Markets

Why American Apparel's Discount Advertising Is the Worst Move It Could've Made

By Jim Edwards

Updated on: September 16, 2010 / 4:47 PM EDT / MoneyWatch

American Apparel (APP) is advertising a sale, offering discounts of up to 50 percent, and that's the worst possible move the troubled company could make right now. (My BNET colleague Carol Tice disagrees. She says it's "exactly what's needed" at the retailer, which faces being delisted from the stock exchange and/or a takeover by its angry creditors.) As Tice notes, AA doesn't usually do discounts, and that's part of the problem. Here's why a fire-sale promotion will only compound CEO Dov Charney's problems:

What's good for the balance sheet may be bad for the income statement: Tice says the extra cash coming from the sale will shore up its balance sheet and help AA convince its creditors that it's reducing inventory and adding cash. But that will have a deleterious effect on AA's income statements: The expenses AA must write off against those sales will be the same as if the items had sold at full price. AA currently trades at a loss. Unprofitable or lower margin sales will only worsen those losses, which are particularly acute at AA because the company recently warned that it may not be a "going concern" (that's accountant-speak for "dead man walking").
AA needs to raise some of its prices, not lower them: Look at page 21 of AA's most recent quarterly earnings report (yes, it's Q1. AA is so screwed up internally that it can't get its own numbers out on time.) The wholesale and internet part of AA's business is much less profitable than the retail segment (i.e. AA's Main Street stores). Yet AA is offering discounts for online shoppers? AA's brand image is tied to its advertising and its retail stores. It should be squeezing its wholesale customers -- the people who buy blank AA T shirts in bulk to print their own designs on them -- and its web customers for more money. No one cares about those sales because they're under the radar, so raising prices there won't harm the AA brand. Besides, as AA's own numbers show, those customers are getting those items for roughly what it costs AA to make and ship them, give or take $5 million. The web/wholesale segment has comparable revenues to the retail segment, but the retail segment makes a $29 million gross profit. Those prices should therefore be marked up.
There are other ways AA can raise cash: It can sell off the useless, overlapping, sales-cannibalizing store locations that it owns (or their leases). AA doesn't need three separate locations in Downtown Manhattan, for instance. Or it could take Charney's father off the payroll. Or the board could ask Charney himself to lend the company some more money (he's done it before). It could reduce advertising expenses (they recently went up again).
You can't go upscale and downscale at the same time: AA recently announced it was going preppy (so say goodbye to your assless stockings and thong leotards!). In order for this repositioning to work, AA must stick to its guns and charge preppy prices.
Someone at AA has to believe in the AA brand: The entire purpose of a brand is to extract a price above that of a comparable commodity. Discounts signal "We're not worth it anymore." AA needs -- stick to its brand -- and continue to demand a premium. Discounts are for "brands" that aren't brands -- i.e. goods that no one would bother to pay more for. Is this really the message AA should send to its brand loyalists, especially given the amount of distracting, non-apparel-related controversy the company already suffers from?
This looks like more evidence of non-rational management: There's a case to be made that the quality of Charney's decision-making has become so bad that he needs to be removed as CEO. (Perhaps Bank of America, which is enforcing the restructuring talks, is engineering just that.) Look at the "litigation" section on page 22 of AA's 10-Q disclosure, where legal threats that may pose a material threat to a company are supposed to be listed. Two of them are sexual harassment suits. One of them alleges AA refused to allow its employees to eat during shifts. One is from Woody Allen, alleging wrongful use of his image in an ad. Another is from -- of course! -- shareholders demanding to know what the hell is going on with their investments. Put that all together with a money-losing company that has a thing for porn and has decided to slash prices like Crazy Eddie. Does this feel like rational management to you?

So, customers, take advantage of AA's discounts while they last. The way this company is going, they won't last forever.

Related: