BusinessWeek Magazine - Oct.20, 2008


Farming in the area (ie.Usman, rural district 300 miles south of Moscow), and across Russia's traditional grain belt, is making a comeback. Commodities traders, food processors, shipping outfits, and others are buying up farms, hoping to cash in on high global grain prices. These new investors are pouring billions of dollars into land, then revamping management and technology in operations that span thousands of acres. Today, large agricultural holding companies control some 10% of Russia's farmland, up from 4% in 2003—though in the most productive areas they have more than a quarter of the land, according to the Institute for Agricultural Market Studies in Moscow. "There's huge potential here," says Robert Coleman, a South African who oversees farms in the region for Agro-Invest, a Moscow group that owns 100,000 acres around Usman. "We've invested in big machines, are applying Western ideas, and are getting great results."

It's easy to see why there's so much interest. The U.N. says Russia has some 480,000 square miles of arable land—an area more than twice the size of France. That's 8% of the world's total, much of it highly fertile "black earth." But owing to decades of agricultural mismanagement, Russia accounts for less than 4% of global crop production and is a net food importer.

THE NEW AGE OF FRUGALITY by Steve Hamm (excerpt)

On a shady lane in New Hope, Pa., a quiet revolution in American culture may be taking shape. Here, a family of four lives in a white, colonial-style house in a manner that once would have been considered All-American but more recently has been seen as just plain weird: They're frugal.

Meet Leah Ingram, Bill Behre, and daughters Jane, 13, and Annie, 11. They walk most everywhere, they rarely eat out, they sometimes buy clothing at consignment shops, and they turn the lights off when they leave a room.

Theirs is no hard-luck-in-a-recession story. The Ingram-Behre family is solidly middle-class, fully employed, and not especially threatened by the conniptions gripping Wall Street. Behre, 43, is a dean at the College of New Jersey, while Ingram, 42, is a successful freelance writer and etiquette expert. They have no credit card debt.

That's now. A little more than a year ago, the family was ensnared in America's consume-at-all-costs culture. During the days of soaring home prices and easy credit, they took out a $101,000 home-equity loan on a previous house and spent lavishly on a lifestyle upgrade—going on three cruises in two years and taking the kids on annual pilgrimages to Disney World. "After 9/11 it became patriotic to shop, and we became as patriotic as anybody," laments Behre, sitting in the dining room after a meal of chicken stir-fry—washed down with tap water.

Ingram and Behre are harbingers of a dawning Age of Frugality. People who overconsumed during the past decade are now rejecting extravagant lifestyles. They're spending less, and more wisely. Some are getting their finances in order. Others are fearful of losing their jobs, shocked by investment losses, or hunkering down amid the general uncertainty.

The penny-pinching is already showing up in the numbers; this quarter could mark the first fall in personal consumption in 17 years. And with credit tight and Americans loaded down with $2.6 trillion in personal debt, consumer borrowing dropped in August, the first such contraction since 1991. Menzie D. Chinn, who teaches economics at the University of Wisconsin, figures consumers won't be in a position to spend freely for five years.

Which brings us to what John Maynard Keynes called the paradox of thrift. What's good for the individual, argued the famous economist, can ignite or deepen a recession. But that won't deter the newly thrifty. "I can't help the economy," says Kim Schultz, a resident of hard-hit Avoca, Mich., who with her husband, Jon, owes $40,000 in credit-card debt. "I've got to help myself." On the other hand, this newfound austerity could—emphasis on could—rewire Americans as savers rather than spenders. And that would help put the economy on a sounder footing over the long haul.

COSTCO'S ARTFUL DISCOUNTS by Jena McGregor (excerpt)

At Costco, where more than 29 million households pay $50 to $100 a year to shop, low prices aren't just a nice-to-have. They're a way of life. Not only does Costco's famously frugal CEO James D. Sinegal cap margins at a sacrosanct 14% on branded goods, he's constantly pushing his buyers to find creative ways to lower prices and add value while getting his managers to crank up their efficiency efforts. Besides the buy-in strategy, Costco has been redesigning product packaging to squeeze more bulky goods onto trucks and revamping processes for moving goods through its depots. Even small tweaks to its well-oiled operations can have a big impact. "If that stuff doesn't really turn you on," says Sinegal, "then you're in the wrong business."

Such tactics are keeping customers' shopping carts full—the $72 billion retailer's sales have been one of the only bright spots in today's brutal retail economy. But they've also been pinching profits. As commodities surged over the summer, Sinegal's call to hold the line on pricing helped prompt Costco to warn in July that its fourth-quarter earnings would be "well below" expectations. On Oct. 8, it announced quarterly net income of $398 million, slightly lower than Wall Street's revised expectations.

But to Sinegal, the short-term earnings pain is worth the potential for long-term market share gain. For one, holding prices low is the best way to protect profits: About 75% of Costco's operating earnings come directly from membership fees, and if prices rose too quickly, some members could flee. In addition, the 72-year-old warehouse club veteran knows that in this environment, Costco's reputation for bargain prices and surprise designer goods could inspire a new crop of warehouse chic devotees. "We should shine at a time like this," he says. "We have always believed that great companies build market share in really tough times."

What Sinegal isn't doing is wavering from the basic model that helped him and co-founder Jeffrey Brotman build Costco into a retail phenomenon. The Issaquah (Wash.)-based company's warehouse model relies on selling core items at rock-bottom prices while scooping up excess inventory from high-end brands. The here-today, gone-tomorrow nature of Costco products tends to foster carts full of impulse buys. The average store does $137 million in annual sales, a volume so high that Costco turns its inventory 11.9 times a year, meaning it often sells goods before it technically has to pay its suppliers. Combine that with high-income customers—the average Costco household makes upwards of $75,000—and "what they're doing is really high velocity retailing," says Boston Consulting Group Managing Director Michael Silverstein, who has studied Costco.

Even CEOs who'd rather not find their designer brands discounted in a warehouse are happy to say they shop there. "I think they have a terrific concept," says Eric Wiseman, CEO of VF Corp., which owns the North Face and 7 For All Mankind clothing lines. David Novak, CEO of YUM Brands, says he buys wine and cleaning equipment there. And QVC CEO Michael George is a proud card-carrying member of one of the first Seattle stores. "You don't just go there for bargains," says George. "You go there for the treasure hunt."

Lately, the loot in that treasure chest is getting even more high end. Over the last year, Versace dinnerware, Waterford crystal, and pastel girls' Lilly Pulitzer dresses have all made their way into Costco's stores, either through new direct selling agreements or diversions from distributors. As consumers cut back, Costco is finding more available inventory and fielding more calls from companies hungry to boost slumping sales. "I think their store will probably look like Saks pretty soon," says an executive at one popular high-end fashion brand. "Their ability to sell stuff is staggering."

"In a tough economy, the ability to change your assortment towards products that are selling more is a huge advantage," says Michael Clayman, a former buyer for Costco and the editor of trade publication Warehouse Club Focus. "If the item isn't a value anymore, or isn't generating the sales hurdles, it'll be deleted."

To hedge against price increases, the giant retailer is even taking the unusual step of commissioning its own pumpkin patches. For years, Costco has offered customers a pumpkin pie for $5.99, selling more than a million of the store-baked pies in the three days before Thanksgiving. Despite margins getting whacked by higher prices on canned pumpkin prices, Costco has opted to maintain its price. So this year, Jeffrey Lyons (head of fresh-food buying) began testing a way to get around the food processing companies' high prices, asking some of the farms that grow its melons to cultivate pumpkins. It will experiment with using the pumpkin in some of next year's pies. "It's not beyond us to figure this out," Lyons says. "We won't be held hostage."

Costco has even gotten vendors to redesign product packages to fit more items on a pallet, the wooden platforms it uses to ship and display its goods. Putting cashews into square containers instead of round ones will decrease the number of pallets shipped by 24,000 this year, cutting the number of trucks by 600. By reshaping everything from laundry detergent buckets to milk jugs, Costco has needed 200,000 fewer pallets a year overall.

Sinegal acknowledges that he can't hold back the cost increases forever. Indeed, within the past six months Costco has twice raised the price of its popular rotisserie chickens, by a total of 20%, to $5.99. But he isn't giving in to higher costs without a fight. "The biggest concern to me is that we lose our way and start thinking it doesn't matter if you charge another dime or another dollar or another hundred dollars," he says. "Without those disciplines, we don't have anything."


Hard times have been pretty good to Rita Cortese. Since 2006, she has owned a Plato's Closet used clothing store in Deptford, N.J. In recent months, Cortese says, business has exploded as people descend on her store to buy or sell castoff shirts, dresses, and jeans. Cortese is so busy she recently built a shed out back to contain her overflowing inventory.

Winmark, the Nasdaq-listed company that sold Cortese her Plato's Closet franchise, is a rarity in a scorched retail landscape: It's growing rapidly and making money. Sales at Plato's Closet outlets open more than a year were up 19.6% in August, vs. 1.7% for the industry as a whole. "I don't wish this economy on anyone," says John Morgan, Winmark's chief executive. "But we're going to make hay while the sun shines."

The company that would become Winmark was born 25 years ago as Play It Again Sports, which sold used hockey sticks, baseball mitts, and so forth. Ten years later the company went public as Grow Biz. But by 2000, it was suffering the usual ills of overexpansion. Enter Morgan, who renamed it Winmark and focused on four franchises: Play It Again Sports, Once Upon A Child (kids' apparel), Music Go Round (used musical instruments), and Plato's Closet (which, like the other franchises, also sells some new items). Today, Winmark has 861 stores nationwide.

Franchisees pay a $20,000 one-time fee, plus 3% to 5% of weekly sales. In return, Winmark provides the business model, training, and marketing. "All the risk falls on the franchisee," says Graeme Rein, research analyst for Bares Capital Management, which owns 14% of the company. "It's on their shoulders to create a profit." Because franchisees pay cash on the spot, they have powerful bargaining leverage. For example, Cortese pays $6.80 for a pair of Hollister jeans and resells them for $18.

Since consumers are going to be hurting for a while, it's a fair bet that Winmark, whose stock has suffered this year along with the rest of the market, will continue to outperform the retail sector. Not that Morgan, who owns a quarter of the company, is standing pat. He's plowing Winmark profits into another franchise operation he expects to do well in hard times—leasing office equipment to credit-parched small businesses. And guess who he's recruiting to run the franchises: managers who've lost their jobs.


ARTEIXO, SPAIN Many U.S. apparel retailers are choking on slow-moving inventories as consumers hold back on spending. But Spain's Inditex, whose Zara chain pioneered cheap chic, is zipping ahead. The $13.8 billion company, which is closing in on Gap for the title of world's biggest clothing retailer, has nearly quadrupled sales, profits, and locations since 2000. This year, Inditex plans to expand by up to 640 stores. "They will weather the storms better than most of their rivals," says Michael Lewis, a supply-management professor at University of Bath's School of Management.

Inditex's secret? Besides selling relatively cheap clothes, which fit the times, the company maintains an iron grip on every link in its supply chain. That enables it to move designs from sketch pad to store rack in as little as two weeks. This "fast fashion" way of doing things has become a model for other apparel chains, such as Los Angeles-based Forever 21, Spain's Mango, and Britain's Topshop, which is set to open in New York next year.

Inditex has spent more than three decades perfecting its strategy. Along the way it has broken almost every rule in retailing. At most clothing companies, the supply chain starts with designers, who plan collections as much as a year in advance. At Inditex, Zara store managers monitor what's selling daily—and with up to 70% of their salaries coming from commission, there's a lot of incentive to get it right. They track everything from current sales trends to merchandise customers want but can't find in stores, then shoot orders to Inditex's 300 designers, who fashion what's needed instantly.

Typically, apparel chains outsource the bulk of production to low-cost countries in Asia. Inditex produces half of its merchandise in factories in Spain, Portugal, and Morocco, keeping the manufacturing of the most fashionable items in-house while buying basics such as T-shirts from shops in Eastern Europe, Africa, and Asia. Wages are higher at Inditex—its factory workers in Spain make an average of $1,650 a month, vs. $206 in China's Guandong Province. But the company saves time and money on shipping. Also, Inditex's plants use just-in-time systems developed in cooperation with logistics experts from Toyota Motor, which gives the company a level of control that would be impossible if it were entirely dependent on outsiders.

In addition, Inditex supplies every market from warehouses in Spain. Even so, it manages to get new merchandise to European stores within 24 hours, and, by flying goods via commercial airliners, to stores in the Americas and Asia in 48 hours or less.

Air shipments cost more than transporting bulk packages on ocean freighters. But Inditex can afford them. The company produces smaller batches of clothing, adding an air of exclusivity that encourages customers to shop often. As a result, the chain doesn't have to slash prices by 50%, as rivals often do, to move mass quantities of out-of-season stock. Since the chain is more attuned to the most current looks, it also can get away with charging more than, say, Gap. "If you produce what the street is already wearing, you minimize fashion risk," notes José Luis Nueno, a marketing professor at IESE Business School in Barcelona.

For rivals hoping to mimic Inditex's results, analyst Luca Solca of Sanford C. Bernstein has a bit of advice: Don't follow the Zara pattern halfheartedly. "The Inditex way is an all-or-nothing proposition that has to be fully embraced to yield results."


Zara is a interesting case study. Together with Apple, they seem to be redefining the process of delivering consumer products. Both exercise tight control over process and are optimized to meet customer demands rather than mere supply side cost management. The freedom, store managers enjoy at Zara to get the stuff they expect their customers to pick up, and Apple stores that allow customers to walk-in and talk face to face with service people, reasserts that the "human" acting as the bridge between customer and company can still make a difference on customer experience and profits. -Ajay

In the Zara model, who in the supply chain holds the raw materials inventory (fabric, zippers, trims, etc.)? How far in advance to they have to commit to it, and how do they know how much to buy? -mark erickson

I wonder if it is sustainable? As they open even more stores is their supply chain scalable enough to sustain the model and keep their tight processes on track? They certainly know how to run a value chain and make it hum but I have some concern that it may start getting too big to properly manage as they face more constraints. -TR

Thanks very much for your responses to the story. @TR: Yes, the challenge Inditex faces is as it expands further from Spain will it still be able to wield the tight control over its supply chain. I think it is sustainable as long as like-for-like sales are growing--if these fall for say, several consecutive qrts and Inditex's costs rise, it could be difficult. @mark erickson: Inditex owns 100 other companies that handle various parts of its supply chain. So for instance, Zara sources around 40% of its fabric from another Inditex-owned company, Comditel. Fabric is purchased in grey so that it can be dyed in season to react more quickly to trends. Prof. Nueno says Zara commits to 35% of raw material purchases and up to 50% of purchases of finished products once the season has already started. -kerry

Zara has excellent products, but the service in its stores is terrible - long lines at the cash register, the runaround for simple returns, etc. I've stopped shopping there. -Kay

It was about time Inditex entered the US market. Here in Europe we've been studying ZARA strategies as a very good example of SWOT analysis and Competitive Advantage. Thumbs up Inditex, break the american rules ;) -Ermela

Zara has another interesting thing. They spend ZERO on marketing. No advertising, no marketing stunts, nothing. Just good prices and word-of-mouth. -Lucio

Sounds like a standard model for success. Give 'em what they want, don't pick up deadwood, stay lean and flexible, be adaptable and move fast. -Christopher H

Although Zara's clothes are fashionable and very cute, I believe they also keep their costs low by producing low quality clothing. I have bought several items there, only to have them fall apart in a matter of weeks. A friend and I who bought the same sweater weeks before me, were in amazement as our sweaters fell apart in unison week after week, until while travelling in Austria in dead winter, I was forced to buy a new one...Never shop there if you would like your clothes to last for the season...Never... -Former Zara Shopper

Oppenheimer Funds' Ron Fielding likes to find gems among tax-exempt bonds that others dump—and often winds up scoring big

"They do take on a lot of risk," says Morningstar analyst Greg Carlson. "But they've got a pretty impressive research team, and they've gotten so many calls right over the long term."

Contrarian's Guide

BusinessWeek - Oct.20,2008