Dealing With Closeouts

By Casey Koteen

Paddling out in large surf is one of the most challenging things you can do as a surfer. It's also one of the most rewarding. The upsides are tremendous, but for every heart-in-the-throat airdrop you make, there are inevitably times where you'll miss a wave only to face a looming closeout that ends up breaking three feet in front of you.

Every season the manufacturing and retailing side of the boardsports business deals with closeout sets of its own. In the apparel industry, basically every 90 days a new cycle starts and manufacturers have to predict what colors, categories, and styles–even down to individual SKUs–they think are going to sell. Sometimes their projections are dead on and they sell every piece at or near full price–the equivalent of getting spit out of a fat Backdoor barrel. Other times, projections overestimate sales, and the thrashing brands take comes in the form of rows of unsold inventory clogging up their warehouses. Or if projections are short of the order file, they miss valuable potential sales.

Excess inventory is a necessary evil of the manufacturing process, and it'll never be eliminated all together. The question to ask then is what's the best way for manufacturers to get rid of it? Just like a retailer who has to make room for incoming product, manufacturers also have to find a way to liquidate merchandise that's creating a bottleneck in their warehouse. And so they do the same thing retailers do–they put it on sale. Manufacturers have limited options when offloading product though, and this is where it sometimes gets sticky.

The Three Channels
There are basically three channels for manufacturers to off-load excess inventory through. The first option is company-owned outlet stores, although a minority of brands have these. Second, manufacturers can offer leftover product at a discount to existing accounts, which include both specialty stores and big-box chains. Third, brands can sell goods to closeout stores like T.J. Maxx, Marshalls, or Ross–often referred to as the "big three." Some companies will also do annual warehouse sales where they open up the warehouse to employees, invited guests, or even the public.

There are only a handful of companies out there big enough to have their own company-owned outlet stores. "At the factory outlet stores," says Roy Turner, president of the Board Retailers Association, "at least they {the manufacturers} can control the product and pricepoint. I do have a fear of it all becoming vertical, because then it becomes very boring. But outlet stores might be–at least in tricky areas–a better way to do it." When done right, retailers have been accepting of these because the manufacturers have kept these outlet stores in remote locations–although there are some exceptions.

Not surprisingly, just about everyone agrees the second option–off-price to existing accounts–is the most preferable. It keeps the distribution clean, the brands can still maintain a decent markup on the product, and specialty accounts get a discount, which keeps them smiling.

Specialty stores are particularly fond of this second option because it involves them getting in-season product off-price. In other words, they get discounts on product that will get there quickly and will likely sell at full price or close to it.

"We buy probably fifteen to twenty percent of our annual purchases at the end-of-season off-price," estimates Tom Brown of 17th Street Surf Shop in Virginia Beach, Virginia.

While retailers can get a deal on merchandise if they wait longer to buy it, that strategy can also backfire if product sells out, and Brown warns against putting too much emphasis on off-price buys: "Other than T-shirts, you really can't hold money back for off-price product, because if it's not there, you blow your season."

While retailers who plan to fill their racks with too much off-price merchandise risk attempting to buy product that might've already sold out, they also risk straining relationships with their vendors. In general, manufacturers begin to frown upon accounts whose off-price dollars start to creep anywhere near half of their total ordering. The longer a retailer waits to buy product, the longer it sits on manufacturers' shelves, which costs them money. It goes without saying that the manufacturers prefer to sell as much product at full price as possible.

There's also a good argument to be made that specialty stores should ideally be filled with the newest and most cutting-edge merchandise. Often product that's doing well will sell out before it becomes available for a discount. If the store's buyer has a good eye he or she will book product that will likely do well, and book it on time so the shop will be guaranteed to receive it. So it's a push and pull between making sure the shop gets the best and freshest product, but also doing some off-price business that can raise margins.

"I've heard some retailers say, 'Why would we want to book out eleven months when you can hold off and then buy anything in season at 30 percent off?'" says Turner. "It's a good point, but personally, I only want a store full of top merchandise. I can also appreciate that there do need to be margin builders."

Timing The Market
Another dilemma with retailers waiting until late in the season to book product is that it puts another variable into the manufacturers' projection process. The problem is that more variables increase the possibility for a glut of inventory. Retailers do have a certain amount of control over manufacturers orders, and, in a way, also of levels of inventory that are left over each season. "A lot of this can be avoided if the retailers were to place the orders on the dates that orders are due," claims Sessions Owner Joel Gomez. "There is some control that retailers have. Sessions would've been a lot more profitable in the last three years if we'd known {earlier} what to order."

How early do the orders have to be? This question quickly connects back to the manufacturers' ongoing debate over the timing of line breaks. One group of vendors is pushing line breaks further out. They hope that one by-product of this move will be an even better command of inventories. "It has to work on the prebook model to help guide people into what we should be making," says Tom Holbrook, executive VP of sales at Quiksilver. "It's not a perfect science, but that's how we do it. We're focusing more attention on the front end as opposed to cleaning up the back. If you do good on the front, the back won't be as big of an issue."

This tact seems logical. If you know early enough how many orders to fill, you could plan your buys much more accurately. Some say nine months is early enough. Others, like Billabong, believe they can get the job done in less time and that the shorter lead time will allow them to react closer in to trends that develop, and that this will result in less excess inventory. "The average lead time on a cut-and-sew product is 90 days," says Paul Naude, president of Billabong U.S.A. "This whole debate about lead times being brought forward is contrary to what's happening in the apparel industry. In the future, I firmly believe that the company with the shortest lead time will win. That's the way the whole world of textiles is moving, and yet there's this talk in this industry to make our lead times longer."

The Big Three
The first two ways of dealing with excess inventory stir up a little bit of controversy, but it's the third option–when branded product ends up at closeout stores like Marshall's, Ross, T.J. Maxx, and other discount chains–that raises retailers' blood pressure. There's a familiar and critical refrain voiced by specialty stores when the topic of closeout business is brought up.

"Kids are Internet savvy, price conscious, and they know there are ways to get the brands without paying full price," says Greg Smart of Inland Ocean Surf Shops in Florida. "If you can get your favorite surf brand's denim two miles down the road from your local surf shop, even if it's two seasons old, well, who cares? You don't have to wear that store's tag on the pants. Try selling a mom a pair of walkshorts that are 44 dollars for one pair, because they're newer, when she's just bought three pairs of brand-name walkshorts for 48 dollars. Three pairs versus one pair–it's not even close."

While every shop out there has a few horror stories about product winding up at nearby discount chains, the fact is manufacturers don't like having product in the closeout stores either. "The T.J. Maxxes of the world will take whatever you want," says Adam Sharp, VP of sales and marketing at Rip Curl. "You can pack it all up, they'll ship you a P.O. and take care of the distribution and it's easy.

"But at the end of the day, doing closeout business is the most unprofitable," continues Sharp, "because you're clearing stuff at cost or next to cost. Whereas if you're doing business with the 'core accounts, it's usually at an off-price rate, but it's more about working with them and strengthening relationships. If, say, Ron Jon needs boardshorts for the month, you fill that hole for them, rather than them going out and doing more private-label stuff or going to one of their smaller vendors."

But it's not just the idea of product ending up at discount chains, it's in the details of when and how much. Most recognize that these stores serve a necessary purpose–to clear out the final assortments of product that no one else will take. The real beef specialty stores seem to have with the off-price process is when good product ends up going to Marshall's or other big-box retailers at a cheaper rate than it was offered to them at.

"What I'm hearing from retailers is that they're frustrated at being offered off-price stuff at 25 percent off and then seeing that it was sold off at a minimum of 60 percent off to the big-box discounters," says Smart. "That boardshort that would normally retail for 48 dollars that we bought at 24, I could buy off-price at $16.80. That's 30 percent off and I appreciate that, but not when I see that same short two months later retailing at twenty dollars at another store. If there was going to be a ten-dollar pricepoint on that short, why didn't I get it? The obvious answer is that I can't back up an eighteen-wheeler and take every single piece."

Would specialty shops ever want to band together to purchase larger chunks of merchandise, effectively keeping more off-price business in the specialty channel? It could keep more product out of discount chains, but it would also mean having to deal with final assortments that, in many cases, have been thoroughly picked over.

"Bring it on," Naude says, "but just remember, you can't pick and choose. The last stop means you take it all. It's got to go somewhere, and if a group of retailers want to set up a closeout channel, I think the industry would welcome it–as long as everybody understands you can't pick and choose."

This leads into the heart of the debate, and it's really a philosophical one. If the model of a specialty store is to have the freshest, most trend-setting product, then they aren't the ideal place for final assortments. If a particular product really misses the mark, it probably shouldn't be in a specialty store, no matter how much margin it can generate.

"There's the perception that there are better and cheaper deals at the end of the food chain," says Holbrook. "The problem is that by the time it gets there, we don't necessarily want to throw that product into a specialty shop. If it's that broken up or the colors are that far off, or whatever else, it may not be something that's brand building."

Dave Hollander of Becker Surfboards takes it even a step further. He suggests that the continued presence of a brand's product in the closeout channels negatively affects the way consumers perceive that company. "Perceived value is everything," he says. "Let's say that someone sees a branded T-shirt for ten dollars, that's probably what they think it's worth." He also says that when a brand is showing up too often at the discount chains, he'll notice real effects on that brand's sales in his store.

Solving The Unsolvable
For the most part, the industry is doing a good job of minimizing product that's going to closeout chains, but everyone agrees even less would be better. So what are some solutions? The improvement that specialty retailers most often mentioned is that they would like a shot at excess inventory before it gets offered up to the broader market. Roy Turner suggests a systematic way that it could be offered to special retailers for a four- to five-day period. "You'd be amazed about how much they {manufacturers} could sell and support specialty retailers," he says.

Some manufacturers already offer a variation of this option. "We have a couple of guys who run what we call the available-to-sell–or ATS–department," explains Holbrook. "They specialize in being a phone-ready conduit to our key specialty accounts. They facilitate reorders at any given time on current- and past-season stuff. Their main job is to sell current inventory at full price and to help accounts get into stuff they're selling. Their number-one priority is to make it as easy as possible to reorder something that's performing well at retail. Their secondary thing, which is a by-product, is that they get requests for off-price stuff."

Greg Smart offers up what he calls the highlighter plan: "Take a map of the U.S. and highlight the states that have coastlines and then say, 'Okay, we're going to dump product, but not to any of these states.' You'd still have a ton of states and lots of area to dump product to people who don't have access to the stuff."

While Smart's plan takes a broad geographical swipe at the issue, it could also include select areas beyond coastal states where a significant level of boardsports retail is already being done. And as these brands continue to grow from strictly boardsports companies into lifestyle brands, these non-coastal markets have grown, too. In other words, the brands are getting better penetration in the middle of the country, so perhaps this idea could gain some traction.

Then there's Jay Moore of World Boards in Bozeman, Montana. While he offers this self-described crazy idea in reference to snowboards, the apparel market could perhaps take a cue from it as well: "Offer it {excess inventory} to the smallest people first–the reverse of what the brands are doing now. In a sense, you'd be offering the small guy a chance to be competitive when he usually isn't. Then you could go to the mid-tier guys, and we'd consume all the rest of it. I guarantee you it would never get to the big-box guys."

Manufacturers would likely counter with two points. One, that the small- to midsize retailers couldn't consume all of the excess, and two, that it would take too much work to disperse all that product. Moore disagrees: "It's not that much work to trickle it down through the staff who already calls retailers and collects money. They have a staff that already does all that." With the infrastructure already in place to deal with distribution, shipping, and collections, Moore believes it would be only slightly more effort for the manufacturers–more work, but toward a good cause. "If you want longevity and good brand recognition consistently," he says, "it's a relationship thing. It's work, it's not instant."

Moore's point really stands the whole issue on its head. The status quo is that vendors often give their largest accounts perks, one of which is access to the first round of off-price goods. This makes perfect business sense, but it also makes sense to give the smaller guys–the people who could most benefit from it–an advantage. "If you enliven the smaller store, it throws back more life into the industry and gets more competition going," says Moore. "If more 'core shops are healthy, is that good or bad for the industry?"