of two things I hear brands and retailers saying all the time.

“Get the right product to the right place at the right time,” and “Give the customer what they want, when they want it, where they want it.”

Those two catchy phrases make a lot of sense and are indicative of two things. First, they tell us how much the customer is in charge. In the days of too much retail space, too many undifferentiated products and near perfect information, that’s probably inevitable. Second, we’re all trying to figure out how, exactly, to do this and the one thing we’ve learned for sure is that it’s really expensive. There’s an advantage here to big players with strong balance sheets, because the cost for a 50 store retail chain to do it is probably not that much different than for a 600 store chain. Let’s put it this way- the cost per store is lower for the larger retailer or brand.

When you accomplish it, you won’t have created a long term competitive advantage; you will have just bought yourself the right to compete. I’m not talking about using a POS system here. I’m saying that from design at the brand to returns at the retailer the systems have to be integrated to keep up with the speed and requirements of your customers.

My Hero

Maybe you remember that a couple of years ago Rip Curl got itself in trouble. They tried to sell the company, but couldn’t get the price they wanted. So they decided to solve the problem the hard way.

They refocused on just being the best surf company they could be. They cut their product offerings by 50% and focused on the ones that their customers needed. They try to offer technology and quality that differentiate the products they do sell. They emphasized efficiency and reduced their distribution. They only sold places where they could make money. What a good idea.

In summary, their primary focus was on improving net income (and reducing working capital invested) rather than gross revenues.

It seems to be working, and regular readers will know I thoroughly approve of what they decided to do. Bluntly, I don’t think they had a choice. And neither do many of you.

The economy is making fast revenue growth difficult. Your customers (who can’t be simply identified as an age group any more) won’t buy what you tell them to buy, but what their community supports. They have endless choices and information. And the continuous investment required to satisfy their product and shopping requirements has gone through the roof- especially for smaller brands and retailers.

Do some surprising things. Perhaps completely outside of what your customers expect. Even contrary to your brand image. If you accept my premise that it’s tougher to get and keep brand loyalty in the days of endless, instant new brands, and that’s it’s damned near impossible to keep up with what’s “cool” anyway, why not surprise your customers this way? It’s a way to claw back a little initiative and not have to be reactive all the time in an impossible attempt to keep up with the rate of change.

Especially as a newer brand, focus on your web site and selling there. You can’t find the customers- they have to find you. Social media, etc. This minimizes marketing costs. What you do spend should be aligned with creating experiences. If you’re not going to grow revenue as fast as you once might have, make sure you’re selling at a price that gives you a solid gross profit. In your brick and mortar retail, be very cautious about whom you open and curate the hell out of them until you know they have you figured out. Do some temporary stores in surprising places for strange reasons. Never over supply.

It’s really a pretty interesting time to be building a brand as long as you acknowledge what I think are longer term conditions under which you have to operate. Rip Curl can watch some of its competitors flail as it just focuses on the bottom line with a business model that’s responsive to existing business conditions using some of the concepts I’ve briefly described above.

You can do the same thing.

Lowe’s New Customer Service Representatives and the Minimum Wage

Lowe’s new in store service representatives won’t need bathroom breaks, vacations, or retirement account. They won’t get sick. Hell, you don’t even have to pay them a salary. And what’s even better, or maybe worse- I’m not quite sure- is that they may be able to help me find the esoteric piece of hardware I need better than the current human ones. And they will be able to do it in as many languages as are necessary.

They’re robots, and you can read about them here. Make sure you watch the video. Read more

What Does the Data on Our Target Market Say About Your Business Strategy?

It was a lot of years ago when I first started reminding you not to focus just on your gross margin percentage, but your gross margin dollars as well. Then, in 2009, with the recession in full swing, I got all excited about Gross Margin Return on Inventory Investment (GMRII) after Cary Allington at Action Watch pointed me to the concept.

I discussed it in some presentations and wrote about it. Here’s one of my articles on the subject. It’s held up pretty well.
I liked the GMRII concept because my reading of history is that debt caused recessions (if recession is an adequate word to explain what we’re going through) last a long time. This one, I concluded, was not going to be different from all the others. It seems, unfortunately, that so far I’m right about that.

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What Happens If (When?) Apparel Prices Rise?

We sell a lot of apparel. It’s where we, as an industry, make somewhere between a lot to most of our money. We’ve benefited over many years from apparel prices that have risen slowly if at all, and certainly more slowly than inflation. This article demonstrates that. It further tells us that apparel prices have started to rise and that they may rise more in the future. 

The increase is due to rising labor costs in China, and the cost of inputs, especially cotton. What happens if the cost of getting a garment made continues to rise or even does some catching up with general price levels?
 
We’ll do what we can, of course, to keep that from happening. You are all aware of some movement out of China to lower labor cost countries. However, you’ll note in the article how much apparel still comes from China.
 
We’ll try and pass on some price increases to consumers, but that has its limits. Especially in this economy. Perhaps it’s an extreme example, but you may recall that UGGs tried to pass on a big increase in sheepskin cost to consumers and the consumers wouldn’t accept it.
 
I imagine we’ll cut the number of pieces we make with the goal of increasing volume per style. That’s already happening at some companies and it’s my longstanding recommendation that you take a look at your SKU numbers anyway. There’s money to be made there.
 
We’ll try and substitute cheaper materials without sacrificing quality. We’ll design for easier manufacturing.
 
We can look hard at our customers and try to figure which ones are, or are not, sensitive to price increases and why. Your dream is to have a customer who wants/needs your product so badly that price doesn’t matter. Mine too.
 
You might find yourself taking a hard look at your distribution as price increases can mean that certain products will no longer be competitive in certain channels.
 
I can’t help but notice that these are all good things to do anyway, and I hope they are already part of your normal business processes. Let’s hope apparel prices stay under control though, of course, “hope” is never a valid strategy. 

 

 

Aunt Jenny’s Egg Beater, Hoodies, and Water Heaters; The Evolution of Manufacturing, the Future of Fast Fashion and the Impact of the Internet

My Aunt Jenny died maybe 12 years ago at the age of like 97. I helped clean out her house and one of the things I saved was her egg beater. It was made by the Dazey Manufacturing Company in St. Louis. I don’t know if it’s 60 or 90 years old. The company is out of business. 

I didn’t keep it for sentimental reasons (I mean, it’s an egg beater). I kept it because it’s the best damned egg beater I’ve ever seen and I wouldn’t know what to replace it with. It’s made of heavy duty stainless steel. Except for some paint chips on the handle, it looks and works like the day it was made. It spins so effortlessly and smoothly that it keeps going for north of half a dozen turns after you release the handle and is well balanced and almost vibration free.   No planned obsolescence here.
 
I really miss products like this. I believe that paying more for a product that lasts a long time (if you can find them) is a better financial decision than paying less and having to replace it often.
 
So I was intrigued to find this article on a hoodie made by American Giant. I’ve ordered the full front zip one for $79.00 (shipping included). It’s made in the U.S., only available online, and is supposed to last a long, long time. The product is backordered due, I assume, to all the favorable publicity they’ve had.
 
They started by redesigning the hoodie from scratch, as you’ll read in the article. CEO Bayard Winthrop “…argues that by making clothes in America, he can keep a much closer eye on the quality of his garments, and he can make changes to his line with much more flexibility. An Asian manufacturer wouldn’t have been able to do all of the custom, intricate work that American Giant’s clothes required.”
 
Okay, hold that thought. Let’s move on to the water heater.
 
The December issue of The Atlantic has an article called “The Insourcing Boom” by Charles Fishman which you can read here. Anyway, General Electric owns something called Appliance Park in Louisville, Kentucky. It includes six factories, each as big a suburban shopping center, and it’s where GE use to make all its appliances. It employed 23,000 at its 1973 peak, but only 1,863 by 2011. They tried to sell it in 2008 but there were no takers.
 
But in February, 2012, they started a new line to make their high end GeoSpring water heaters there. On March 20, they started making high end French door refrigerators there. By now, they’ve probably started making a stainless steel dishwasher and they are working on an assembly line to make front loading washers and dryers, the article says.
 
Bringing certain products back to the U.S. to make has to do with higher Chinese labor costs and, for better or worse, lower U.S. ones.   But that’s not the whole story. When they took a close look at the GeoSpring water heater, they found it was a manufacturing nightmare that could only be justified when labor was $0.25 an hour. In their redesign, they cut out 20% of parts and reduced the cost of materials by 25%. They cut required labor hours from 10 in China to 2 in Kentucky. Quality and energy efficiency improved.
 
Okay are you ready for this? The Chinese made product retailed for $1,599. They were able to cut the retail price of the U.S. made one by 19% to $1,299. I assume they are holding their margins or they wouldn’t have done it.
 
Here’s what I said in a recent article talking about U.S. manufacturing.
 
“Once the labor cost differential isn’t so dramatic, then other costs become more important. Travel, freight, time to market (which impacts the amount of inventory you have to hold), communications issues, surprise delays, custom duties, control of intellectual property and quality control are among the costs that may be higher with foreign production. But most general ledgers aren’t set up to isolate those costs.”  I missed, by the way, energy costs which are also making the U. S. more attractive.
 
“It’s an accounting hassle, and no fun. But if you take the time to figure out those costs, you may find there’s a certain logic to making some formerly foreign produced products in the U.S.”
 
I’m guessing the CEOs of both General Electric and American Giant would agree with me.
 
The American Giant business model works because the product is only sold through their web site. They have no brick and mortar retailers. I may be willing to pay for quality, but if you had to add a retailer’s margin in there, it would be out of my price range.
 
Pretty clearly, the internet can facilitate the sale of higher quality products by avoiding a level of distribution and cost. I’m not quite sure if that’s completely good or bad, but it’s a fact. I’ve written before that I thought we were early in the process of figuring out the model for internet and retail coexisting. Here’s an impact I hadn’t thought of until now; it might facilitate U.S. production and higher quality. The benefits of having design, production, marketing and fulfillment in one place are, I suspect, significant. 
 
Let’s distinguish between fast fashion and supply chain and inventory management. Fast fashion (which I define as rapid turnover of artificially supply constrained product) is a marketing idea. Good supply chain and inventory management is necessary to fast fashion, but it would be a good idea even if nobody ever came up with the fast fashion moniker. It can never be bad to be able to react quicker to the market and hold less product in inventory.
 
Every company I write about these days is talking about managing their supply chain better, reducing their time to market and “micromanaging” their inventory. They don’t all use the term fast fashion, but to some extent that’s what they are reacting to or trying to emulate. It’s so universal it seems like a bubble.
 
I’m wondering if fast fashion isn’t a trend that will run its course. I understand the excitement it can generate, but once the novelty wears off, I am uncertain shopping more often for product that isn’t really that well made just because it’s “new” will support a long term business model. 
 
In the days of our ongoing economic malaise, it can be hard to find a lot to be positive about. But as I use Aunt Jenny’s eggbeater to make an omelet, wait with anticipation for a hoodie I expect will last a long, long time and wonder if I should be replacing my water heater, I’m feeling kind of hopeful about what might be an important long term trend back towards higher quality products and domestic manufacturing.

 

 

Miscellaneous Stuff; Not Your Typical Market Watch

I read a lot of stuff. From time to time I come upon something I want to share with you. Often I hold on to it until it fits into something I’m writing. But at this point, I’ve got a few articles I’ve been saving that it’s just time to spring on you in the hope you might find them interesting or even useful. 

The first, and the most eclectic of the three, comes from the investor George Soros. It’s entitled “The Tragedy of the European Union and How to Resolve It.” Soros has been a hell of a successful investor over many years and at this point is worth bazillions. Part of the reason for his success, I think, is his sense of history and culture and his ability to look beyond the next month or year or more. As an investor, that has allowed him to see more clearly than most and to have some patience.
 
This is written at a high level, but the quality of the writing makes it a pretty easy read, and there are no graphs or mathematics. Obviously, it’s not about action sports or youth culture or fashion. But many of you do business in Europe, are already impacted by what’s going on there, and know there’s a great deal of uncertainty about a how it all work itself out.
 
Soros has an opinion about what the choices are, or at least should be. Whether those seem reasonable to you or not, his historical analysis of how Europe found its way to its current mess is about the best I’ve seen in the space he uses. I recommend turning off your cell, disconnecting from the internet, locking your door and reading this thoughtfully.
 
The second article is called “A Seasonal Business Aims to Survive the Off-Season.” I imagine this might strike a little closer to home for those of you in the snow business. The business in question is a restaurant and specialty food store, and its lean months are October through April. Still, I think you’ll find some of the issues they face and actions they consider to improve their off season and manage their cash flow recognizable. From time to time, I’ve said that we spend, as an industry, way too much time talking to each other and confirming what we already think and want to believe. Here’s a chance to see how a small business not in our industry deals with a similar issue.
 
Building a Brand When You Can’t Afford an Ad Agency” will strike a chord with everybody in our industry who has built a business from scratch. Interestingly, it’s not about social marketing and the internet.   I like it of course because what this guy did is pretty much consistent with what I’ve told people who’ve called me to ask how to build their new brand.  If I can find some Tito’s Handmade Vodka, I might have to change from Grey Goose (straight up with a twist).                   
 

 

 

A Minor Mind Dump

I’ve had a few ideas lately and come across some information I wanted to share. None of them seemed worthy of its own article, so I thought I’d just spew them out as they sprang into my mind. I have no idea how this is going to turn out.

First, a housekeeping issue. I know that Quiksilver, Zumiez and PacSun have come out with earnings reports. I am greedily collecting their press releases and conference call transcripts, but won’t have anything to say until they release their 10Qs or 10Ks. I just don’t think it’s worth your time to read, or my time to write, an analysis that doesn’t include the unbiased and completer information of the SEC filings. Hope that makes sense to you.

Next, I want to talk about the evolution of consumer habits as they relate to the internet. It wasn’t that long ago that I wrote about how being able to buy something and take it home was an advantage that brick and mortar retailers had over the internet. Somehow, last week I realized that probably wasn’t true anymore. I’m now perfectly happy buying on line and waiting a few days or even longer for the item to arrive rather than go out and buy it. And having asked a few other people (hardly a scientific sample I admit), it appears that I’m not the only one.
 
Now, if the price is lower or there’s no sales tax well or shipping is free, even better. And I don’t mind that delivery services have gotten better. But I don’t think those are the deciding factor. I think I’ve somehow just gotten comfortable with the fact that most of the stuff I need (think I need?) I don’t need the same day I decide to buy it.
 
If I’m right, and most people are thinking that way, then it would help to explain why small retailers are struggling and internet sales for most brands are growing so quickly.
 
But it’s not that one day people wanted to buy at the store and get their stuff and next day they were content to wait. It’s an evolutionary process that’s happening over years. The question is why it was only last week that I went, “Oh shit, how could I not have noticed this before?”
 
Maybe you all already knew this. But I haven’t seen any discussion of it, and I’ve always been kind of fascinated by how trends evolve and finally get recognized in business as a competitive opportunity (or problem).
 
I like to spot what I think are meaningful competitive trends and wish I could do it more often. I try and improve my odds by doing things like turning off the internet when I’m writing/thinking. Like now. Truth is, our brains aren’t designed for multitasking and there’s no email that’s going to arrive that can’t wait until I’m through writing.
 
I pretty much flee the mainstream media because I consider it to be mostly human interest stories and noise rather than hard news and analysis.
 
I thought I would share with you this article about Spain on a web site called Stratfor.  If you do business in Spain, I think you’ll find it valuable and you’ll get more good information about conditions in Spain in the 15 or 20 minutes you spend reading it than you will get anywhere else. If nothing else, you’ll probably notice that the unemployment rate of Spaniards age 25 and under is 45%. We kind of sell a lot of stuff to that group.
 
I pay for Stratfor, but it’s free right now. It seems they got hacked by Anonymous and are still trying to recover. Very embarrassing to be a global intelligence/security firm and have to admit that your subscribers’ passwords weren’t encrypted.
 
Okay, I’m done. I’ve editorialized a bit but enjoyed it. As long as I’m doing this for free, I’m allowed to have some fun. Go check out Stratfor. It’s worth a few minutes of your time every day.    

 

 

What Will You Do When Your Greek Receivables are in Devalued Drachmas?

There are lots of public company quarterly reports I should be writing about, but I am going to step off that track and think, for a bit, the unthinkable.

Or at least it was the unthinkable. But at this point the Eurozone seems to be moving towards two choices, either of which has huge implications for managing any international business.

Let’s review for a minute. What are the three things you can do to get rid of debt? You can pay it off. You can default (a “restructuring” is basically an agreed on default). And finally, at least if you’re a government, you can inflate it away by printing money.
 
The third approach has always been the favorite among governments, because it’s kind of sneaky and doesn’t require politicians to directly take anything away from anybody. It’s happened many times. But don’t take my word for it. Go and read This Time is Different; Eight Centuries of Financial Follies. The point, of the book, of course, is that it’s never different. It won’t be this time. I reviewed the book on my site and you can buy it here.
 
Next, let’s talk about Iceland. Iceland thought it had turned itself into a financial capital, and its banks borrowed lots and lots of money from various British and other European banks. They were, of course, heavily leveraged. So when the cash stopped flowing and they couldn’t renew any of those loans, everything went to hell in the proverbial hand basket. The British and other Europeans howled that Iceland’s government had to make good on their banks debt. Unlike the Irish government, Iceland said, “Uh, actually we don’t.” And they didn’t.
 
Their economy went south and their currency devalued dramatically. It was ugly. But with the competitive boost of a devalued currency, they’ve started growing again.
 
That’s how it’s supposed to work. But Greece, and Ireland, Italy, and Spain, can’t devalue their currencies because they are part of the Euro.
 
Next, let’s talk about the bond market. The bond market is the biggest, meanest, son of a bitch on the continent. It has decided that there’s more risk in these country’s debt, and has pushed their interest rates way up. Italy is up over 7% even with the European Central Bank buying Italian debt (increasing demand and theoretically driving the cost down). Inevitably, higher interest rates make the debt burden even higher and paying off the debt harder. Spain is around 7% as well.
 
So what is Greece, or Ireland or Italy, to do? Austerity! Fiscal Responsibility! Which might work if they could devalue their currency as it is working in Iceland. It’s painful, but it can work. But with this much debt, and no devaluation possible, austerity in the form of spending cuts and tax increases just reduces the economy’s growth, which reduces tax collections, requiring more austerity. It’s a pretty vicious cycle.
 
Here’s the bottom line. There’s too much debt to be paid off. Somebody is going to lose money. They’re just fighting over how much and who.
 
If you’re a debtor nation like the Southern Europeans, you like the inflation solution, because it effectively reduces your debt. If you’re a creditor national like Northern Europe and Germany, you aren’t so enthusiastic because you know inflation also reduces the value of assets. And the Germans, of course have an institutionalized fear of inflation from the hyperinflation of the Weimar Republic. There’s the story of the cup of coffee that cost more when you had to pay the bill then it cost when you ordered it.
 
Remember when Fed Chairman Ben Bernanke told us the subprime crisis would be contained? Then Lehman Brothers collapsed and it wasn’t. I don’t know what will happen in Europe, but it can happen just as dramatically and just as suddenly. Most people seem to think the European banks are a bigger mess than ours ever were. There are simply not two to six trillion Euros (estimates vary) available to bail everybody out (unless they just start printing those Euros) and if there were, it wouldn’t solve any of the competitive issues that lead to this mess.
 
Long term Greek government debt is priced to yield about 30% right now. I’m sure it’s obvious that they can’t pay that, or anywhere near it, and actually service their debt. Something is going to happen. I think it’s either going to be inflation, or one or more countries leaving the Eurozone and defaulting on their debt on the way.
 
In not one quarterly report or conference call I’ve read so far have I seen any discussion of the management of this possible risk. It feels like it’s too uncomfortable to consider. Maybe it’s just concern that talking about it might make it happen. Perception does matter.
 
I doubt any of our major industry players’ sales to Greece are make or break for it. Still, if you’re selling and holding receivables in Euros and have assets denominated in Euros there and Greece suddenly goes back to the Drachma, what exactly happens? Nobody knows. Well, we know the lawyers would make a lot of money.
 
I assume companies are trying to hedge their exposures (not just in Greece) but I’ll bet that’s getting really expensive. I might consider offering discounts for prepayments. I guess you could try and denominate your contracts in dollars, but that might not help. There’s no mechanism for a country to exit the Euro, so they’d be making it up as they go along.
 
I’m not projecting a breakup of the Eurozone, but the possibility of some countries leaving it is certainly higher than it used to be. Frankly, I think they’ll resort to the good old printing press. That’s what’s happened historically, and the powers that be are all issuing coordinated statements about how they will “manage” it; that is, not let inflation get out of control.
 
What am I asking you to do? As always, just to consider the possibility, it’s impact on your company, and your strategy to manage it.

 

 

SIA Article on the Rising Costs of Chinese Production

About a week ago, SIA published a really good article on why production costs in China are rising.  If you haven’t read it you can, and should, here: http://www.snowsports.org/SuppliersServiceProviders/SIANewsletter/NewsletterDetail/Contentid/1272/#top.
The article is pretty tactical in nature, and I thought a little bit of the longer term social and political perspective might be interesting to you.  It should at least convince you that this is probably not a temporary trend.
Chinese governments have always derived their legitimacy from their ability to provide stability and jobs. “Harmony,” if you will.  And when I say “always” I don’t mean a measly couple of hundred years.  The first history of China was written about 1,500 BC.  China’s current export oriented economic system is unsustainable.  The Chinese know this.  But the changes they need to make to improve domestic consumption move up the valued added chain in what they manufacture and resolve some of their significant structural issues are not conducive to that stability.
That’s a very short and very oversimplified explanation of the situation.  But the next time you hear that “everybody” knows that China is going to become the next superpower you might not rush to agree.  Could it happen?  Sure.  But remember in the 1980s when “everybody” knew Japan was going to take over the world?  Didn’t quite work out that way.  The chart below illustrates one of the issues China has.  Note the coming decrease in the working age population.