Falling Crude Prices, Container Rates Not Expected to Provide Much Margin Relief

 

Most said any savings on shipping in the current quarter will either be absorbed by vendors or evaporate as retailers cut their prices in a rush to convert their inventory to cash as the economy weakens.
That’s because vendors typically set shipping prices for pre-season orders a year in advance and freight costs on pre-season orders are already locked in through summer of next year for many.  Shipping program prices for fall/winter 2009 will get set next month and the volatility of oil prices makes it too difficult to predict the impact of the shifting cost structures.

“I don’t know if any of these short-term changes in the situation are going to give anyone relief because these costs are fixed so far out,” said Jim Wagner, a freelance product designer who works with many brands in the outdoor sporting goods industry. “Most people are paying F.O.B. so they may feel a little bit of shuffle.”

Retailers making their own freight arrangements, meanwhile, have not yet seen significant drops in fuel surcharges, in part because diesel prices are falling more slowly than gasoline. Since Aug. 4, the average weekly on-highway diesel price has fallen 19.2% to $3.65 a gallon, according to the Energy Information Administration, while fuel surcharges levied by FedEx and UPS have dropped 750 basis points, or 7%, to 9.25%. Crude oil prices, by comparison, have fallen nearly 40% during that period.

On average, freight costs represented 3.9% of expenses and 1.5% of gross sales for outdoor retailers surveyed in a financial benchmarking study published by Outdoor Industry Association in 2007.  Freight was the fourth largest expense for the stores surveyed, which had an average net profit margin of 5%. Stores with less than $1 million in sales had net income of just 3.9% of sales.

With such slim profit margins, one would think a 40% decline in crude oil prices might give retailers more margin points to play with should they have to cut prices this holiday.  Yet retailers are not expecting any windfall.               

“If you think of freight being no more than 5% of my costs and then think of fuel being a relatively small part of the overall freight bill, a change of 15% to 20% will have no impact on my margin,” said Ira Watchel, who runs Champagne Surplus in Illinois.

 

Sporting goods manufacturers shared that outlook.  At Mammut Sports Group, CEO Bill Supple estimates freight costs make up 5% or less of landed cost. The number varies depending on the mix of sea and air used to get product from the Swiss company’s factories overseas to the U.S. market. 

 

Mammut has had to rely more on air freight lately to get product to market in a timely manner. That has muted the effect of a dramatic fall in container shipping costs. Moreover, Mammut has already shipped about 70% of its fall/winter product to U.S. retailers.

Mammut locked in its costs for spring/summer 2009 this summer as diesel prices were peaking.  That, along with rising commodity and labor costs in Asia and the weaker dollar, forced the company to raise its wholesale prices despite the souring economic outlook.  If oil prices and container rates hold, there is a chance Mammut will enjoy slightly better margins come spring and be able to hold its wholesale prices for fall/winter 2009, Supple said.

Mammut is scheduled to set prices for fall/winter 2009 in about three weeks at a sales meeting in Switzerland. It will then start to preview the line to U.S. dealers. “I don’t know that I’m that confident today – given the fluctuations in the market – that a $75 barrel oil will hold,” Supple said. “We will all have to make those calculations pretty soon.” 
For retailers making their own shipping arrangements on the spot market, there could be some relief, but not much.

“Maybe talking one or two points for retailers,” said Supple. “You are not talking about a lot of room for retailers to drop prices to stimulate demand and still maintain a reasonable profit.”

Falling container imports have prompted ocean carriers to eliminate fuel surcharges that were adding $400 to $600 – or about 10% – to the cost of importing containers from Asia, according to Bryan Davis, VP of merchandizing for Nation’s Best Sports, the sporting goods retailer buying group.

“One of the positives of this economic downturn is that steamships are only running at 90% and domestic carriers are running at lower capacity,” said Davis. “So you can get better spot market quotes today.”

Still, Davis thinks any freight savings will evaporate in the current retail environment. Davis expects aggressive discounting as big box retailers who expanded rapidly in the last three years rush to convert their inventory to cash to pay interest and bills in a very precarious credit market.

“The question is how much more aggressive is retail going to get as people fight for market share.” Davis said.  “We are not anticipating gaining margin because of freight.  Will it help offset some of the margin pressure we anticipate in the first quarter and second quarter?  Maybe.

“I would anticipate there will be some moving off fuel charges over time,” said Jennifer Mull, CEO for Backwoods, an outdoor retailer with nine stores in the Midwest.  “But nobody trusts the trend.”