Why sales are falling and the danger of price reduction

At present, the Russian retail market is undergoing a phase of slowdown, or stagnation of sales. What caused the formation of such a difficult situation for retail and which anti-crisis strategies are ineffective, argues Daria Nuclear.

 Daria Nuclear – Managing Director of the Esper Group of companies.

 Esper group — a company that provides market research, business analytics, and consulting support in the field of corporate strategy and marketing. 

www.esper-group.com

 Although fashion market turnover grew by 4,4% in 2013, this growth was offset by significant exchange rate fluctuations in late 2013 and early 2014. Even after adjusting sales figures for inflation, this translates into actual losses for most operators. The largest losses were suffered by the mass-market segment (the mid-price segment at the lower and middle end of the spectrum), with retail prices ranging from €30 to €100 per pair of shoes.

The crisis did not affect all market segments

Leading fashion companies are recording retail growth of 1-2% like-for-like and consider this figure sustainable, as other companies are experiencing even higher losses. Footwear performance, however, is far less dire; many managed to increase sales by 3-5% in physical terms. In value terms, revenue growth was up to 15%. Therefore, the ongoing recession has not been as devastating for footwear manufacturers as one might expect. Moreover, to a certain extent, one can expect that for domestic footwear companies, the downturn will become an opportunity, in the Chinese interpretation of the term "crisis," reviving new and more effective concepts.

When it comes to the footwear market in Russia as a whole, the most dynamic segments today (as opposed to the clothing market) are traditionally the mid-price and higher segments. The luxury footwear segment is the most dynamic (sales growth in this group was 16,64% in 2013, and is projected to exceed 15% in value terms this year). Sales in the mid-price segment (100 to 250 euros per pair) are also growing at a significant rate – 11,76% in 2012, although this market is saturating faster and growth this year will not exceed 7% (which, however, is a radically different picture compared to the clothing market, for which growth of 1,5% is only possible under an optimistic scenario).

Decrease in purchasing activity

Let's examine the underlying causes of what's happening in the market from a macroeconomic perspective to understand what shoemakers in the Russian market have that clothing manufacturers have been sorely lacking during this recession.

2012 was a very successful year for retailers, marking the peak of the recovery year, when most companies reached their pre-crisis peaks. During the pre-election period, an active monetary policy was implemented, and the refinancing rate was also low against a backdrop of low inflation. This allowed a significant portion of the population with average and lower incomes (60% of whom were public sector employees) to receive both additional payments before the elections as a result of the direct and indirect injection of funds into the economy and to gain access to affordable consumer loans. The expansion of disposable income was the driver of consumer demand. After the elections, the payment policy accordingly began to taper off, and rising inflation led to an increase in the refinancing rate, thereby reducing consumer lending opportunities. The expected wage increase in early 2013 did not materialize, placing additional constraints on consumer demand in the fall of 2012/2013. The first signs of a slowdown were noticeable back in the winter and spring of 12, but this could partly be attributed to seasonal factors: the unusually long winter undoubtedly impacted sales of certain product categories, particularly clothing, footwear, and accessories, as most brands' spring/summer collections were not suited to the weather conditions. The extent of this impact could be assessed from the second quarter data, when sales began to grow at a compensatory rate, albeit slower than expected. However, by May 13, the market entered a clear cyclical stagnation unrelated to seasonal factors.

Advertising

Advertising of Business Global Expo LLC, Taxpayer Identification Number (INN) 7710961530, erid: 2W5zFJRB7Va

While traffic levels at leading retailers remained relatively stable (on average, traffic across the top 200 shopping centers declined 3,5% year-on-year compared to 2012, and December 2013 was -5% compared to December 2012), the conversion rate in mass-market stores fell by an average of 44%. Unsurprisingly, this translates into reduced sales, even with active sales promotions.

The abundance of players in the market and the constant growth of supply against a backdrop of limited demand (as a result of large collection orders in anticipation of a recovery in 2013), the pace of which is not keeping pace with supply due to stagnant income levels and high interest rates on loans, mean that consumers at all levels are becoming more price sensitive.

 However, the footwear market, unlike the clothing market, remains significantly undersaturated compared to the US and EU markets. With an average consumption of 4,4 pairs per year in Russia, this is approximately two and three times lower than in the EU and US, respectively. Thus, the market continues to grow at a faster pace, allowing for countercyclical development. Furthermore, footwear occupies a special position within the fashion industry, along with children's clothing and underwear. These are categories that still retain a largely functional significance, while clothing and "fashion" as such are increasingly focused on emotional consumption. Consequently, even as incomes decline, functional needs are nonetheless satisfied. Finally, downward price movement for footwear occurs much less frequently than for clothing. Demand for footwear is price-inelastic, meaning that consumers accustomed to a particular segment of footwear and the associated quality (whether real or perceived) will not be willing to return to a lower price level. For them, the functionality of such footwear will be significantly reduced, and wearing it will be practically harmful to health. In this context, even an increased debt burden does not lead to a decline in spending on footwear—or on food, medicine, and other factors associated with functionality. This means that, in a short-lived recession like the one we're currently experiencing, footwear will likely maintain a stable market position, which would only worsen if the recession lasts longer than 18 months.

Thus, the entire year of 2013 was marked by high levels of household indebtedness, with disposable incomes not only failing to grow but actually declining due to inflation, the need to pay interest on loans, and repay the bulk of debt from stable or declining incomes. Combined with the large volume of goods ordered, this led to overstocking at retailers, who by the fall of 2013 had begun actively promoting sales, primarily through price promotions. Some overstocking was also observed at footwear companies due to the inflated expectations that plagued the entire fashion market.

Reducing the price is not a solution

A slowdown in sales growth is certainly undeniable. Another question is how difficult it is to achieve nominal sales growth today, when consumers are demonstrating heightened price sensitivity for fashion products, tempting them to extend this approach to footwear by selling off excess inventory. True, surveys show that shoppers today are willing to pay less for products, while expecting more. They shop less frequently, make fewer impulse purchases, and are less willing to purchase more than one item per receipt. The average number of items per receipt among the top 20 mass-market players has decreased to 1,22, down from 1,3 a year earlier. However, given the specifics of the footwear market, the low effectiveness of price promotions should be clearly assessed. They may be effective in the short term and will appeal to the most financially vulnerable group of consumers, who are forced to deny themselves even essential and functional items during a crisis and instead opt for lower prices. However, in the long term, this measure is completely ineffective, and even dangerous. Excessive consumption of footwear will lead to subsequent "consumption limits," which retailers already faced in 2010, when, following the unprecedented sales of 2009, consumers were unwilling to spend on clothing and footwear again, even during the recovery phase. Price manipulation will not only disrupt this process in the long term, but will also indirectly hinder the qualitative development of the market—especially design, which remains a competitive weakness for Russian footwear manufacturers in particular.

The wage freeze for public sector employees has reduced their purchasing power.

At the end of 2013, another significant event occurred that further pressured demand—and contributed to the poor sales in late 2013. The 2014-2016 budget was adopted, declaring a freeze on public sector wages, including the abolition of indexation. Since 60% of mass-market consumers are employed in the public sector (either their parents or the consumers themselves), this factor has a direct impact on retail sales, significantly reducing purchasing power. Speaking of shoemakers in this context, it's worth noting that this "karma" also applies to them—again, not without caveats. While public sector workers do indeed purchase footwear largely from the mass-market segment, their demands are also higher. Since quality requirements in the mass market are limited by the natural limits of "quality for money" (which is low in the mass market), appearance is compensated for by frequently replacing pairs of shoes. Since most budget workers have dress codes, they also require footwear of a certain classic, formal or semi-formal style. Such footwear in the mass market looks respectable, but wears out quickly, as it is made from less expensive materials and is not constructed in the most durable way. As a result, the frequency of replacing pairs of mass-market shoes (which is, on average, no higher than in the luxury or premium categories) is significantly higher among consumers in the budget segment, creating a countercyclical trend during a crisis. Finally, relatives of budget workers (especially children) tend to mirror the consumption pattern and also frequently replace their shoes, especially if the children attend public schools and kindergartens, where they are also required to meet specific shoe standards. Children of budget workers are often not left at home with a family member, but attend public preschool, which expands the range of children's footwear consumption in large quantities – again, regardless of the crisis.

 All of these caveats, of course, do not have an absolute impact on all footwear companies, since they are not comparable in terms of functionality, style, price level, or initial competitive position. However, they can be used to develop anti-crisis strategies that will not only prevent a decline in sales in a difficult economic environment, but also ensure some growth, while avoiding overconsumption and not limiting the potential for dynamic development during the upward wave of the cycle.