Abercrombie's Tough Line

Retailer Abercrombie & Fitch (NYSE:ANF) reported a 20% decline in comparable store sales for January 2009, raising more concerns about its strategy to limit the number of markdowns it offers customers during the recession.

The Dilemma
All retailers are faced with the dilemma of whether or not to cut prices during times of slowing or declining sales. If a retailer cuts prices, cash flow is increased in the short-term, because inventory can be converted to cash. The side effect of cutting prices, however, is lower margins, or even losses, on the bottom line. Another side effect of "cheapening" a brand is that consumers may come to associate the retailer with discounts or lower end merchandise. (Learn more in The Industry Handbook: The Retailing Industry.)

The retailer that holds the line on prices risks losing market share, but those sales will at least be profitable. Furthermore, the retailer can defend its brand in the marketplace.

The recession adds another layer of complexity to the pricing decisions faced by retailers. Most retailers carry debt and utilize a credit line to provide some of its working capital, which is especially sensitive to the demands in the marketplace regarding liquidity. In addition, a retailer's access to credit, which tends to get tight during a recession, is compromised. Finally, customers are exceptionally more price conscious during a downturn, which requires retailers to devise pricing as well as cost-cutting strategies to stay alive.

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Abercrombie Strategy
Abercrombie has stated clearly that it will not be overly promotional on price. During the fiscal Q3 2008 conference call, CEO Michael Jeffries said, "It is clear to us that the short-term relief provided by the use of promotions is more than offset by the damage inflicted on the brand in the long-term. Promotions are a short-term solution, with dreadful long-term effects."

The choice to maintain its pricing structure, despite the recession, not only is based on financial considerations, but on the perceptions of investors, too. Some retailers pander to the investment community and take the easiest road of giving them what they want, even when to do so is not in the best interest of the company and its brand. Of this trend, Jeffries is prudent. To investors, he said, "We hear your concerns about how we are dealing with the short-term challenges and the economic downturn."

Competition
American Eagle Outfitter (NYSE:AEO), which has been more willing to offer value pricing to its customers, reported weak earnings in the last quarter, citing a "decline in top line sales and increased promotional activity." In addition, its same-store sales dropped 22% in January 2009.

Aeropostale (NYSE:ARO) stated during its quarterly conference call that the company is "continuing to try a variety of promotions." Because customers have responded well to its strategy, the company reported same-store sales growth of 11% in January 2009.

Urban Outfitters (Nasdaq:URBN) reported a 1% drop in same-store sales for the quarter ended January 21, 2009. However, the degree to which Urban Outfitters has offered promotions during the downturn, in comparison with its competitors, is unclear.

Bottom Line
Abercrombie's strategy may prove successful in the long-term. A study conducted by research firm Gordman Group, and presented at the National Retail Federation, revealed that customers value retailers that "had fair everyday prices, helpful sales people and a friendly return policy." Less important were "discount coupons, loyalty programs, contests and layaway programs." In this case, only time will tell if Abercrombie's reluctance to slash prices, like many of its rivals, will lead to long-term success for the company and its brand.