After a hard morning workout, my favorite thing to do is relax in the sauna and chat with my friends at the gym. Usually the conversation is pretty light (predominantly news, sports, weather) but every now and then we’ll chat about business.
Before I go on, I should probably explain that my gym is located in the fashion district and most of my gym friends are in the 55+ age range.
This past week, one such friend, Richard, was telling me that April is one of the worst months of the year in his business and every year it gets worse. Richard works for a fashion design and production company, and although I haven’t asked, I’m pretty sure he’s either the President or CEO. I was very interested to hear how his business has evolved over the years, so I prodded for him to tell me a bit more.
He explained that in the 1970’s, his business was easy. He’d pack up a box of clothing samples, take the train to Boston and pitch department stores to sell his merchandise. Back then, there were five department stores with corporate offices in Boston and each one had three separate divisions of clothing buyers. So essentially he’d have 15 separate buyers to pitch on each trip to Boston. From his 15 clients, he’d always get plenty of orders and secure his revenue stream for the season.
However, over the years the business evolved. Seizing the opportunity to make some good money, more clothing production companies popped up to compete with Richard’s company. At the same time, department stores started losing market share to other, more vertically integrated clothing retailers.
Since 1970, 14 out of the 15 department store corporate offices in Boston have closed. The only one that remains is Macy’s, which happens to do all of it’s buying out of New York. Essentially, over the course of 40 years, Richard went from having 15 clients in Boston to having zero. Simultaneously, more competition on the production side has led to downward pricing pressure as Richard’s competitors have started to ferociously undercut each other on price.
Over the years, things got more and more aggressive. The way the business works today, to me, sounds just short of abusive.
Today, at the beginning of each clothing season, Richard will sign a contract with a department store for a specific volume of merchandise at an agreed upon price. Say – 10,000 units for a total of $100,000. Signing that contract is the last time Richard has any influence on what happens with his clothes. The pricing, merchandising and selling is all done by the department store. Additionally, the store always has a financial plan for the clothes that they buy from Richard. If their goal is to hit a 40% gross margin, they expect at least $140,000 in sales revenue from Richard’s inventory.
At the end of each season the department store will add up all the sales they got from Richard’s clothes and see if they hit their planned margin. If they exceed their planned margin, Richard will sometimes get a nice thank you note. However, if they don’t hit their revenue target, they will call Richard and try to charge their revenue shortfall back to his company. So, at the end of the spring season, if the store only made $130,000 off Richard’s clothes, they would call him up in April and try to get him to pay $10,000 to make up for their revenue shortfall.
The worst part is, the store usually doesn’t even tell Richard their planned gross margin for his merchandise. Often, the first time Richard learns about their financial plan is in April when they’re calling to ask for money.
As Richard exited the sauna, prepared to face another day of department store calls, I couldn’t help but think how similar Richard’s business is to the advertising agency business.
In both cases, downward pricing pressure has totally changed the dynamics of the industry. In 1970, ad agencies charged 15% of media and took home fat profits. Today, most agencies charge a very low percentage of media (~3-5%) and/or an hourly fee. In both Richard’s business and the ad agency business, a surplus of suppliers have led to borderline abusive procurement practices from buyers.
Just goes to show, the only constant in life is change. If you don’t stay ahead of the curve, you better get ready to watch your profits disappear.