FOREWORD
If you you thought we were in a tough competitive retail landscape over the last couple of years, you would be in the company of many other retailers. However, a fundamental and perhaps simplistic economic analysis is hard to ignore, we have been trading in 'NICE' (non-inflationary constant expansion) times. Ten years of growth and prosperity has masked the increasingly competitive environment and underlying changes in supply and demand for retail products and services.
The retailers' relative share of consumer spend has been declining. There has been almost permanent price deflation over most products sold requiring increases in throughput just to maintain sales growth. There has been a relentless expansion of floor space and this capacity is still forecast to increase over the coming years. Add to this the exponential growth of the internet and multi-channel retailing which has, in most cases, added to the cost base whilst cannibalising sales.
Forecast demand from consumers is most definitely on the way down, yet selling space is on the way up. Commodity prices, fuel costs, governance and regulatory requirements are spiralling, all leading to a squeeze on margins.
Many retailers have risen to the challenge before and taken costs out year on year but how much more can be shaved? Our view is that the historic operating model used by many retailers in the good times will not be a platform for going forward. A fundamental shift is needed as we move into turbulent times. We present some high level thoughts in this Retail Review to ready your business for tough times and would be delighted to have a more detailed discussion about your future.
Richard Lloyd-Owen
THE UK IS FACING ECONOMIC TURBULENCE
Times are tough
Rising fuel and energy bills, stock market volatility, credit restrictions and a growing crisis in the housing market all point towards a possible economic slowdown and recession in the UK. Most retailers are seeing a downturn in spend or, at the very least, expecting a slow down in spend and Mervyn King, Governor of the Bank of England, said in May 2008 "For the time being at least, the 'nice' decade is behind us. We are travelling along a bumpy road as the economy rebalances".
High food and energy prices have caused consumers to shift away from non-food and non-fuel products. Declining house prices are leading to a perceived loss of wealth. Consumer spending on durable products has, consequently, been very weak. To the extent that spending is not growing at all, consumers are becoming increasingly price sensitive leading to a shift away from high-priced stores toward discounters.
In commodity markets, the factors that have contributed to the huge increase in prices go far beyond the current economic downturn. Rapid growth and demand in emerging markets and weak investment in new capacity were the principal culprits in the trebling of oil prices. As for food prices, large subsidies for biofuel production, increased demand and climate change have all played a big role in causing prices to rise. All of these factors will continue, and prices may be quite volatile in the near future.
Nevertheless, as a nation we will still spend around £285 billion in the UK retail industry this year. Growth may have all but evaporated but retail remains a massive sector: demand is not about to disappear. There are lessons to be learned from the recession of the early 1990's.
DEALING WITH AN UNCERTAIN ENVIRONMENT
Given the turbulent economic climate, the talk around the boardroom table has taken on a gloomy tone, with each executive at the table having to lower his or her expectations for the coming year. Most chief executives realise that approaching a downturn with a negative, defensive attitude as a management team is not a winning strategy.
To be sure, such unpleasant realities are part of what it means to compete in a market-based economy. The question is how to turn the challenges during a downturn into opportunities to be a better management team and company – how can retailers emerge from this situation with greater market share and with a more competitive business model? What strategies and tactics can help position them to survive, and even thrive, during this economic storm?
- Place the customer at the heart of every decision
The single most important thing is to ensure that you deliver what your customers really want and need. Sounds obvious? Perhaps, but many UK retailers have historically not been market driven in terms of either culture or structure. Customer understanding is about much more than studying the sales figures on a Monday morning. It is about anticipating demand and understanding how to stimulate it. It is about placing that customer understanding at the heart of the decision-making of the retail business. Every decision must take the customer into account and to a greater or lesser extent, be driven by them.
Understanding what your customers want is particularly critical in a period where customer attitudes will change, customers will value the proposition and shopping experience differently, and in particular what worked well during the 'good times' could unravel and not work in the future.
This is particularly relevant when only a quarter of customers are loyal. With customer attitudes changing, retailers will need to be even quicker at tracking and measuring what they are doing, and even quicker at changing the business, what worked well yesterday may not work tomorrow. Pace of understanding and being able to change fast enough will be a key differentiator to help protect your biggest asset, your existing customer base. - Evaluate your competitive position
While spending will continue, the key issue is how big a share of that spend can you capture, and how can you defend it. The structural changes that have in any case been taking place in the industry are moving towards an increasingly polarised marketplace. At one end are the category killers: retailers who dominate markets with huge stores, massive product assortments which give real authority, and unbeatable prices. These models deliver huge volumes at relatively lower margins.
At the other end of the spectrum are the niche players, more targeted at the aspirational end of the market where consumers are willing to pay a premium for something a bit more special. Branding and exclusivity play a big part here.
While the category killers are essentially focusing on consumers' needs, the niche players are targeting their wants. Niche retailers can deliver higher margins because (in theory at least) they are adding more value. However, they will not sell anything like the volumes of their category killing counterparts.
Then there is the middle ground. This is a more challenging territory to trade in because businesses face pressure from either end of the spectrum. It is essential to have a very clear, consistently executed proposition. There are, of course, opportunities to extend the proposition into both territories but the danger of being seen as neither fish nor fowl is great.
Wherever you sit in this market, you will share your customers with many other retailers: true fidelity does not exist in retail. Your customers' perceptions of what you do will be influenced as much by your rivals as by you. Understanding those perceptions is a precondition of influencing them. If you reduce your prices by 5% but your competitors reduce theirs by 10%, you have in effect increased your prices, or that is how your customers will view it. Most retailers' core customers are extremely knowledgeable about the main stores they frequent. A prerequisite of successfully navigating through this downturn is not only understanding customers, but being able to take that knowledge and tailor the proposition accordingly. - Conserve cash to protect yourself
When looking to make changes which would bring performance improvements in the short term, many retailers feel like they are between a wall and a hard place. Many of the initiatives required to speed up the cash cycle may involve restructuring of the supplier base, distribution network or system infrastructure and therefore have an inherently long lead time before benefits come on board. On the other hand short term improvements are often seen as limited as customers generally tend to pay in cash or cash equivalent while many of the outgoing flows, such as labour, rent, taxes, can be viewed as being fixed.
What about suppliers? While squeezing suppliers may be seen as normal practice when looking to conserve cash, retailers should remember that the suppliers that they squeeze today are the same suppliers that they will look to fuel future growth – in other words they should be treated with respect.
This does not mean that nothing can be done. While most businesses believe they pay their suppliers on time or even slightly late, we find that typically between 10 and 15% of invoices are paid early when compared with negotiated terms. Limiting payment runs to once a week can add up to 3 days, consolidating supplier spend (especially on non-merchandising) and ensuring that just one payment term is used with each supplier, can each bring a marked improvement in payables performance. - Tighten up on key operating processes
Customer reaction to a retailer's proposition can change very quickly. Retailers will need to get on top of measurement and comparison to plan, and start to plan and take action as soon as new trends and deviations from plan are reported. It is all too easy to blame the weather, or the football, and hope trading will turn around in a few weeks. It is also prudent to tighten up on swifter invoicing of debtors; negotiate longer credit periods or extra discount for early payment to creditors; focus on minimising buffer stock and clearing out surplus lines.
Many companies have "lazy" business processes that miss opportunities to improve orders, collections, and consumption of working capital. Performance metrics that focus on cash flow are often missing from management goals and incentives. During a downturn, contracting demand causes most businesses to experience a combined cash and margin squeeze. Inventory turns decelerate and inventory ages excessively, driving a need for increased price reductions that simultaneously affect working capital and margin. It's actually a better strategy to reduce inventory commitments early in a contracting economy. It becomes important to know which part of the economic cycle you are experiencing – the decline, the bottom, or the recovery. - Be careful before cutting marketing spend
Traditionally, marketing spend is one of the first areas to be cut in hard times. However a key imperative is to keep selling and attracting customers to your stores, so cutting marketing seems unwise. Retailers need to evaluate where they are getting a return and eliminate areas that are not bringing in new business. Even though there are many techniques for understanding what marketing is effective, ranging from simple to sophisticated, it is an area that is often overlooked and under utilised in retail. - Re-evaluate your investments
Most organisations have plans to grow and expand requiring investment of some type. It is advisable to re-evaluate the plans and postpone non-essential investments, but make sure they are not required to enable you to take advantage of the upturn when it arrives. Another area to look at is the enterprise cost base. Most organisations build their infrastructure and operating model incrementally, often evolving to an operating model and cost structure which is inefficient and not totally aligned to the business model. Taking an approach of stepping back and designing a new operating structure aligned to the business and future strategy can result in significant cost savings, especially if relatively large investments are planned to support future growth. - Build agility and responsiveness into your planning
process
It's probably time to re-examine your internal processes for planning and responding to changes in the market and in consumer demand. Most businesses use planning cycles that are tied to using historical demand. The planning process is slow, tedious, distracting, negotiated and therefore largely static. Traditional planning cycles are based on the calendar year and not adapted to the challenges of rapid change and transition that exist today. Companies need to think about planning differently. The concepts of planning and uncertainty may not seem to go together, but they can give you a competitive advantage if you rethink your planning cycles and create a more responsive planning process. The management team will often sit on their "plan" for too long in denial of the facts on the ground. But a period of economic transition requires more aggressive planning with shorter cycle times. - Look at variable costs
The majority of retailers have recognised that whilst they are strong at procuring product and managing the cost price, they have historically not been so good at managing the other costs in the business. Some retailers have focused on some of the easy cost savings such as supplier terms, but it is likely that there are still considerable savings to be had and it is still worth a focused audit of the operational cost base, followed by a targeted profit protection programme.
Every business has both contributing and non-contributing components, and over time the business accepts certain practices and assumptions that should be challenged. They may accept losing money during the non-peak season if they can make it up during the peak demand period. They may accept categories of products or locations that make a negative profit contribution to achieve sales goals. Challenging these non-contributing components doesn't mean eliminating them. They can often be restructured, reengineered, renegotiated, or re-priced to become contributors.
The automatic response of most companies is to reduce their overhead costs. However, consider that most businesses are highly leveraged across a large base of consumers or customers. This type of business model may deal with hundreds of suppliers and vendors, thousands of items, and sometimes millions of transactions. This means that reductions in highly leveraged, variable costs yield far greater economic benefits than slashing fixed costs.
An economic decline creates a decline in demand and an increase in supply. This increases the customer's leverage, but can also increase the leverage of the business with its suppliers. The management team needs to aggressively challenge variable expenses, cost of goods, and transactional costs to enable it to offer more competitive prices and to maintain margins that consumers will demand and respond to.
If the share of private label merchandise increases, retailers should modify its buyers, talent pool and increase the capability of its buyers to understand the manufacturing process and the manufacturing cost structure of the product they buy in order to have a deeper capability to negotiate sourcing prices. This would also make for more profitable partnerships with private label vendors. Too often, buyers of brands limit their job to negotiating back margins with the vendors without understanding the true manufacturing costs. - Realign and restructure
Restructuring is never easy, but it can be easier to restructure during a challenging period. It is also better to do it before you must do it and in ways that reduce disruptions to the business. Employees recognize the imperative to be more competitive and will be more supportive of orderly restructuring. - Negotiate away risk
In addition to negotiating lower costs with your suppliers, consider shifting some of your business risk onto these suppliers. For example, retailers should identify the risks of holding inventory such as currency risk, obsolescence, overstock, and then push some of these risks back onto their suppliers. By shifting risk, the negotiations move beyond a single focus on bargaining for the lowest price and move towards a business discussion on how both parties can win by better partnering and sharing risks and rewards.
Retailers should also consider how to reduce risk by adapting hedging strategies to remove volatility and uncertainty from their merchandise costs. Evaluate currency and commodity risk exposures and opportunities. Options and derivatives can be used to decrease risk and volatility. The challenge is to hedge in a manner that maintains maximum flexibility. Too often hedges prematurely commit an organization to a fixed price on a fixed date. In volatile times, it might be smarter to pay more for a more complex foreign exchange contract that contains options and collars, rather than purchasing a fixed foreign exchange contract for a set amount of currency on a future date. In short, hedge to maintain maximum flexibility while protecting your business. - Recognize opportunities
During periods of expansion and growth, asset values often peak at levels that defy economic analysis. Conversely, during contractions assets and resources can become available at fire sale prices. This could be the time to buy undervalued assets – grow opportunistically when competitors are forced to dispose of assets at prices below their intrinsic value. - Upgrade your workforce
When growth drives demand for additional staff, companies pay less attention to individual performance and compensation is driven by competitive market forces. During a contraction you can re-align compensation with contribution and performance to retain and foster a higher performance work force.
RIDING THE STORM
We often fail to recognize that downturns and recessions are part of a cycle that rebalances our market-based economy, which needs to reinvent itself to improve and grow. We need to accept that we live in a competitive world that is subject to increasing complexity and uncertainty. To survive, and even thrive we need to build business models that are more responsive, adaptable, and efficient with resources and assets. Business leaders need to focus on turning uncertainty into opportunity.
The items covered in this report are on many agendas but acting on all fronts with speed may seem daunting, and clearly prioritisation is required to reflect your business needs. Some of the incremental changes discussed will help the bottom line. Many will enhance your flexibility in challenging times. In some cases more fundamental transformations will be required as the pace of change increases volatility and with it more innovation and change. The good news is that the tools to help you adapt to change have also never been greater.
It is important that retailers are careful about how they respond to the possible downturn so that they not only continue to profitably trade, but that they are in a strong position to quickly take advantage of the upturn when it arrives. Beyond the matter of economic cycles, there is increasing evidence that uncertainty and volatility may simply become a permanent condition in the external business environment. Uncertain weather patterns plague traditional retail forecasting. Huge and transformational innovation is changing the way we shop, communicate and interact with each other. The transparency of information has shifted power to consumers, who have reacted by demanding more choice at lower prices.
The most successful retailers will use this time to prepare their business to be able to rapidly respond to the upturn when it arrives and take market share from their competitors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
