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Monday, February 9, 2009 as of 6:12 AM EST POLITICS My Account My Online Journal Help Welcome, Cherrie Clark Logout Today's Paper Video Columns Blogs Graphics Journal Community Home World U.S. Business Markets Tech Personal Finance Life & Style Opinion Careers Real Estate Small Business FEBRUARY 9, 2009, 7:12 A.M. ET Saks Upends Luxury Market With Strategy to Slash Prices New! To sign up for Keyword or Symbol Alerts click here. To view or change all of your email settings, visit the Email Setup Center. Email Newsletters and Alerts The latest news and analysis delivered to your in-box. Check the boxes below to sign up. SIGN UP Companies within this Article Saks Inc.(SKS) 2.72 0.00 2/6 People Who Viewed This Also Viewed... Politics Obama's First 100 Days Inauguration Day Rod Blagojevich Journal Reports Columns & Blogs 1 of 10 U.S. Senate Nears Vote on Stimulus Bill 2 of 10 Partisan Divide Haunts Obama's Policy 3 of 10 Hathaway to Head Cybersecurity Post Ca To Co TOP STORIES IN U.S. MORE IN POLITICS » By VANESSA O'CONNELL and RACHEL DODES When Saks Fifth Avenue slashed prices by 70% on designer clothes before the holiday season even began, shoppers stampeded. "It was like the running of the bulls," says Kathryn Finney, who says she was knocked to the floor in New York's flagship store by someone lunging for a pair of $535 Manolo Blahnik shoes going for $160. Saks's deep, mid-November markdowns were the first tug on a thread that's now unraveling long-established rules of the luxury-goods industry. The changes are bankrupting some firms, toppling longstanding agreements on pricing and distribution, and destroying the very air of exclusivity that designers are trying to sell. The problem Saks faced last November is one that haunts the U.S. economy as a whole: From car makers to home builders, companies are stuck with inventories that are far too fat. (See related article.) Saks's risky price-cut strategy was to be one of the first to discount deeply, rather than one of the last. Managing high-fashion inventory is tricky. Clothing can go out of style in just months, so stores don't want to keep it around. But cut prices too soon or too deeply, and shoppers start to expect it. Stephen I. Sadove, Saks's chief executive, says his action helped his company avoid massive losses, or worse. "These herculean things," including slashing inventories, were done to "make sure that the company survives," Mr. Sadove said in an interview. Pressured by Saks, and hit by the worst holiday season in almost 40 years, rivals including Neiman Marcus Group Inc. and Barneys New York, a unit of Istithmar World of Dubai, slashed prices, too. They cut much more deeply and aggressively than usual, starting as early as late November -- with shopping season barely under way. That, in turn, clobbered smaller boutiques. "It didn't seem logical to continue," says Linda Dresner, owner of a Park Avenue shop that for a quarter-century specialized in procuring unusual items favored by the fashion cognoscenti, like $1,000 dresses by Japanese label Comme des Garçons. She closed her doors in December, unable to keep up with the price- cutting. Retailers are still feeling pain. Last Thursday, Saks said January sales fell nearly 24%. Neiman Marcus expects its first quarterly loss in a holiday shopping period that anyone at the retailer can remember. Last year, luxury goods had become especially important to retailers because sales of these News Alert In Today's Paper This Week's Most Popular On WSJ.com In My Network Ackman Tries to Mollify Investors Firms Race To Slash Inventories Microsoft to Bolster Cellphone Strategy Chaos in Jet After It Hit River Bailout Plan May Use Private Bank for Bad Assets Email Printer Friendly Text Size Share: Yahoo Buzz Article Comments (13) U.S. Edition More News, Quotes, Companies, Videos SEARCH Saks Upends Luxury Market With Strategy to Slash Prices - WS... http://online.wsj.com/article/SB123413532486761389.html?mo... 1 of 6 2/9/09 7:19 AM

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  • Monday, February 9, 2009 as of 6:12 AM EST

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    FEBRUARY 9, 2009, 7:12 A.M. ET

    Saks Upends Luxury Market With Strategy to Slash Prices

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    By VANESSA O'CONNELL and RACHEL DODES

    When Saks Fifth Avenue slashed prices by 70% on designer clothes before the holiday seasoneven began, shoppers stampeded. "It was like the running of the bulls," says Kathryn Finney,who says she was knocked to the floor in New York's flagship store by someone lunging for apair of $535 Manolo Blahnik shoes going for $160.

    Saks's deep, mid-November markdowns were the first tugon a thread that's now unraveling long-established rules ofthe luxury-goods industry. The changes are bankruptingsome firms, toppling longstanding agreements on pricingand distribution, and destroying the very air of exclusivitythat designers are trying to sell.

    The problem Saks faced last November is one that hauntsthe U.S. economy as a whole: From car makers to homebuilders, companies are stuck with inventories that are fartoo fat. (See related article.)

    Saks's risky price-cut strategy was to be one of the first todiscount deeply, rather than one of the last. Managinghigh-fashion inventory is tricky. Clothing can go out of stylein just months, so stores don't want to keep it around. Butcut prices too soon or too deeply, and shoppers start to

    expect it.

    Stephen I. Sadove, Saks's chief executive, says his action helped his company avoid massivelosses, or worse. "These herculean things," including slashing inventories, were done to "makesure that the company survives," Mr. Sadove said in an interview.

    Pressured by Saks, and hit by the worst holiday season in almost 40 years, rivals includingNeiman Marcus Group Inc. and Barneys New York, a unit of Istithmar World of Dubai, slashedprices, too. They cut much more deeply and aggressively than usual, starting as early as lateNovember -- with shopping season barely under way.

    That, in turn, clobbered smaller boutiques. "It didn't seem logical to continue," says LindaDresner, owner of a Park Avenue shop that for a quarter-century specialized in procuringunusual items favored by the fashion cognoscenti, like $1,000 dresses by Japanese labelComme des Garons. She closed her doors in December, unable to keep up with the price-cutting.

    Retailers are still feeling pain. Last Thursday, Saks said January sales fell nearly 24%. NeimanMarcus expects its first quarterly loss in a holiday shopping period that anyone at the retailer canremember.

    Last year, luxury goods had become especially important to retailers because sales of these

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    so-called "star" brands such as Prada, Gucci and Dolce & Gabbana -- which sell in departmentstores as well as their own boutiques -- stayed strong into mid-2008, even though retailingoverall was sinking by then.

    By mid-November, there were already a fewsigns of trouble. Five days before Saksslashed its prices, Neiman Marcus had cut itsown by 40%. And designers themselves werequietly trying to drum up cash by sellingcurrent fashions at fire-sale prices (to 90%off) at private "sample sales," often tuckedaway in industrial buildings in New York.

    But Saks's maneuver marked an openabandonment of the longstanding unwrittenpact between retailers and designers overwhen, and to what extent, to cut prices.Those old rules boiled down to this: Leave

    the goods at full price at least two months, and don't do markdowns until the very end of theseason.

    That worked fine in the good times. Demand was high, and so were everyone's profit margins.

    But Saks's surprise discounting forced companies and brands that have their own retailoperations -- including Prada SpA, PPR SA's Bottega Veneta and LVMH Mot Hennessy LouisVuitton SA's Marc Jacobs unit, which had opened hundreds of their own stores in the pastdecade -- to follow suit or forfeit sales.

    Giving designers a heads-up wasn't an option, Saks says, without risking that rival departmentstores get wind of its strategy. "We live in a competitive environment," says Ron Frasch, Saks'schief merchandising officer. "Also, who do you tell and who don't you tell?"

    Perhaps the biggest consequence is that customers are now questioning the entire premise ofluxury goods: Why pay top dollar today if big markdowns could be coming tomorrow?

    "Shopping has changed as an experience for me" because of all the discounting, says RozSilbershatz of New York. Over the holidays she bought, among other things, a $1,000 BadgleyMischka gown for $290.

    Previously, the 29-year-old communications executive had paid full price for items including a$2,500 Jimmy Choo handbag. "I am so shocked that I ever did pay full price," she says. "I couldnever do that again."

    Designers are starting to fight back. Discounting "is the way of spoiling everything," says GianniCastiglioni, president of Milan-based designer label Marni SRL, known for $2,000 dresses madefrom innovative materials such as polyvinyl chloride (the "PVC" in household pipes) that arefavored by the art-gallery set.

    Some, including Marc Jacobs and Derek Lam LLC, are thinking about splitting their product linesor withholding some top items from department stores in order to feature them in their ownstores. And at New York Fashion Week, which starts Friday, some designers might offer retailersonly their "pre-fall" collection, but not what they actually show on the runways, which wouldappear only in their own shops, according to one buyer for a Saks rival. This person declined toname the two brands weighing this strategy.

    Saks executives aren't in favor of that. It's the runway collection that's "setting the image andsetting the tone" for a designer's look, says Mr. Sadove.

    Diane von Furstenberg, the designer and president of the U.S. fashion designers' tradeorganization, says another solution might involve producers leasing space in department stores.

    The idea appeals to brands because it gives them complete control over display and staffing.Department stores, however, have some issues. It diminishes control over their owndepartment-store brand and can also get confusing for shoppers, if say a "store-wide" saledoesn't apply to items bought in various leased-out areas of the shop floor.

    Leasing is more common Europe and Asia but relatively rare in the U.S. Saks leases a slice ofits space to Louis Vuitton and Fendi, among others.

    From his corner office overlooking 49th Street, Mr. Sadove, 57, says he's working on damagecontrol with designers. "If people's feathers got ruffled, we want to unruffle them."

    WireImage

    Inside Saks Fifth Ave. in New York City, on Nov. 24, aday before the store started its 70%-off sale that sentshockwaves through the luxury-goods industry.

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  • Saks has an incentive. "Almost everything we sell is 'designer' in one form or another," Mr.Sadove says.

    Still, he and Mr. Frasch, defend their actions, saying they needed to swiftly fix a big problem thatno one saw coming.

    When Saks started planning its 2008 holiday season a year ago, there were few clues that thesix-year boom in luxury goods was about to flop. Although other retailers were starting to suffer,it appeared that Saks's wealthy clientele -- its typical shopper has a $175,000 annual householdincome -- might help the chain buck the trend.

    The Dow Jones Industrial Average was approaching 13000, and "our customer feels good," Mr.Sadove said in November 2007, as Saks reported higher profits.

    So, in February 2008, Mr. Sadove told hismerchants to place orders accordingly whenthey jetted to Milan and Paris to buy for thefall season.

    Then, September struck. Mr. Sadove was inParis on Sept. 29, attending runway shows --but his eyes were glued to his BlackBerry ashe watched the Dow drop nearly 800 points inone day.

    Next, he watched big spenders becamepenny-pinchers. That month, Saks'ssame-store sales fell 11%. In October, they

    declined another 17%, the worst monthly drop since the 2001 terrorist attacks.

    The change happened "over as short a period of time as you can possibly imagine," Mr. Sadovesays.

    The result: a huge disconnect between Saks's inventory and shoppers' appetite. At Saks'sannual "private sale nights," early-November events for top customers, the usual 40% discountsgot no response.

    After lunch on Nov. 10, Messrs. Sadove and Frasch gathered with other executives to strategize.The Thanksgiving kickoff to shopping season was still a few weeks away, and maybe people'sbillfolds would loosen up by then. But Mr. Sadove was anxious.

    So he floated the idea of deep price cuts.

    Some colleagues urged drawing the line at 50%. But Mr. Frasch felt strongly that wouldn't beenough.

    "I felt, the sooner we react, the better," he recalls. "I said, 'Let's not wait till December 26th' " todo something dramatic.

    Their decision: A 70%-off sale would be used, but only in a worst-case scenario, if sales keptdeclining and shoppers remained bored by less eye-popping 40% rollbacks.

    Extreme discounting of luxury goods is perilous. Not only does it potentially leave your bestcustomers feeling duped for paying full price, it also erases fat profit margins of 50% or more.

    "We are going into a period of total unknown," Mr. Frasch told the team.

    As Thanksgiving approached, things stilllooked very bad. So the 70%-off signs wentup.

    On sale day, Tuesday, Nov. 25, a line ofhundreds of women snaked out the entranceof Saks's eighth-floor shoe department inNew York to buy, among other things, $800Christian Louboutin pumps price-chopped to$250.

    Nationwide, boutique owners wereblindsided. In Los Angeles, less than threemiles from Saks's Beverly Hills store, Tracey

    Ross, a well-known boutique owner there, decided not to match the cuts right away. So she was

    Associated Press

    A window display at the store Feb. 4, a day before thecompany reported that January sales fell nearly 24%.

    View Full Image

    AFP/Getty Images

    Hard-hit luxury retailers, like stores at the BeverlyCenter mall in Los Angeles, continue to offer steepmarkdowns.

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  • stuck trying to sell $2,400 dresses and $1,400 handbags at full price when similar goods were inthe bargain bin, relatively speaking, just around the corner.

    Ms. Ross says she phoned and pleaded with designers to take their merchandise back. Theywere "in complete denial," she says. "They said, 'You're Tracey Ross. You'll sell it.' "

    In the end, she says, she had to discount so steeply that she couldn't pay her designers. "I amlike, 'Do the math. I sold your $800 shoes for $50.' " She closed her store and filed forbankruptcy protection on Christmas Eve.

    Some designers also added to the pain by enforcing minimum-order agreements on boutiques.In good times, hot brands had the power to set terms like these.

    Some boutique owners were incredulous. "Could you imagine if I told my customer, shopping inmy store, 'Here is your budget'?" says Elyse Walker, who owns five boutiques in PacificPalisades in Southern California.

    Her sales were down 5% for the year -- but profits fell 50% due to deep holiday discounting.

    Meanwhile, in Milan, Mr. Castiglioni of the designer label Marni was at home in mid-Novemberwhen he received a call from the manager of his New York store saying customers weresuddenly walking in and demanding 50% to 70% off. "They were saying, 'Why should we pay fullprice?' " Mr. Castiglioni recalls.

    In New York, American designers started contacting Ms. von Furstenberg, the head of theirtrade group, looking for advice. "I was very upset. Everyone was," the designer says. That levelof price-cutting "cannot happen again," she says.

    Part of the problem is the designers' own fault. Over the past 15 years, their products havebecome so ubiquitous -- Gucci is sold in airport, Hermes has mall shops -- it's undermining theimage of exclusivity. In a January survey of rich shoppers by the Luxury Institute, a researchfirm, roughly half of high-net-worth consumers said luxury brands are becoming commoditized;64% said they were overpriced.

    "The luxury industry has to devise a new business model," says Arnold Aronson,a consultantand former Saks chairman.

    Among the designers rolling out separate lines for their own shops is Aeffe SpA, the Italianparent company of Alberta Ferretti and Moschino. The company had just opened stores in NewYork and West Hollywood, Calif., in August and September -- just in time to come underdiscounting assault. Aeffe USA's president, Michelle Stein-Borgna, says shoppers' expectationshave already changed. A few days ago, one of her store managers informed her that "customersare coming in and asking for discounts on spring merchandise right now."

    Her response: "Absolutely not. It's a vicious cycle," she says. Aeffe is now thinking about cuttingback what it offers to department stores in areas where it has its own shops.

    Similarly, New York design house Derek Lam, which is known for cocktail dresses that sell from$1,200 to $3,500, is opening its own New York store next month. To protect itself against otherretailers' discounts, it's thinking about creating "special editions" of key items that wouldn't besold in Saks and other retailers.

    Others are taking the opposite approach. In December, Sergio Rossi, the Italian shoe andhandbag designer, closed all three of its U.S. Sergio Rossi stores. Instead, the label, which isowned by the Gucci Group unit of French company PPR, plans to stick with boutiques anddepartment stores.

    A spokeswoman for Gucci Group says the store closures were a strategic decision unrelated todiscounting.

    For emerging designers, the situation is more dire. "The department stores really hurt us," saysPhilip Leeming, co-designer for Falls, a dress-designing duo.

    Late last year, Saks informed Falls and other designers that they would be expected to coversome of the cost of Saks's price-cut decisions. Saks says the designers weren't asked toshoulder the full burden of its extreme discounting at year's end.

    "It was horrendous," says Leong Ong, Mr. Leeming's business partner.

    Last year, Falls shipped its own lines to 160 different retail customers. Today, it is drasticallycutting production and instead focusing on designing for retailers' private-label lines. "There'sless chance of them asking for returns" on unsold goods, Mr. Ong notes.

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    In hindsight, Saks executives say they may have cut too much in some areas. "We didn't needto do what we did in accessories," Mr. Frasch says. High-end shoes and handbags wouldprobably have sold out, even at higher prices, because shoppers see them as more practicalwardrobe updates than another new outfit.

    The retailer is still not out of the woods. Saks shares were recently trading at $2.72, down from$22 in December 2007. In mid-January, it laid off 1,100 people, or 9% of its work force, andcould close some stores.

    This year, Saks is spending about 20% less on merchandise to keep inventories lower, but Mr.Frasch acknowledges the number is only a guess. The luxury-goods business is "absolutelyflying blind," he says.

    His boss, Mr. Sadove, agrees. "One of the big questions that people are asking," he says, is:"Will people ever buy at full price again?"

    Write to Vanessa O'Connell at vanessa.o'[email protected] and Rachel Dodes [email protected]

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