Is Ann Taylor’s Pricing Paying Off?

Ann Taylor reported their Q3-2009 went up despite drop in sales. Their gross margin went up by $7.7 million while their sales fell by $64.8 compared to same  Q3-2008. Kay Krill, President and Chief Executive Officer, commented,

Our results for the quarter were a direct result of our strategy to maximize gross margin performance by tightly managing inventories, focusing on full-price selling and controlling costs. I am pleased that our performance also reflects the cumulative benefits of our ongoing restructuring program initiatives.

I have been writing all along about the need to cut promotions, focus on protecting pricing and practice effective price management to deliver profit growth. But I am not fully convinced that price increase contributed to Ann Taylor’s profit growth. In fact they may have lost more than they gained from price realization and any profit growth was a result of their cost cutting. I will focus on the gross margin number when I say profit in this discussion.

Ann Taylor cut down on promotions and focused on charging full-price with the net result of increase in average prices. Another measure is inventory control. Total inventory per square foot at the end of the third quarter of 2009 was down 20.7% versus year-ago. If we assume (see note below) that this reduction can be equated with drop in volume of the same level, from the revenue change and volume change assumption we can compute that the average price increased by 10.6% (See end of this post). In other words 1% increase in price resulted in 2% drop in volume (price elasticity 2).

Their percentage gross margin  was 48.8% the previous year.

Loss of profit from drop in volume (due to increase in prices) = 20.7%*48.8% =  10.1% of  Q3-2008 revenue

Increase in profit from 10.6% price increase = (100%-20.7%)*10.6%   =        8.4%  of Q3-2008 revenue

This is a net loss due to drop in volume. Since their profit in Q3 2009 increased YoY, the profit increase is entirely due to cost control and other effectiveness measures in merchandising.

So did Ann Taylor make the right decision to improve prices? Could they have delivered higher profit by keeping their promotions and price levels? Unless there is a strategic reason to preserve brand premium and long term profit, this price increase was not a profit maximization move.

Footnotes:

On the volume drop  assumption, this could be wrong because sales volume is a flow metric while inventory was a point metric. But this  is inventory per square foot of store, so it is a good stand in for volume. Another possibility is that a portion of the 20% reduction is to respond to volume that is already lost due to recession (demand curve shift). If the price elasticity drops to 1 or low, then yes the price increase makes perfect sense.

Calculating price increase :

R = P * Q;       (P2/P1) = (R2/R1)*(Q1/Q2)  (R2=$527, R1=$462, Q2 = (100%-20.7%)*Q1)