Cost Declines Go to Promotions at Harris Teeter

Retailers hoping to gain a benefit from falling commodity prices are in for a double whammy: Manufacturers of branded goods aren't lowering prices as much as retailers would like, and whatever money retailers do save will have to be plowed back into promotional pricing to keep traffic up in a slow economy. The effect is blunting the margin benefit of so-called sticky pricing that retailers can typically

Retailers hoping to gain a benefit from falling commodity prices are in for a double whammy: Manufacturers of branded goods aren't lowering prices as much as retailers would like, and whatever money retailers do save will have to be plowed back into promotional pricing to keep traffic up in a slow economy.

The effect is blunting the margin benefit of so-called “sticky pricing” that retailers can typically achieve when their costs fall, analysts said. And it follows a period of price inflation that arrived too rapidly for retailers to fully benefit from either.

“Retailers are having to fight more for business — it certainly is not coming as easy as it once did. So promotional retailers have to become more promotional, and retailers that are value-driven have to be more value-driven,” Neil Stern, senior partner at McMillan Doolittle, Chicago, told SN. “The business is just not coming to the door. You have to work for it, and that has some impact on margins.”

The difficulties of operating in such an environment were illustrated in recent quarterly financials from Ruddick Corp., the Charlotte, N.C.-based operator of the upscale Harris Teeter chain.

Ruddick's first-quarter report showed operating earnings staying relatively flat while its comparable-store sales fell by 2.1%. Sales of discretionary items were down, the company added, and customers traded down not only from branded goods to private-label items, but within the range of private-label items as well.

The chain said, however, that sales turned positive again when it dialed up the heat on its promotions in January. According to Karen Short, an analyst at Friedman, Billings, Ramsey & Co., New York, that meant increasing items that are reduced on its “Unreal Deals” roster from about 600 to 1,000.

“In general, we think the company managed the business well, although comps in the quarter were very weak,” Short said in a conference call last week. “They're basically managing the business to protect share.”

Andrew Wolf, an analyst for BB&T Capital Markets, Richmond, Va., said Harris Teeter expanded gross margins in the quarter partly as a result of its costs for goods falling. Stores typically can boost profits on the lag between reductions in their costs and reductions to shelf prices, he said.

“In a better economic climate, [reduced product costs] would be very good, because retailers then would be lowering prices more slowly than the slowdown in inflation on the buy side,” Wolf explained. “To some extent, that's what Harris Teeter did. But it impacted sales, because others were more aggressive in their promotions.

“It's a two-edged sword in the industry now,” he added. “You can either protect the gross profits, but watch your market share slip to others who are more aggressive; or you can protect your market share and not achieve the gross-margin expansion you would have hoped for, given that product cost inflation is easing up.”

Retailers, however, have not been seeing the kind of reductions in branded goods to match reduced inflation, analysts said. This, Stern said, is because many manufacturers are “locked in” to agreements with their suppliers that were crafted when commodity prices were rapidly increasing.

According to Short, retailers, including Harris Teeter, have largely passed along reductions in their costs for private-label items in the form of lower retails, even as branded goods remain at higher prices. This has widened the pricing gap between branded and private-label goods and boosted sales of the latter. Harris Teeter said private-label penetration increased by 23 basis points to 24.88% of sales.