Taking Stock

Wall Street Weighs In on Tech Trends in Retailing

One measure of a successful company is how much confidence investors have in it. This can be measured by looking at a stock price over time. If it's up, the news is usually positive; down and you can usually bet that the retailer is going through hard times. There are, of course exceptions, but the truth is that investors base their buying and selling decisions on the advice of Wall Street analysts. Why does Wedbush Morgan recommend selling WTSLA (The Wet Seal)? And why does Lazard Freres encourage purchasing TGT (Target)?

The metrics that these recommendations are based on come from many different sources. Yes, metrics such as comps or gross sales still play a huge role. But many analysts are increasingly looking beyond the numbers into technology. A smooth CRM implementation, for example, can often mean the difference in competitors and many of the retail stocks that have done well. Although there's currently a debate as to whether or not technology provides a competitive advantage, it's easy to point to examples in retail where it has. Technology played a huge role in Chico's rise as a retailer, and Wall Street is increasingly taking notice.

"Right now CFOs are looking for quick paybacks, and they're looking for optimization systems, be it markdown optimization, forecasting or other tools," says Jeffrey Klinefelter, managing director and senior research analyst, Piper Jaffray & Co. "What I sense is two, three, four years down the road, a number of these companies are going to need to replace their core systems, their ERP systems. I think that's going to be an interesting thing to watch because some of these systems now are homegrown."

The Value of Technology
The feeling on Wall Street seems to be that there are key areas where retailers can use technology to drive growth. These include assortment planning and price optimization. This has forced many analysts to become more technology savvy, and there are now signs that what analysts traditionally track is changing. In addition to comp store sales and some of the obvious indicators, there is more peeking beneath the covers of what technologies retailers are using and what impacts those might have.

"I think we've been forced to look at technology more closely because in the last couple of years, in many cases, sales gains for retail were really hard to come by" says Dorothy S. Lakner, executive director, equity research, CIBC World Markets. "We've been forced to look at gross profit and look at how retailers were managing to achieve gross profit increases, even in the face of flat or declining same store sales. That has made us look at how they're doing it."
Sourcing was one of the areas analysts saw retailers getting benefit. But the current buzzword is markdown optimization. Some of the companies Lakner covers, for example, have adopted ProfitLogic, and she has noticed that after adoption they are getting gross margin benefits from being able to know when to mark a product down and how deep a markdown to take.

This is technology used to achieve a decisive advantage. CIOs want technology that aligns with core business goals. In retail, that means driving down costs and increasing profits. Wall Street analysts have realized this, and it is clear that they are now believers in it's power. Investors have also seen the value of technology and have rewarded the retail leaders who value IT.

"Depending on the sector, I think we tend to see CEOs who get technology or CEOs who don't," says Bob Buchanan retailing industry group leader/VP, A.G. Edwards. "The Home Depot, for example, changed top management to bring somebody in who got technology, whereas the prior regime really did not get technology. The Gap is a shining light within specialty apparel where you have a new team who understands technology. I think it's so much better when the top people get the technology and champion the initiatives. Nordstrom, although still early in its Retek implementation due to be finished by mid next year, is a great example. Blake Nordstrom was able to champion the implementation of Retek and narrowly focus them on perpetual inventory; whereas his predecessor had 20 great ideas a day and nobody knew exactly which one to focus on."

Differentiating Factors
Assortment is a key step in differentiation. Proper assortment ensures that not only is there great variety within a given store, but also that the store isn't selling the same items as its competitors. It also allows retailers to sell products with minimal markdowns.

"We're seeing prices actually increase on average," says Lakner. "And, what's happening because inventories are low, the consumer is literally being retrained to buy at full price because it isn't going to be there when it gets to the markdown rack."

This has produced changes in customer behavior. Previously, savvy consumers waited for inevitable sales dues to inventory overload. Customers could always get what they desired at lower prices if they just waited for it to go on markdown. That's not the case anymore. Lakner hears company after company talking about better full price selling and customers buying at full price. And some are getting a better margin at markdown, which is one of the benefits of using markdown optimization tools.

Deborah Weinswig, director, U.S. equity research, Smith Barney, seems to agree with Lakner and contends that increased differentiation among competitors leads to higher selling prices for everyone. The logic being that a glut of any one particular product will eventually lead to markdowns. Having unique products has helped retailers such as JCPenney differentiate its product offerings and place itself on much stronger footing.

"JCPenney's merchandising team has delivered an impressive turnaround," says Weinswig. "In the women's contemporary and home categories, the company has really been firing on all cylinders and has pulled away from their competition in terms of quality, price and differentiated product offering."

JCPenney uses I2's TMMP for merchandise planning. The department store is widely recognized as coming out of a successful reorganization that has placed it in a postion where it is much stronger and able to compete with the likes of Federated and May Department stores. Wall Street has noticed and rewarded these efforts. JCPenney's stock has risen 60 percent — from 25.20 to 40.41 — from January 2, 2004 through November 15, 2004. Technology implementations and upgrades played a huge role in that turnaround. As information about technology projects with positive results pours in, Wall Street places more emphasis on technology savvy retailers. However some are finding the path easier than others.

And this, also, is something analysts have noted. "It's much easier to implement a system and innovate the way you manage your inventory in hard lines," says Buchanan. "When you get into apparel, there's assortment planning. There's size, style. There's color. There's regions of the country that have weather trends and different climates."

But technology is not always viewed as a panacea. Buchanan believes that, "within specialty apparel, it's still far more important to make sure that you have the right product." Supply chain optimization may help here. Specialty apparel retailers find it very helpful to choose the right product than actually move it efficiently through its distribution networks. Investments in supply chain planning and execution technologies can go a long way toward helping resolve this issue.

It's worth noting RFID here. It is clearly a new technology with big potential. As such, RFID is a growing concern to analysts. While most admit that it's still to early too know exactly what to expect, it is clear that many are excited with the technology's potential. Retailers that choose to implement this technology will certainly have more information at their disposal, and many vendors stand to gain too. Often overlooked among thediscussion about tags and readers is the need for new software packages to handle the massive amounts of data that the technology will collect. Bear Stearns analyst Philip Ailling believes that Manhattan Associates, for example, may be well positioned to capitalize on RFID. The company also has a $2 million equity stake in Alien."I would expect some snags along the way. RFID won't happen overnight, but it's definitely going to happen," says Ailling.

Customer Segmentation
Increasingly, retailers are examining the science of the business and focusing on both customer segmentation and workforce management. By getting more associates in the stores to talk to customers and provide feedback combined with looking at demographics and using demographic tools many stores are able to segment and find their best customers. Workforce optimization vendors such as Kronos and Reflexis help get the right associates into the stores at the right times, and CRM software from Teradata, Siebel and others can assist in the implementation of customer loyalty programs.

Chico's is often pointed to as the premier example of customer loyalty segmentation programs. It has been estimated that more than 90 percent of its sales are coming from Chico's passport club members, a group of extremely loyal customers. Many on Wall Street believe that Chico's successes show how loyalty can reward a company as well as the investor.

"I don't think I've ever in my entire career seen a company post double digit, same store sales gains for as long as they have, which is seven and a half years now, and very high profit margins, among the highest in the industry," says Lakner. "And it's clearly going to the bottom line."

One difference in the Chico's loyalty program from other retailers is that it is not based on store credit cards. This helps draw in consumers who prefer not having to have another credit card in their purses and wallets. Loyalty programs can be unsuccessful for this and other reasons, and the end result is often increased markdowns, excessive coupon offers and, ultimately, lost profits. Chico's, Lakner contends, has pushed everyone to start thinking about loyalty programs in ways other than just the credit card offering.

This unique form of loyalty program shows value across all forms of retailing. Youth retailers benefit because most teenagers do not have credit cards. In highly competitive markets where consumers are motivated by price, having something extra to get customers into stores can produce a competitive edge. Target, for example, donates a certain amount of money to a school of its customer's choice because the retailer figured out through research that its customers are very concerned about education. In the case of teens, promotions like bounce-back coupons and buy one, get one free can often get customers interested in returning.

Causes for Concern
"I think it's still not perfectly clear what investors in retail companies really perceive as value add," says Klinefelter. Adding that investors are looking for for retailers to assign increasing operating margin to go with some predictability. Using the markdown optimization example, investors have been able to see dramatic improvements within the business, but there are other driving factors.

Investors increasingly want to know what kind of systems a retailer has in place and where they are still deficient. They want to know the areas where increased investment might lead to significant profits. But they also want to know where technology improvements can lead to problems. This has already been seen in areas such as planning and allocation, where technology implementations caused new problems for retailers to work through.

"I think right now kind of a flash point is what happened with Ross stores recently where they shifted into a new planning and allocation system, and it has been very, very difficult for that company to navigate through this," says Buchanan. "That's kind of a concern right now. I think everyone recognizes that most people have basic systems and that markdown optimization is probably the best because in fashion retailing, the biggest risk to your business is markdowns and inventory management. But I think there's a concern right now after a couple of high profile cases of just how smoothly these things can go."

It is well known that a poor IT installation can lead to millions in lost revenue and, ultimately, the CIO's job. Because of this, most retailers are requiring ROI within a specific time period before any CFO signs off and releases needed funds. This should help set investors and analysts minds at ease. It also ensures that CIOs who do their homework will still have a job after a huge upgrade.

Beyond the Bottom Line
Wall Street has always looked beyond the bottom line when analyzing companies. Profit sheets are still the best indicator as to how a company is doing, but retail can be a little more fickle. Fashion trends, the state of the economy and even weather patterns come into play for a business that compares sales on a monthly basis. Weather is certainly being blamed for many of this year's weak numbers — especially in Q3.

"There is the entire Southeastern region that certainly has not had favorable weather, by any means, and that has been impacting trends across the country," says Klinefelter. "Analysts are all sort of amateur meteorologists, and the weather has not been favorable. It's been warmer than last year. You hate to use the weather excuse, but I think we finally decided that we're all just going to use the weather excuse because the weather does impact retail."

Technology can help here also — at least with forecasting. Planning software that takes weather trends into account is available for retailers who keep good records. While this can not prevent bad weather, it can give a clear picture of what the impact a blizzard will be on business and help retailers plan accordingly. Investors will still hear the weather excuse, and there might never be a way to get around this, but planning for disaster might soften the blow of weak sales due to bad weather.

It is clear that Wall Street expects top retailers to invest in technology. Those that do, more often than not, are rewarded on the bottom line and on the trading floor. Technology can both help a retailer and hurt a retailer. This has changed the metrics that Wall Street analysts look for in retailers.

"I think Wall Street has changed the way it looks at companies," says Lakner. "Analysts are being forced to consider these other things besides just the top line."