Neo: “That’s not possible.”
Morpheus: “I promised you the truth, Neo, and the truth is that the world you were living in was a lie.”
Neo: “How?”

Morpheus: “I’ll show you.”
—From The Matrix (1999), starring Keanu Reeves as Neo and Laurence Fishburne as Morpheus.

What if you woke up in January 2005 and discovered that much of what you thought you knew about driving shareholder value was wrong. That you’d been living — and selling — in a world that looks real but is a distorted version of the truth. That’s the situation facing major retailers as they look back on the 2004 holiday season.

Here are some of the rules that appear to have been broken this holiday season.

  • Q4 is make-or-break for retailers
  • Focus on driving traffic every day – but especially on Black Friday
  • Don’t worry about ecommerce sales – they’re icing on the cake
  • Whatever you do – avoid out-of-stocks – they’ll cost you sales during Q4

Further investigation proves that these “rules” are being followed by some retailers, those who aren’t making money. Profitable retailers know something other retailers don’t: that in the new reality of retailing, the old rules aren’t rules anymore.

Is Q4 really make or break?

Let’s take the old saw that Q4 is make-or-break for retailers. Turns out that this is not the case. Below is a chart that plots Market Value/Sales (the Y axis) against EBITDA (earnings before interest, taxes, depreciation, and amortization) as a % of Sales (the X axis) for a set of specialty retailers. Retailers “above the line” have stocks that trade at a substantial premium above the price they should get based on their market cap and earnings. Likewise, retailers below the line trade at a substantial discount. Funny thing, this chart. Only about 33% of the variation in Y (Market Value) is explained by changes in X (Earnings). The strength of a retailer’s brand, variability of earnings, and other factors account for the other 67%.

 

As it turns out, virtually all the retailers above the line deliver positive earnings not just in Q4 but throughout the year. In other words, the financial markets value retailers who are profitable 365 days a year much more than the ones who only make it happen during Q4.

This has implications for our second rule – whatever you do make sure it drives traffic every day but especially on Black Friday.

Putting Black Friday in perspective

Most retailers obsess about the promotions they run day in and day out. This obsession peaks at the end of November and Black Friday. For those unfamiliar with the term, this is the Friday after Thanksgiving when – legend has it – retailers turn the corner and magically become profitable after sloshing around in red ink for most of the year.

According to the old rules, the way to maximize your chances of seeing black ink that Friday is to field a door-busting promotion. You know the kind of promotion I mean: Give away a DVD player worth $29 to the first 500 customers who enter your doors Friday a.m., for example. The idea behind these big and splashy promotions is that people willing to line up at 4am just to get their hands on a free DVD player will drop big bucks once they get in the store.

In fact, Black Friday creates a kind of alternative reality for price seekers, a special kind of shopper, who is always and only looking for the lowest price. Loyal to no retailer, this customer will only spend money on items priced so low as to deliver the retailer almost no margin. Customers like this are worth firing – which is what Best Buy did this fall – when they went public with a plan to exorcise its “devils” – that is customers that are unprofitable and bound and determined to stay that way based on these and other behaviors. Price seekers will take each and every promotion you offer them with alacrity. What they won’t do is purchase items at full price. If you are like most brick-and-mortar retailers you’ll end up spending $50-$100 to acquire this customer only to see the customer spend less – considerably less – than this when they purchase.

Given these economics, it is no surprise that retailers like Target – which resides very much above the line – experimented with a very different kind of promotion this holiday season. Instead of using price to drive door-busting behavior, it simply asked for permission to market to the customer. Customers were asked if they wanted a wake-up call delivered by one of 10 characters, to get them into the store earlier and avoid the rush. This gave Target an opportunity to acquire customers who valued Target and also potentially to understand what kind of customer they might be acquiring. Bribes – excuse me! Free stuff just for going to Target – were not needed to drive customers as part of this promotion. Results speak for themselves. Target was one of the few retailers that reported a sales increase by 5.1% this past December 2004 vs. December 2003.

Think ecommerce last not first

Another fallacy that retailers tend to fall into come Q4 is thinking of their ecommerce sites last rather than first. The belief here is that customers will wait until the last minute to purchase gifts, which gives brick-and-mortar stores a major advantage over ecommerce retailers. This belief is based on a fallacy, that retail stores are the main way most customers want to shop and that the customers who shop through your ecommerce site are somehow not core to your business. Not so. Our work with clients suggests that high-value customers tend to shop through multiple channels and the channel they chose depends on the usage situation. During most of the year approximately 2% of revenues in the retail sector happen via ecommerce sites. During Q4, this number increases to 30%, an increase of 15x. An amazing figure when you consider that during Q4 total shopping revenues go up dramatically — by a factor of 2-3x.

Putting ecommerce first means getting your customers familiar with your ecommerce site well in advance of the holidays or any other peak buying period for that matter. Studies show that customers like to shop at sites with a familiar interface, which is why we see so many sites mimicking amazon.com in look and feel. When it comes to ecommerce, focus on the familiar vs. making your site seem novel or new.

Another way to put ecommerce first is through fielding promotions that encourage selective customers to do more buying at your website. Many retailers don’t field these kinds of promotions, fearing cannibalization. To this we say, bah humbug. Multi-channel customers deliver more value to your company. Period. Full stop. Want to accelerate growth in revenues? See if you can isolate a group of customers on your file who look like your high-value customers but who – unlike your high-value customers – are not yet purchasing through your ecommerce website. Invariably, we find that the fastest way to grow the value of these customers is to get them using multiple channels, particularly the web. Multi-channel customers like your brand, the retail experience, the merchandise assortment, or all of the above so much that they will buy from you across all usage situations.

Do out of stocks matter?

Increasingly, retailers are recognizing that no matter how much technology and smart people they throw at the problem, anticipating consumer demand is a Herculean task. Which means out-of-stocks happen, even to best-in-class retailers. And at the worst times, such as holidays. Out-of-stocks continue to matter, but not as much as they once did, thanks to stored value, the technology behind gift cards.

These little cards are truly a gift from the gods as far as the retailers are concerned. Gift cards allow retailers to shift demand from Q4 to Q1. This evens out demand, enabling retailers who don’t have the clout to get their hands on a particularly “hot” product in Q4 to make the sale anyway. And there is a host of evidence that when the customer comes back in store — gift card in hand — they’ll spend more than the face value of the card and will purchase higher-margin items that are not on sale.

We learned this holiday season that high-performing retailers have stopped lulling themselves into believing that if they wait for Q4 profits will come. Instead, they’re making profits a year-round affair. They’re making new rules up as they go along – and downloading them into the brains of their disciples. Film at 11.

— Marcia Kadanoff