When a rack of dresses goes unsold in a department store, forcing the merchant to mark them down, someone's profit evaporates.
For more than a decade, the manufacturers who supplied the merchandises have been the ones to compensate for lost profits. Now these suppliers are fighting back against department stores' demands in a battle that could ultimately mean higher prices for consumers.
Right now, shoppers are the beneficiaries of generous discounting. But if, as the manufacturers want, stores start taking more responsibility for unsold merchandise, that could mean smaller markdowns and less of a selection on the selling floor, analysts said. And if stores win this fight, shoppers might see lower-quality garments as suppliers look to cut costs.
The highly contentious issue has caught the eye of the Securities and Exchange Commission, which has begun an inquiry into Saks Inc.'s collections from its vendors. Analysts think other major department stores could face similar scrutiny.
"This has successfully opened a can of worms," said Allan Ellinger, senior managing director of MMG, a boutique investment banking company that specializes in the apparel industry. "There is this hope that some government agency will possibly put an end to this, and create some policing. No one is saying that they don't want to be responsible for what they do, but (manufacturers) don't want to have their pockets picked."
"Stores have to be smarter," Ellinger said. "They should not be overbuying."
Many suppliers declined to talk about the issue for fear of harming their relationship with stores, but there are clear signs they're tired of reimbursing retailers.
Jeff Knopman, president of Profit Solutions Group Inc., which works with apparel and accessories manufacturers to reclaim money charged by department stores, saw his business increase 25 percent last year.
"Clients are now standing up for themselves and questioning" each charge, Knopman said.
When department stores started asking for what the trade calls markdown money in the late 1980s, suppliers agreed to compensate them for lost profits given that business was healthy. But amid weak sales and price deflation over the last few years, stores have shifted more of a financial burden to vendors.
In many cases, stores have demanded money for reasons or amounts that suppliers never agreed to, which is illegal, Ellinger argued. Manufacturers initially complied, fearing they'd lose future business if they didn't. But retailers' financial demands have increased, prompting vendors to put up more of a fight.
The SEC's investigation was prompted in part by one of the retailer's former suppliers, Onward Kashiyama USA, which filed a suit against the company a year ago. The lawsuit claimed Saks took certain charges not allowed under the terms of their sales agreement, and never offered an explanation.
Julia Bentley, a spokeswoman at Saks Inc., declined to comment.
Tensions between manufacturers and stores have increased as consolidation in the retail industry has given merchants more power in negotiating contract terms. Many suppliers fear that the situation will only worsen with Federated Department Stores Inc.'s plans to buy May Department Store Co., creating a $30 billion powerhouse with almost 1,000 stores. The deal is expected to close in the third quarter.
The problem grows out of the fact that consumers are demanding big discounts and have plenty of other shopping alternatives.
According to C. Britt Beemer, chairman of America's Research Group, based in Charleston, S.C., less than 12 percent of consumers polled said they are willing to pay full price on apparel. That compares to 24 percent five years ago, he said.
The process works like this: Before a supplier ships a garment, the manufacturer and the retailer agree to a wholesale price, usually half the retail price. The retailer than negotiates payment terms, but after the season is over, stores can ask for deductions, or so-called chargebacks, if the merchandise was damaged, didn't come in the right containers or just didn't sell well, the most controversial issue, according to Michael C. Appel, a retail expert at the corporate restructuring firm Quest Turnaround Advisors.
In fact, retailers are increasingly forcing suppliers to guarantee them a profit on items. So if a manufacturer guarantees a store a profit of 30 percent on a dress, but the merchant only made 10 percent, vendors are asked to make up the 20 percent difference. Knopman of Profit Solutions now counsels clients not to guarantee a certain profit level.
In a prepared statement, Federated spokeswoman Carol A. Sanger said, "Essentially, we are paying higher prices upfront, and then 'negotiating' for our money back at the end. The vendor essentially has been sitting with our money until we reclaim it. .... All of this is built into the manufacturer's financial system, so even though they like to complain about chargebacks, the system really is a symbiotic one that works for both parties."
But plenty of industry executives disagree, noting that a large number of these chargebacks are unjustified. They also argue that the practice makes it hard for vendors to plan their business — stores and suppliers may agree to a price of the garment, but manufacturers never know how much will be charged back to the vendor until the season is over, said Bud Konheim, chief executive at Nicole Miller, a New York-based designer company.
That uncertainty forced Nicole Miller to "walk away from that method of doing business," said Konheim, whose company sells to such stores as Nordstrom Inc. and Neiman Marcus, which typically don't do business in that way. He said he selectively sells to certain units at Bloomingdale's and other department stores.
For smaller suppliers , stores' financial demands could threaten their ability to stay in business. But even apparel heavyweights Kellwood Co. and Jones Apparel Group Inc. are vulnerable — both struggled with lower fourth-quarter profits.
Ellinger noted that many suppliers haven't fought back for fear of having future orders canceled, but that is expected to change following the SEC's investigation of Saks' Saks Fifth Avenue Enterprises division.
In early March, Saks announced that during the company's 1999-2003 fiscal years, Saks Fifth Avenue improperly collected from vendors a total amount of up to $21.5 million, and said it intended to reimburse or otherwise compensate the companies. It said it informed the SEC of its own internal investigation, prompting the agency to open an inquiry.
Kashiyama is expected to be one of the suppliers who will be reimbursed. In its suit, Onward Kashiyama claims Saks owes $9.27 million, though the figure could now be as high as $13 million, according to Christopher T. Owen, attorney for Onward Kashiyama.
"For two years, we tried to get Saks to explain the figures to justify the markdown money," Owen said. "We were very patient, and we just didn't run to court. ... We knew we were being taken advantage of. All they had to do was to explain the math."