Why Nordstrom Rack Is Key To Managing Overbought Inventory

This is an excerpt from Thursday's (3/4) Point of Sale retail supply chain newsletter sponsored by ArcBest.

Ordering apparel inventory is hard. In normal times, retailers order inventory upwards of six months in advance, hoping what they ordered isn't out of fashion by the time it hits the shelves. Although consumer preferences changed rapidly, at least overall demand was steady and predictable. 

COVID has and continues to rampage through the apparel industry, suppressing demand for pretty much everything besides athleisure. Over the summer, retailers had difficult planning decisions to make. Remember back to May, June and July… We had no idea what to expect. Vaccines were barely dreamed of but we had just come through what we believed was "it" (the first wave). Optimism was brewing, the stock market was rebounding quickly, consumer confidence was growing and consumers were flush with the first round of stimulus. There were many variables apparel companies could have pointed to as evidence for normal, or even slightly higher holiday ordering. 

But many did not give into the temptation. Retailers like The Gap GPS, Macy's M, Victoria's Secret LB, and many others were able to squeeze higher margins on lower sales and avoid year-end discounting due to inventory prudence. At the same time, retailers like Levi Strauss LEVI and Urban Outfitters URBN said they may have left some sales on the table because of it. 

As a higher-end apparel retailer, Nordstrom JWN felt that customer demand would be strong enough to warrant "increased receipt plans" when planning for the holiday season. This enabled Nordstrom to achieve better than anticipated sales during the quarter, but it experienced shipping delays that resulted in holiday inventory not arriving until after the peak shopping season. 

Anne Bramman, CFO of Nordstrom, said during the earnings call that the makeup of the inventory is "largely non-seasonal", which means JWN may not need to liquidate or dispose of it immediately. But CEO Erik Nordstrom said the company is taking immediate actions to realign its inventory position. 

However, executives were adamant that although they were overbought, there will be no "…giant markdown kind of clearance event…That's not the most practical and prudent way for us to solve for inventory issues, and we'll solve for those in the right way," Nordstrom said. 

It remains unclear what "the right way" means, and it also remains unclear how much inventory Nordstrom wants to hold this year (and moving forward). Between Nordstrom and Bramman, the word flexibility was used nine times during the call with all but two referring to inventories. Nordstrom stated its plan to cut its sales to inventory spread in half by the end of the first quarter, but at the same time is "building additional flexibility into [our] buying plans in the first half." 

This desire for flexibility could simply equate to higher inventory levels, especially as it expands its new strategy of wider product assortments and faster delivery from 10 markets currently to 20 at the end of March. CEO Erik Nordstrom said the company wants to have "more and more inventory that's available for same day or next day pickup". 

Despite the potential for higher inventory carry, this is a smart move. Nordstrom was early in adopting curbside pickup and offers pickup at ~350 stores, but only 10% of online orders were picked up in-store in Q4. As the company makes more products available for pickup, it expects to see an instant reaction and feels it is not "anywhere close to the ceiling on there". 

A larger percentage of sales being picked up in store could help Nordstrom offset incremental costs that compressed margins in Q4. The company said experienced higher than expected costs associated with product fulfillment. Over the past year, Nordstrom has ramped up fulfillment capabilities at Nordstrom Rack and this led to some inefficiencies. The company said the issues have been clearly identified and are not expected to recur going forward. 

Additionally, the company saw "higher than planned outbound freight expenses due to carrier surcharges and costs associated with our decision to mitigate carriers shipping constraints, by shifting to higher cost shipping options." This is a non-freight person's way of saying, "Our routing guide disintegrated like the Avengers, so we had to source capacity in the spot market at a time when spot rates were up 50% yoy." Precise, I know. 

Recently, there has been a marked shift in Nordstrom's business model away from traditional wholesale. At its Investor Day presentation last week, the company announced plans to reduce wholesale from 85% to 50% of overall sales. The move represents a pivotal shift, coming in the aftermath of a pandemic that exposed and accelerated the weaknesses associated with wholesale, including the pace of the promotional cycle and amount of unsold inventory.

Department stores have been hit particularly hard by the Covid-19 pandemic and the resulting retail fallout. Nordstrom competitors Barneys and Neiman Marcus have gone bankrupt, while Macy's, which owns Bloomingdale's, is closing 20% of its stores.

Moving towards more drop-ship, concession and revenue-sharing models provides retailers with much more flexibility. Not only does it allow retailers to greatly expand product assortment and offer products from brands around the world, it alleviates the costs of carrying the inventory. 

This type of flexibility has made Nordstrom an attractive retail partner for digitally-native brands. An example is Blueland, which sells eco-friendly cleaning kits on Nordstrom.com through a traditional wholesale model but also appreciates the potential of drop-ship. "With wholesale, it shows a commitment to our product and our brand," Blueland co-founder and CEO Sarah Paiji Yoo told Vogue. "The beauty of drop ship is that we would hold the inventory and have flexibility based on demand, but we see Nordstrom as a sort of influencer channel." 

This strategic pivot is partially the reason Nordstrom expects inventory levels "to be fully realigned in the second quarter." The wording here is noteworthy due to Nordstrom's ability to leverage its off-price Nordstrom Rack brand. Nordstrom is at a major advantage when it comes to discounting and promotions because it doesn't have to immediately jump to liquidation, disposal, or return to the manufacturer. Rather than send to landfill or pawn off to TJMaxx or Ross, JWN can make one last push in Rack stores and on the Rack website. 

Erik Nordstrom said, "I think it's important to think about Rack business that it's not a standalone business, it is very integrated to our model. So our model is two brands, Nordstrom, Nordstrom Rack, and having digital and physical business." 

Not every retailer can lean on an off-price arm to mitigate the negative impact of over-ordering. I think this is exactly why retailers and brands across the board have slashed spring apparel orders. Brands are still left with an entire season's worth of last year's spring clothing, and the immediate future may be even more uncertain now than it was when Nordstrom over-ordered last year. With so much uncertainty ahead, apparel brands are going to continue the prudence that won them the holiday season despite the temptation of vaccine euphoria. Nordstrom is in a unique position where over-ordering doesn't always lead to liquidation under cost. Most others are not so expect them to be conservative through the first half of the year. 

The second half? Your guess is as good as mine.

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