Paltry pricing power threatens profits in 2002
By Julie MacIntosh
NEW YORK, Dec 28 (Reuters) - The rising number of bargain basement deals on offer from the store counter to the factory gate means a recovery in corporate profits may severely lag any rebound in the U.S. economy as companies find they have little power to raise prices, economists and fund managers warn.
A broad mix of retailers and manufacturers discounted their goods this year to convince customers to open their wallets in the face of a recession and surging levels of unemployment.
The average cost of a DVD player, one of the year's hottest sale items, dropped to $158.88 from $202 last year, according to eBrain Market Research estimates. Scooters that sold for almost $100 last year sat tagged at $9.99 at some stores, and Virgin is offering CDs for $9.99 -- almost half normal prices.
Analysts said prices for tech gadgets and other common consumer goods have dropped across the board, thanks to cheaper parts and savvier online comparison shopping by consumers.
While consumers welcome discounts, they're sending shock waves through many industries in the form of reduced profits.
``Profits will be harder to come by next year,'' said Andy Damm, a portfolio manager with BlackRock Advisors Inc., which oversees $225 billion. ``We just don't see pricing power being pushed up until the second half of next year.''
The biggest fear is customers have got so used to discounts it will take a long time before they will be prepared to pay full price again, even if the economy starts to pick up.
PUSHING DEMAND FORWARD
Sales of everything from computers to cars have been spurred this year by steep discounts -- especially during the fourth quarter, when retailers slashed prices to empty their shelves during the holiday shopping season.
Dell Computer Corp. (NasdaqNM:DELL - news) sold the standard version of its Inspiron 8000 notebook computer for $1,899 in October 2000. It now sells an Inspiron 8100 with a faster microprocessor and twice as much memory for $1,149, helped by lower component costs.
The dot-com crash and prolonged weakness in the telecommunications equipment market mean that much of Corporate America is also loathe to pay full price for technology systems of many kinds.
Economists argue the price-based boost in sales of some products may have borrowed against next year's sales and could trigger a sudden drop-off in demand for some products.
``There's probably going to be a little bit of a payback for that in the first part of next year, especially in the auto sector,'' Goldman Sachs Chief Economist Bill Dudley said.
Zero-financing programs from U.S. automakers pushed sales of new cars and trucks to record highs this fall, but the artificial bubble in demand could burst, analysts caution, and result in sharply lower sales -- and steep discounts -- next year.
Along with the automakers, many other manufacturing firms slowed their 2001 production schedules in response to fewer requests for machines, parts and other capital goods.
Manufacturers will not fire up their idle production lines until demand increases, Dudley said, making higher prices especially unlikely in the near term.
``You need demand first to drive capacity utilization rates up, and then only once that happens will pricing power return,'' he said. ``I would think it's quite a while away, generally.''
PRICING UPSIDES
The negative effects of the trend are far-reaching, hurting most retailers and many manufacturers. And it is feeding through to raw materials producers.
The world's largest aluminum maker, Alcoa Inc. (NYSE:AA - news), warned last week its fourth-quarter earnings would likely be less than expected as it faces ``lower volumes, depressed metal prices and overall weak downstream markets.''
Wood products giant Weyerhaeuser Co. (NYSE:WY - news) earlier this month warned prices for lumber and other wood products were ``considerably lower'' than expected.
Weak demand and declines in capacity utilization are affecting a broad range of companies, Dudley said. But select industries, such as steel, homebuilding and parts of the entertainment industry, have factors working in their favor.
U.S. steelmakers, which have long been plagued by cheaper imports they call unfair, may raise prices on their products if the U.S. government imposes tariffs or quotas on imports, as proposed by the U.S. International Trade Commission earlier this month.
Movie theater chains, such as AMC Entertainment Inc. (AMEX:AEN - news), have reduced discounted matinees in favor of full-price tickets as demand remains high, BNP Paribas analyst John Maxwell said. High demand and higher ticket prices have pushed box office receipts to record levels this year.
Strength in the U.S. dollar -- particularly following its recent surge against the yen -- means competition from foreign producers with lower costs is also likely to undermine U.S. companies' pricing power -- not only in the United States but in foreign markets too.
Still, the nation's services sector, which is largely insulated from foreign competition as customers seek to buy close to home because of the convenience, should retain its ability to increase prices, Dudley said.
Homebuilders, boosted by unseasonably warm weather and a recent surge in housing starts and home sales, are likely to see some pricing leeway, he said.
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