Liza Davis ana tne bargann Funting custonner Retailers form the link between the producer of goods and the consumer. Getting the merchandise that customers want to buy is critical to their success. Doing it profitably is essential for their survival. - Jason Asaeda, Department \& General Merchandise Stores Analyst 1 The annual strategic planning retreat at Liza Davis, a publicly-traded upscale women's fashion chain, was more contentious than usual. It was early August 2009, the economy was in a worldwide recession, and Liza Davis stores had felt the pain along with everyone else in fashion. The weeklong meeting at Liza Davis headquarters in Providence, Rhode Island, was fraught with bad news and dire warnings. Jane Offerman, the company's CFO, presented the financial results (see Exhibit 1 for selected financial statements): Compared to the same period last year, the quarterly and six month net sales were down 21% and 26%, respectively. After restructuring, we showed a net loss of nearly $18 million for the first half of the year versus net income of $48.5 million in the first half of 2008 . However, we have managed to reduce our inventory by 30% and our SG\&A expenses by more than 10% compared to this time last year. With the projection of weak winter demand we expect to break even for the remaining of the year, closing with a loss of $18 million for 2009. Adding to an already difficult situation, the executive leadership team was divided on how to position the company to weather the downturn and emerge as a strong competitor in the low margin, zero-sum world of retail fashion. Adam Medina, the vice president of marketing, proposed to shift the focus to bargain hunters: The bargain hunter is the future-it's a growing segment. If we don't cater to them, they will flock to our rivals, who are dropping prices and escalating markdowns and sales. To stay competitive in this market, we need to find ways to encourage this customer - at the very least we should completely revamp our rewards program and increase sales and discounts. Mary Jo Chapman, the vice president of merchandising, expressed another view: Just because everyone else in the industry is running after the bargain hunter doesn't mean that is what we should do. Let's think carefully about this. We have an extremely valuable brand image at Liza Davis. Our core customer base wants to shop at a quality retailer, not a bargain basement. Even though it's painful now, I believe that we will be better off in the long run if we resist the temptation to undervalue our merchandise and our brand. In the fall of 2008, Saks Fifth Avenue, panicked by the credit crisis and fearful of heavy inventory losses, rocked the industry with huge and early markdowns - up to 70%, "well below the break-even point" and "introduced the most economically ravaging period in the history of American fashion." 2 Rival retailers quickly jumped into the markdown fray, but to no avail: same store sales dropped 10% to 30% in the fourth quarter 2008 over the same period in 2007, and annual growth of women's apparel entered negative territory (see Exhibit 2 for sales and growth rates). In January 2009, Saks laid off 1,100 people, including its director of women's fashion. 3 By the summer of 2009, the customer exodus from high-end discretionary goods showed little sign of abating and key indicators for apparel demand through 2013 were weak (see Exhibit 3). Retailers responded by keeping a tight grip on expenses and inventory. Inventory declined 6% at specialty stores and 10.3% at department stores from May 2008 to May 2009. Talbot's, one of Liza Davis's competitors, reported a 21.3% decrease in inventory at the end of fiscal year 2008 over fiscal 2007.4 Many believed the glory days in the fashion industry were gone for good. As one industry analyst wrote: .. . [T]he consumer will not recover until 2011 and, even then, spending patterns will look different from the recent past. We see a "new normal" shopping environment, with a more [budget] constrained consumer, which will force [apparel retailers] to adjust to lower sustainable levels of demand ... . Moreover, even when gross domestic product (GDP) returns to growth ... the consumer will not return to pre-recession frivolity. A starker picture is in store for purveyors of consumer goods and services. 5 Department and specialty stores were particularly damaged by the downturn, as customers sought lower prices and more value for their money. One market study showed department and specialty stores losing significant market share to mass merchandisers and other retailers through 2013 (see Exhibit 4). The study went on to explain the challenges for specialty stores in the new environment: Specialty stores have seen a mixed performance in recent years. Retailers such as plus-sized clothing merchants have seen growth, while others, notably stores that delayed lowering prices when the economy receded in the latter part of the historical period, saw contractions in sales during 2008 and into 2009. Specialty stores generally charge higher prices for their apparel than other retailers and attract customers through merchandising (i.e., carrying the latest styles) and marketing, with brand identification being especially important. 6 Liza Davis Stores: Classic Chic for the Professional Woman In 2009, Liza Davis operated 990 specialty women's own-label apparel stores throughout the United States in regional and super-regional enclosed malls and upscale open-air strip malls. The corporate headquarters housed the merchandising and marketing departments, as well as all corporate center functions (see Exhibit 5 for an organizational chart). The total annual budget for the merchandising department was $20 million and the total annual budget for the marketing department was $79 million. The Liza Davis distribution center in Atlanta, Georgia received all merchandise from suppliers and shipped to the stores. Typically, stores were designed to employ an average of 15 sales clerks. Starting in January 2009, however, in response to the depressed demand in the industry, the company reduced staffing to 10 full time equivalents (FTEs) per store and 10,625 FTEs company-wide. Store salespeople were paid a relatively low wage, an average of $9.60 per hour (including taxes and benefits), in addition to a 7.5% commission on sales. The stores sold four categories of merchandise: tops, bottoms, dresses/suits, and swimwear/outerwear, and stocked an average of 1,500 stock keeping units (SKUs) each season (spring/summer and fall/winter). Liza Davis stores were in the "better" and "bridge" apparel categories," with an average price point of $90 for their spring/summer 2009 collection. The company's core customers were professional career women aged 35 and older in medium-high and high income brackets. Liza Davis marketed its clothing lines with the slogan "classic chic for the professional woman" and believed product design, marketing, brand image, and customer service were its most important competitive advantages. "You Look Great in That!": Retail Operations from Sourcing to Point-of-Sale The fashion retail industry, particularly women's apparel, had a short selling season and long product lead times, making it difficult for retailers to anticipate and respond to consumer desires. Successful companies not only foresaw fashion trends and produced what their customers wanted, but also managed to find a profitable balance between markdown risk (losing profits) and stock out risk (losing sales and alienating customers). The retail operations at Liza Davis started with the annual strategic plan. The corporate executive committee used indicators, such as trends in consumer spending, consumer confidence, and GDP, and historical company sales, to set goals for sales, expenses, margins, and profitability for the entire company and the four major geographic regions (east coast, west coast, mid west, and south). A customer browsing the fall collection in September of 2009 might not realize that the process to bring that silk blouse (in the right size and in a color that brings out her eyes) to her local Liza Davis store actually started 16 months prior, in April 2008, as ideas and sketches in the company's design studio. Six months later, in November 2008, the designers completed the prototypes of the collection, after which the budget was set and sourcing contracts signed. Manufacturers throughout Asia worked for seven months to realize the vision of the designers and shipped the finished merchandise to the distribution center by the beginning of July 2009 a full two months before the collection hit the sales floor. The distribution center (part of the logistics department) shipped items to the stores by August. The same process was repeated for the spring collection. Liza Davis had invested heavily in IT infrastructure and electronically linked all stores to the distribution center so that overages at one store could be shipped to other stores that ran short. The distribution center also kept a certain amount of safety stock for those items anticipated to be top sellers and shipped them as needed to stores throughout the selling season. However, there was no in-season replenishment from the manufacturers. Generally, Liza Davis marked up all merchandise by 190% over invoice. In keeping with industry norms, the company traditionally resisted markdowns for the first three months after introducing a new line. The stores then marked down unsold merchandise by 25% for the following two months and 60% for the sixth month the merchandise remained on the floor. After six months, the company sold any remaining items to a liquidator for an average of 50% below cost. Buyers received a bonus based on the percentage of total quarterly sales that was sold at full price. Table A shows the average percentages of sales at different markdown levels for items in a collection. Table A Breakdown of Sales per Price Point (Percentage of invoice, average 2006-2008) Source: Case writer. Born to Shop: Reward Cards and Customer Segments Marketing campaigns began in conjunction with the introduction of the new lines. Marketing plans included print ads in fashion and women's magazines and selected television and radio ads. Liza Davis had also begun to post banners on selected Internet sites. The marketing department also managed the customer loyalty program, called the Liza Card, launched in 2001. By 2008, 1.7 million customers owned a Liza Card and accounted for 55% of all customer purchases. Cardholders earned one point for each dollar purchased and bonus coupons of $25 for every $500 spent, with additional benefits for customers who accumulated annual points of 1,000 and 5,000 . Each year all cardholders received four direct mailing campaigns: one preview event for each season and one preview event for each major sale (with higher tier members being invited to exclusive events). Cardholders received an annual coupon for their cumulative points along with the winter sale preview event mailing. c The remaining marketing budget was reserved for activities related to general advertising. See Table B for the 2009 marketing budget. Table B Marketing Budget FY 2009 Source: Case writer. With the detailed level of customer information that Liza Davis gathered through the loyalty card program, it was able to segment cardholders into groups based on purchase behavior. The company identified two distinct groups of cardholders, one that was highly fashion-conscious, mostly purchased items full price at the beginning of the season, and only occasionally purchased items on sale. The other group, dubbed the "bargain hunters," only purchased items on sale. The bulk of the customers were somewhere in between. Stores and the Customer Experience Liza Davis's 990 retail stores leased an average of 4,700 square feet, 25% of which was for stockroomon-selling purposes. The stores budgeted $632 million in operating costs per year. Sales people received extensive training on the merchandise and were encouraged to be helpful without using aggressive selling techniques. The store manager determined the amount of staff in the store at any given moment, with the goal of maintaining a steady level of occupation without overstaffing. Managers added staff to the schedule in four-hour increments. Table C shows the total store operations budget. Table C Store Operations Budget Source: Case writer. In 2007, the company commissioned a study from a national consulting firm to enhance the customer experience at Liza Davis stores. Consultants analyzed how sales were conducted and trained sales staff in sales techniques. They developed scripts for sales staff to follow to greet customers and to handle various situations, both usual and extreme (for example, what to do if a client became disruptive). The study found that, on average, salespeople spent 20 minutes with customers who purchased items, two minutes with customers who did not purchase items, d and 15 minutes processing a return. Approximately 25% of customers who entered the store purchased merchandise (known in the industry as the conversion rate) and 20% of a salesperson's time was spent on stock management. In addition, twice per year, sales associates spent eight hours to prepare the store for the new season (for a total of 16 hours per sales associate per year) and four times per year they spent eight hours to prepare for each discounting period (for a total of 32 hours per sales associate per year). This work was conducted outside of the normal store operating hours and employees earned an overtime rate of 1.5 times their normal hourly wage. The study also included an analysis of the checkout receipts to identify patterns of customer behavior. The study found that the average number of products purchased per transaction was 1.7 . Stores averaged 35 transactions per day with an average sale per transaction of $153. One in ten sales resulted in a return, and one in four returns resulted in merchandise having to be destroyed because of original defects or customer damage. The stores tracked which customer returned the item but the system was unable to collect data on the reason for the return and whether the merchandise was in a saleable state. Two percent of merchandise was lost through shrinkage (shoplifting, employee pilfering, and damage). After the study was complete, the company installed traffic counters in all the stores and an ERP (enterprise resource planning) system that, as part of its functionality, tracked the number and type of transactions performed per store. The numbers in 2008 and the first half of 2009 were not significantly different from the findings of the study. Profitability Measurement System Liza Davis had a culture that placed a premium on analyzing and understanding data. It owned a sophisticated profitability measurement system that calculated profits of products, customers and stores. Management believed that this data allowed Liza Davis to stay a step ahead of competitors, who continued to use gross margin as the only measure of profitability. Liza Davis measured profitability in three ways, at the product, customer, and store level, as follows: Product Profitability, calculated for all SKUs in the collection as sales (full price and discounted price, or write-off), less: - Invoice cost/price of merchandise - Sales commissions - The cost of shrinkage, and the costs of the merchandising and logistics functions, allocated proportionately to the invoice price - Store replenishment activities allocated proportionately to the invoice price, as follows: - New season's activities allocated to all merchandise in the store - 25%-discount activities allocated to all merchandise that is sold at 25% markdown - 60%-discount activities allocated to all merchandise that is sold at 60% markdown Customer Profitability, calculated only for customers who owned a loyalty card as profits of all products purchased by a customer, less coupons used in the purchases (from campaigns or from loyalty card), less $10 per customer (allocation of the cost of marketing resources used in managing the loyalty card). Store Profitability, calculated for each store as profits of all products sold in the store, less: - Coupons - Rent and occupancy, equipment, depreciation, and supplies - Staff salaries (excluding seasonal replenishment and discounting activity costs) - Allocation of non-loyalty card marketing costs, distributed evenly across all stores - Allocation of the headquarter offices of store operations (except for logistics) After calculating the customer profitability for 2008 and the first six months of 2009, Jane Offerman, Liza Davis's CFO, realized that bargain hunter customers were severely unprofitable (see Exhibit 6). When she announced the results of the profit calculations to the strategic committee, she understood that it would add fuel to the heated debate that raged over the attractiveness of bargain hunting customers. Bargain Hunters: The Debate After returning from a lunch break, the committee again took up the general discussion of which customer segment to target and the related, but more specific, decision on how to calibrate the rewards program for the upcoming year. As the committee pondered changes to the reward program, Medina argued that the bargain hunter was beneficial for Liza Davis: "We have the opportunity to introduce and encourage people who previously wouldn't shop at Liza Davis to try it out. Once they experience the high quality and customer service we offer, they won't balk at paying full price once the economy improves." Chapman again disagreed: It is madness to cater to this segment. Look at the profitability numbers-if this segment grows to become larger than our full price shoppers, we can't break even, let alone run a profitable business. If they do not generate gross margin how can they even contribute to the fixed costs of a store? Moreover, if we try to cater to them they will distract sales associates from attending to customers buying full price. Adam, if this continues, Liza Davis won't be around long enough to reap the benefits you say will come from these customers. Offerman agreed: "We should think about disallowing reward points on discount sales, since they don't generate margin. I know that is not a common practice in the industry, but it makes sense from a profitability standpoint." Exhibit 1 Liza Davis Financial Statements for Quarter Ending August 1, 2009 (in thousands, except per share amounts) a Selling, general, and administrative expenses consist of: store operations (75\%), marketing (9\%), and support functions (16\%). Exhibit 1 (continued) Balance Sheet: August 1, 2009 January 31, 2009 August 2, 2008 Assets Current Assets Liabilities and Stockholders' Equity Current liabilities Trade notes and accounts payable Credit facility Accrued salaries and bonus Accrued tenancy Gift certificates and merchandise credits redeemable Accrued expenses and other current liabilities Total current liabilities Deferred lease costs Deferred income taxes Other liabilities Stockholders' equity Total liabilities and stockholders' equity $859,426 \$ 845,186 S 1,189,111 Source: Casewriters. Exhibit 2 Women's Apparel U.S. Retail Sales Trends (all retail channels) Source: Adapted from "Freedonia Focus on Women's Retail Clothing," The Freedonia Group, Inc., May 2009, p. 2 Note: Retail channels include department stores, specialty stores, mass merchants, and other (including off-price retailers, factory outlets, catalog, Internet retailers, and small volume retailers, such as sporting goods stores). Exhibit 3 Key Indicators for U.S. Retail Sales of Women's Clothing (\$B except where noted) Exhibit 4 Women's U.S. Retail Clothing Sales by Outlet (\$B) Source: Adapted from "Freedonia Focus on Women's Retail Clothing," The Freedonia Group, Inc., May 2009 , p. 13. Note: "Other" category includes off-price retailers, factory outlets, catalog, Internet retailers, and small volume retailers, such as sporting goods stores. Exhibit 5 Liza Davis Organizational Chart as of August 2009 Source: Casewriter. Exhibit 6 Pro-forma Profitability for Full Price and 60\% Discount Customers (2009) Source: Casewriter. a 3.1\% of invoice, calculated as: merchandising budget divided by total invoice costs of merchandise sold and not liquidated. b 10.3\% of invoice, calculated as: logistics budget divided by total invoice costs of merchandise sold and not liquidated. c0.3% of invoice calculated as 9,900FTEs16 hours * $14.4 per hour divided by total invoice costs of merchandise sold and not liquidated. d 1.4% of invoice calculated as 9,900 FTEs * 16 hours * $14.4 per hour divided by total invoice costs of merchandise sold at 60% discount. Note: Total invoice costs = annualized cost of goods sold for 2009(364,272,0002). 2. Using the information in Exhibit 6, re-calculate the profitability of bargain hunters if merchandise not sold at full price is invoiced at opportunity cost instead of full price. Discuss how the cost of the write-down is assigned to full-price customers. 3. Calculate the cost of a return, considering transaction activity costs, material costs and the reversal of gross margin. What additional information would you like to have (if any) to aid in your estimation? 4. What should Liza Davis's strategy be for discount customers? Should they change the loyalty program to incent or discourage discount purchases? Liza Davis ana tne bargann Funting custonner Retailers form the link between the producer of goods and the consumer. Getting the merchandise that customers want to buy is critical to their success. Doing it profitably is essential for their survival. - Jason Asaeda, Department \& General Merchandise Stores Analyst 1 The annual strategic planning retreat at Liza Davis, a publicly-traded upscale women's fashion chain, was more contentious than usual. It was early August 2009, the economy was in a worldwide recession, and Liza Davis stores had felt the pain along with everyone else in fashion. The weeklong meeting at Liza Davis headquarters in Providence, Rhode Island, was fraught with bad news and dire warnings. Jane Offerman, the company's CFO, presented the financial results (see Exhibit 1 for selected financial statements): Compared to the same period last year, the quarterly and six month net sales were down 21% and 26%, respectively. After restructuring, we showed a net loss of nearly $18 million for the first half of the year versus net income of $48.5 million in the first half of 2008 . However, we have managed to reduce our inventory by 30% and our SG\&A expenses by more than 10% compared to this time last year. With the projection of weak winter demand we expect to break even for the remaining of the year, closing with a loss of $18 million for 2009. Adding to an already difficult situation, the executive leadership team was divided on how to position the company to weather the downturn and emerge as a strong competitor in the low margin, zero-sum world of retail fashion. Adam Medina, the vice president of marketing, proposed to shift the focus to bargain hunters: The bargain hunter is the future-it's a growing segment. If we don't cater to them, they will flock to our rivals, who are dropping prices and escalating markdowns and sales. To stay competitive in this market, we need to find ways to encourage this customer - at the very least we should completely revamp our rewards program and increase sales and discounts. Mary Jo Chapman, the vice president of merchandising, expressed another view: Just because everyone else in the industry is running after the bargain hunter doesn't mean that is what we should do. Let's think carefully about this. We have an extremely valuable brand image at Liza Davis. Our core customer base wants to shop at a quality retailer, not a bargain basement. Even though it's painful now, I believe that we will be better off in the long run if we resist the temptation to undervalue our merchandise and our brand. In the fall of 2008, Saks Fifth Avenue, panicked by the credit crisis and fearful of heavy inventory losses, rocked the industry with huge and early markdowns - up to 70%, "well below the break-even point" and "introduced the most economically ravaging period in the history of American fashion." 2 Rival retailers quickly jumped into the markdown fray, but to no avail: same store sales dropped 10% to 30% in the fourth quarter 2008 over the same period in 2007, and annual growth of women's apparel entered negative territory (see Exhibit 2 for sales and growth rates). In January 2009, Saks laid off 1,100 people, including its director of women's fashion. 3 By the summer of 2009, the customer exodus from high-end discretionary goods showed little sign of abating and key indicators for apparel demand through 2013 were weak (see Exhibit 3). Retailers responded by keeping a tight grip on expenses and inventory. Inventory declined 6% at specialty stores and 10.3% at department stores from May 2008 to May 2009. Talbot's, one of Liza Davis's competitors, reported a 21.3% decrease in inventory at the end of fiscal year 2008 over fiscal 2007.4 Many believed the glory days in the fashion industry were gone for good. As one industry analyst wrote: .. . [T]he consumer will not recover until 2011 and, even then, spending patterns will look different from the recent past. We see a "new normal" shopping environment, with a more [budget] constrained consumer, which will force [apparel retailers] to adjust to lower sustainable levels of demand ... . Moreover, even when gross domestic product (GDP) returns to growth ... the consumer will not return to pre-recession frivolity. A starker picture is in store for purveyors of consumer goods and services. 5 Department and specialty stores were particularly damaged by the downturn, as customers sought lower prices and more value for their money. One market study showed department and specialty stores losing significant market share to mass merchandisers and other retailers through 2013 (see Exhibit 4). The study went on to explain the challenges for specialty stores in the new environment: Specialty stores have seen a mixed performance in recent years. Retailers such as plus-sized clothing merchants have seen growth, while others, notably stores that delayed lowering prices when the economy receded in the latter part of the historical period, saw contractions in sales during 2008 and into 2009. Specialty stores generally charge higher prices for their apparel than other retailers and attract customers through merchandising (i.e., carrying the latest styles) and marketing, with brand identification being especially important. 6 Liza Davis Stores: Classic Chic for the Professional Woman In 2009, Liza Davis operated 990 specialty women's own-label apparel stores throughout the United States in regional and super-regional enclosed malls and upscale open-air strip malls. The corporate headquarters housed the merchandising and marketing departments, as well as all corporate center functions (see Exhibit 5 for an organizational chart). The total annual budget for the merchandising department was $20 million and the total annual budget for the marketing department was $79 million. The Liza Davis distribution center in Atlanta, Georgia received all merchandise from suppliers and shipped to the stores. Typically, stores were designed to employ an average of 15 sales clerks. Starting in January 2009, however, in response to the depressed demand in the industry, the company reduced staffing to 10 full time equivalents (FTEs) per store and 10,625 FTEs company-wide. Store salespeople were paid a relatively low wage, an average of $9.60 per hour (including taxes and benefits), in addition to a 7.5% commission on sales. The stores sold four categories of merchandise: tops, bottoms, dresses/suits, and swimwear/outerwear, and stocked an average of 1,500 stock keeping units (SKUs) each season (spring/summer and fall/winter). Liza Davis stores were in the "better" and "bridge" apparel categories," with an average price point of $90 for their spring/summer 2009 collection. The company's core customers were professional career women aged 35 and older in medium-high and high income brackets. Liza Davis marketed its clothing lines with the slogan "classic chic for the professional woman" and believed product design, marketing, brand image, and customer service were its most important competitive advantages. "You Look Great in That!": Retail Operations from Sourcing to Point-of-Sale The fashion retail industry, particularly women's apparel, had a short selling season and long product lead times, making it difficult for retailers to anticipate and respond to consumer desires. Successful companies not only foresaw fashion trends and produced what their customers wanted, but also managed to find a profitable balance between markdown risk (losing profits) and stock out risk (losing sales and alienating customers). The retail operations at Liza Davis started with the annual strategic plan. The corporate executive committee used indicators, such as trends in consumer spending, consumer confidence, and GDP, and historical company sales, to set goals for sales, expenses, margins, and profitability for the entire company and the four major geographic regions (east coast, west coast, mid west, and south). A customer browsing the fall collection in September of 2009 might not realize that the process to bring that silk blouse (in the right size and in a color that brings out her eyes) to her local Liza Davis store actually started 16 months prior, in April 2008, as ideas and sketches in the company's design studio. Six months later, in November 2008, the designers completed the prototypes of the collection, after which the budget was set and sourcing contracts signed. Manufacturers throughout Asia worked for seven months to realize the vision of the designers and shipped the finished merchandise to the distribution center by the beginning of July 2009 a full two months before the collection hit the sales floor. The distribution center (part of the logistics department) shipped items to the stores by August. The same process was repeated for the spring collection. Liza Davis had invested heavily in IT infrastructure and electronically linked all stores to the distribution center so that overages at one store could be shipped to other stores that ran short. The distribution center also kept a certain amount of safety stock for those items anticipated to be top sellers and shipped them as needed to stores throughout the selling season. However, there was no in-season replenishment from the manufacturers. Generally, Liza Davis marked up all merchandise by 190% over invoice. In keeping with industry norms, the company traditionally resisted markdowns for the first three months after introducing a new line. The stores then marked down unsold merchandise by 25% for the following two months and 60% for the sixth month the merchandise remained on the floor. After six months, the company sold any remaining items to a liquidator for an average of 50% below cost. Buyers received a bonus based on the percentage of total quarterly sales that was sold at full price. Table A shows the average percentages of sales at different markdown levels for items in a collection. Table A Breakdown of Sales per Price Point (Percentage of invoice, average 2006-2008) Source: Case writer. Born to Shop: Reward Cards and Customer Segments Marketing campaigns began in conjunction with the introduction of the new lines. Marketing plans included print ads in fashion and women's magazines and selected television and radio ads. Liza Davis had also begun to post banners on selected Internet sites. The marketing department also managed the customer loyalty program, called the Liza Card, launched in 2001. By 2008, 1.7 million customers owned a Liza Card and accounted for 55% of all customer purchases. Cardholders earned one point for each dollar purchased and bonus coupons of $25 for every $500 spent, with additional benefits for customers who accumulated annual points of 1,000 and 5,000 . Each year all cardholders received four direct mailing campaigns: one preview event for each season and one preview event for each major sale (with higher tier members being invited to exclusive events). Cardholders received an annual coupon for their cumulative points along with the winter sale preview event mailing. c The remaining marketing budget was reserved for activities related to general advertising. See Table B for the 2009 marketing budget. Table B Marketing Budget FY 2009 Source: Case writer. With the detailed level of customer information that Liza Davis gathered through the loyalty card program, it was able to segment cardholders into groups based on purchase behavior. The company identified two distinct groups of cardholders, one that was highly fashion-conscious, mostly purchased items full price at the beginning of the season, and only occasionally purchased items on sale. The other group, dubbed the "bargain hunters," only purchased items on sale. The bulk of the customers were somewhere in between. Stores and the Customer Experience Liza Davis's 990 retail stores leased an average of 4,700 square feet, 25% of which was for stockroomon-selling purposes. The stores budgeted $632 million in operating costs per year. Sales people received extensive training on the merchandise and were encouraged to be helpful without using aggressive selling techniques. The store manager determined the amount of staff in the store at any given moment, with the goal of maintaining a steady level of occupation without overstaffing. Managers added staff to the schedule in four-hour increments. Table C shows the total store operations budget. Table C Store Operations Budget Source: Case writer. In 2007, the company commissioned a study from a national consulting firm to enhance the customer experience at Liza Davis stores. Consultants analyzed how sales were conducted and trained sales staff in sales techniques. They developed scripts for sales staff to follow to greet customers and to handle various situations, both usual and extreme (for example, what to do if a client became disruptive). The study found that, on average, salespeople spent 20 minutes with customers who purchased items, two minutes with customers who did not purchase items, d and 15 minutes processing a return. Approximately 25% of customers who entered the store purchased merchandise (known in the industry as the conversion rate) and 20% of a salesperson's time was spent on stock management. In addition, twice per year, sales associates spent eight hours to prepare the store for the new season (for a total of 16 hours per sales associate per year) and four times per year they spent eight hours to prepare for each discounting period (for a total of 32 hours per sales associate per year). This work was conducted outside of the normal store operating hours and employees earned an overtime rate of 1.5 times their normal hourly wage. The study also included an analysis of the checkout receipts to identify patterns of customer behavior. The study found that the average number of products purchased per transaction was 1.7 . Stores averaged 35 transactions per day with an average sale per transaction of $153. One in ten sales resulted in a return, and one in four returns resulted in merchandise having to be destroyed because of original defects or customer damage. The stores tracked which customer returned the item but the system was unable to collect data on the reason for the return and whether the merchandise was in a saleable state. Two percent of merchandise was lost through shrinkage (shoplifting, employee pilfering, and damage). After the study was complete, the company installed traffic counters in all the stores and an ERP (enterprise resource planning) system that, as part of its functionality, tracked the number and type of transactions performed per store. The numbers in 2008 and the first half of 2009 were not significantly different from the findings of the study. Profitability Measurement System Liza Davis had a culture that placed a premium on analyzing and understanding data. It owned a sophisticated profitability measurement system that calculated profits of products, customers and stores. Management believed that this data allowed Liza Davis to stay a step ahead of competitors, who continued to use gross margin as the only measure of profitability. Liza Davis measured profitability in three ways, at the product, customer, and store level, as follows: Product Profitability, calculated for all SKUs in the collection as sales (full price and discounted price, or write-off), less: - Invoice cost/price of merchandise - Sales commissions - The cost of shrinkage, and the costs of the merchandising and logistics functions, allocated proportionately to the invoice price - Store replenishment activities allocated proportionately to the invoice price, as follows: - New season's activities allocated to all merchandise in the store - 25%-discount activities allocated to all merchandise that is sold at 25% markdown - 60%-discount activities allocated to all merchandise that is sold at 60% markdown Customer Profitability, calculated only for customers who owned a loyalty card as profits of all products purchased by a customer, less coupons used in the purchases (from campaigns or from loyalty card), less $10 per customer (allocation of the cost of marketing resources used in managing the loyalty card). Store Profitability, calculated for each store as profits of all products sold in the store, less: - Coupons - Rent and occupancy, equipment, depreciation, and supplies - Staff salaries (excluding seasonal replenishment and discounting activity costs) - Allocation of non-loyalty card marketing costs, distributed evenly across all stores - Allocation of the headquarter offices of store operations (except for logistics) After calculating the customer profitability for 2008 and the first six months of 2009, Jane Offerman, Liza Davis's CFO, realized that bargain hunter customers were severely unprofitable (see Exhibit 6). When she announced the results of the profit calculations to the strategic committee, she understood that it would add fuel to the heated debate that raged over the attractiveness of bargain hunting customers. Bargain Hunters: The Debate After returning from a lunch break, the committee again took up the general discussion of which customer segment to target and the related, but more specific, decision on how to calibrate the rewards program for the upcoming year. As the committee pondered changes to the reward program, Medina argued that the bargain hunter was beneficial for Liza Davis: "We have the opportunity to introduce and encourage people who previously wouldn't shop at Liza Davis to try it out. Once they experience the high quality and customer service we offer, they won't balk at paying full price once the economy improves." Chapman again disagreed: It is madness to cater to this segment. Look at the profitability numbers-if this segment grows to become larger than our full price shoppers, we can't break even, let alone run a profitable business. If they do not generate gross margin how can they even contribute to the fixed costs of a store? Moreover, if we try to cater to them they will distract sales associates from attending to customers buying full price. Adam, if this continues, Liza Davis won't be around long enough to reap the benefits you say will come from these customers. Offerman agreed: "We should think about disallowing reward points on discount sales, since they don't generate margin. I know that is not a common practice in the industry, but it makes sense from a profitability standpoint." Exhibit 1 Liza Davis Financial Statements for Quarter Ending August 1, 2009 (in thousands, except per share amounts) a Selling, general, and administrative expenses consist of: store operations (75\%), marketing (9\%), and support functions (16\%). Exhibit 1 (continued) Balance Sheet: August 1, 2009 January 31, 2009 August 2, 2008 Assets Current Assets Liabilities and Stockholders' Equity Current liabilities Trade notes and accounts payable Credit facility Accrued salaries and bonus Accrued tenancy Gift certificates and merchandise credits redeemable Accrued expenses and other current liabilities Total current liabilities Deferred lease costs Deferred income taxes Other liabilities Stockholders' equity Total liabilities and stockholders' equity $859,426 \$ 845,186 S 1,189,111 Source: Casewriters. Exhibit 2 Women's Apparel U.S. Retail Sales Trends (all retail channels) Source: Adapted from "Freedonia Focus on Women's Retail Clothing," The Freedonia Group, Inc., May 2009, p. 2 Note: Retail channels include department stores, specialty stores, mass merchants, and other (including off-price retailers, factory outlets, catalog, Internet retailers, and small volume retailers, such as sporting goods stores). Exhibit 3 Key Indicators for U.S. Retail Sales of Women's Clothing (\$B except where noted) Exhibit 4 Women's U.S. Retail Clothing Sales by Outlet (\$B) Source: Adapted from "Freedonia Focus on Women's Retail Clothing," The Freedonia Group, Inc., May 2009 , p. 13. Note: "Other" category includes off-price retailers, factory outlets, catalog, Internet retailers, and small volume retailers, such as sporting goods stores. Exhibit 5 Liza Davis Organizational Chart as of August 2009 Source: Casewriter. Exhibit 6 Pro-forma Profitability for Full Price and 60\% Discount Customers (2009) Source: Casewriter. a 3.1\% of invoice, calculated as: merchandising budget divided by total invoice costs of merchandise sold and not liquidated. b 10.3\% of invoice, calculated as: logistics budget divided by total invoice costs of merchandise sold and not liquidated. c0.3% of invoice calculated as 9,900FTEs16 hours * $14.4 per hour divided by total invoice costs of merchandise sold and not liquidated. d 1.4% of invoice calculated as 9,900 FTEs * 16 hours * $14.4 per hour divided by total invoice costs of merchandise sold at 60% discount. Note: Total invoice costs = annualized cost of goods sold for 2009(364,272,0002). 2. Using the information in Exhibit 6, re-calculate the profitability of bargain hunters if merchandise not sold at full price is invoiced at opportunity cost instead of full price. Discuss how the cost of the write-down is assigned to full-price customers. 3. Calculate the cost of a return, considering transaction activity costs, material costs and the reversal of gross margin. What additional information would you like to have (if any) to aid in your estimation? 4. What should Liza Davis's strategy be for discount customers? Should they change the loyalty program to incent or discourage discount purchases