Tidings of...?

Retailers are playing it safe. That could backfire if shoppers splurge

Adrianne Kalyna is the kind of shopper that retailers dream about, especially in this year of economic ambiguity. The 44-year-old executive recruiter expects business to slow at her Chicago firm. Her investment portfolio is down 40% and she doesn't see a turnaround anytime soon. Yet Kalyna still expects to spread plenty of holiday joy. She plans to spend about $2,000, mostly on her teenage son. Says Kalyna: "You can't have a doomsday attitude for Christmas."

Plenty of retailers don't share her optimism. Fearful of a weak economy, rising unemployment, and such unknowns as the prospect of war with Iraq, most are hunkering down for another rough holiday season even as they're still smarting from a disappointing back-to-school season.

Making matters worse, white-knuckled shopkeepers are getting little hint from consumers that the Christmas season will turn out better than they think. Although shoppers like Kalyna helped send retail sales, excluding autos, up a surprisingly strong 0.7% in October, sales slowed in early November as buyers deserted the stores.

With such shifting winds, it's no wonder that anxious retailers fear the worst. They have so lowered their expectations that the modest 4% rise in sales of general merchandise predicted by the National Retail Federation would come as a relief. Certainly, no one is counting on seeing a repeat of the 5.6% rise that they posted last year.

The result: Pessimistic retailers are in their most defensive, cautious mood in years. They've thinly stocked shelves and kicked off a more aggressive than the usual round of preholiday sales in an attempt to lure shoppers. And don't look for anything radically new or different on display. "We're planning it flat," warns Gerald R. Szczepanski, chief executive officer of teen retailer Gadzooks Inc. (GADZ ) "I don't see there's anything really encouraging going on in the economy."

That strategy may yet prove right. Certainly, no one wants a replay of last year's mess, when overstocked shelves still brimmed with unsold toys and gifts on Dec. 26. To avoid that mistake again, retailers are cutting way back on inventories this year. In September, they had less than one and a half months of merchandise on hand, according to the U.S. Census Bureau. That's down about 4% from inventory levels of last year. For department stores the conundrum could be particularly vexing. Inventories of both Federated Department Stores (FD ) and May Department Stores (MAY ) are down nearly 5% from last year's levels. Their game plan is to boost profits by selling more goods at regular price, instead of last-minute markdowns.

Yet, there's a risk: If retailers have gauged shoppers wrongly and Christmas sales prove stronger than expected, stores may be caught badly short. Rather than cashing in on demand, retailers could find themselves with empty shelves when they might have been reaping profits. Retailers' conservatism "could turn out to be a self-fulfilling prophecy," says Wendy Liebmann, president of WSL Strategic Retail, an industry consultancy.

Indeed, there is fresh evidence that shoppers could loosen the purse strings more than expected. Along with the October sales boost, consumer confidence has been growing lately. The University of Michigan's much-watched confidence index rose some 5% in early November from the prior month. "It won't be as good as last Christmas, but it won't be a disaster," says Arthur C. Martinez, former CEO and chairman of Sears, Roebuck & Co.

Not all store chains, of course, are gloomy. Discounters such as Wal-Mart Stores (WMT ), Target (TGT ), and Kohl's (KSS ) will probably fare best of all. A Nov. 12 survey by consultant Deloitte & Touche found that 71% of consumers will make such price-cutters their top choice. And the big toy chains are hopeful that while mom and dad may cut back on other parts of the family budget, they'll continue to splurge on toys for junior. "They didn't spend it in August and September," says Toys CEO John H. Eyler Jr. "Will some of that come back into the holiday? We think it could, particularly spending on children."

Even before the traditional Thanksgiving kickoff for holiday shopping, higher-priced outlets, wary of being left out, have been feeding appetites for bargains. Outfits such as Federated Department Stores Inc. and May Department Stores Inc. have been launching a series of one-day sales and flooding consumers with coupon mailings. They have no choice. "People are much more hesitant to make purchases when there are no markdowns or coupons available," says Lisa Routh, an Atlanta sales associate at Rich's Department Store, a unit of Federated.

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By Robert Berner in Chicago and Christopher Palmeri in Los Angeles, with Louise Lee and Robert D. Hof in San Mateo, Wendy Zellner in Dallas, Nanette Byrnes in New York and bureau reports

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