Well-known apparel brands that have perfected the art of offering year-long deep discounts are in for hard times as the latest Union Budget proposal has started eating into their margins.

The imposition of mandatory excise duty could distort their cost structure, according to a recent study by lCRA Ltd. However, it remains to be seen whether such companies are ready to tweak their distinctive marketing strategy of offering high discounts throughout the year.

MRPs

The MRPs of discount brands are disproportionately higher than the final sales prices. In addition, discounts are offered throughout the year. Therefore, the implication of excise duty as a percentage of actual realisation is much higher for discounted brands than for non-discounted brands.

According to ICRA estimates, effective excise duty would work out to 10-45 per cent for brands offering discounts between 50 and 90 per cent.

In the Union Budget for 2011-12, the optional excise duty levy was changed into a mandatory levy at a unified rate of 10 per cent for branded garments with abatement of 55 per cent. The change was effected to bring branded readymade garments under the purview of excise under the impending Goods and Service Tax regime, where exemptions are not favoured.

Mr Rohit Inamdar, Senior Vice-President, ICRA, says, “The mandatory excise duty will hit discount apparel brands that have adopted a steep discounting strategy whereby they offered discounts in the range of 50-90 per cent on the printed maximum retail price (MRP) throughout the year in a bid to capture a larger market share and also build their respective brands. The high MRP allowed these participants to maintain their operating profit margins in the range of 13-18 per cent despite these heavy discounts.”

Under the new scenario, discount brands have three alternatives to maintain their cash inflows at earlier levels: a) increase MRP while maintaining discounts at the same levels b) reduce discounts with the same MRP/ share excise burden with customer c) reduce the MRP.

ICRA expects that a reduction in discounts while maintaining MRP at the same levels may not be sustainable over the long term, as the effective excise duty is much higher than what is levied in the Budget. In fact, even premium brands have resorted to increased discounts to liquidate inventory.

Additionally, discount brands are facing stiff competition from private labels of the large format chain retail stores such as Shoppers Stop, Pantaloons, Westside, Reliance Retail and Spencer's that are aggressively promoting their own labels while offering value-for-money propositions to their customers.

In the last few quarters, discount brands have suffered from slowing sales growth and even a decline in sales in some cases, thus, squeezing their cash flows. Pressure on sales along with large and slow-moving inventory in the books may have a significant impact on the liquidity of discount apparel manufacturers. Therefore, it is clear that there is pressure on discount brand manufacturers to maintain their growth trajectory.

As offering large discounts is an integral part of the pricing strategy of such brands, with discounts generally offered throughout the year, there may be a shift in the marketing strategy of discount brands.

Due to mandatory excise duty, discount brands may correct their MRPs and start following the conventional route, whereby promotions and discounts are typically limited to end-of-season sales organised to clear unsold inventory in preparation of the new season.

ICRA believes that a correction in MRP seems to be the only viable approach in the prevailing environment for branded apparel manufacturers as well as their customers, as the effective price increase for the customers can be limited at around 5 per cent while the cash inflows of the companies can be maintained. Discount apparel brand manufacturers may also choose not to correct their MRP fully and continue to offer low discounts in the range of 10-20 per cent throughout the year.

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