EY Retail Operations - Six Success Factors for a Tough Market

8/10/2019 EY Retail Operations - Six Success Factors for a Tough Market

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Retail OperationsSix success factors for a tough market


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Contents

Introduction 1

Complexity = cost ... simple operating models are lean 2

Staff are your biggest non-product cost and your biggest asset 4

Fixed store costs should still be actively managed 6

Supply chain is a core competency ... even if you outsource 8

Get the level of capital expenditure right 10

Online is not a bolt on 12

Contacts 13


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1Retail Operations Six success factors for a tough market

The roll call of retail failure has become longer in the past few months. Many well-knownretail brands in the UK and Europe have got into nancial dif culty and changed handsin distressed sales or have been wound up and disappeared altogether. But, howeverbleak the consumer outlook may appear to be, the picture is not uniform across the retaillandscape. Some retailers are weathering the storm and even prospering in the face ofgeneral downturn on the high street.

Undeniably, much of the impact we have seen has been the result of irreversibletechnological change and the rise of online shopping. Also, the governments austeritymeasures have driven sharp reductions in discretionary consumer spending. However, ourexperience of working on many retail deals over the past ve years indicates that some ofthe pain may be self-in icted.

A successful senior executive in the grocery trade once told us: The retail game is notcomplicated: all you have to do is understand what your customer wants to buy, offer it ata price they are prepared to pay and make sure it is available when they want to buy it.

This maxim assumes that if you get this formula right, everything else will follow. And, inan otherwise benign consumer environment, that is probably true. Our view is that in thecurrent climate, at the very least, retailers really need to get those things right. We believe

that retailers also need to focus on cost, capital expenditure, supply chain ef ciency andintegrating their online channel, to ensure that you can do those three things and bepro table. We have distilled these observations into six operational success factors, whichwe think help both retail investors and retail bosses in challenging or validating currentpractices and performance.

Introduction


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2 Retail Operations Six success factors for a tough market

Complexity = cost ... simple operating modelsare lean

A key driver of complexity in a retailenvironment is the number of uniqueStock Keeping Units (SKUs) and thenumber of formats and fascias. Whilstoffering a large number of SKUs mayseem to be offering customers what they

want, it adds cost to the operation. HighSKU counts result in larger distributioncentres, higher stock levels, more suppliersto manage, and more effort to maintainproduct availability.

A grocery retailer we worked with a fewyears ago introduced huge ef ciencies tothe organisation by cutting its SKU countfrom 12,000 to c. 6,000. This allowedthem to eliminate national distributioncentres and to reduce the total number ofregional distribution centres, all without

compromising service levels, or on-shelfavailability. This was accomplished bychanging the balance of A-brand andprivate label, and de-listing B-brands,whilst maintaining the perception ofcustomer choice.

The same retailer eliminated fascias andsize formats which were inconsistent withits core demographic and value proposition(re-branding certain stores and closingothers). The removal of this complexityenabled a 50% reduction in central costs.

Levers for headcount reduction includedprocess simpli cation, consolidation ofcentral functions and outsourcing ofnon-core functions.

Another very successful food retailer takesthis successful approach a step further,adhering strictly to a single-format modeland a very small, targeted SKU rangewhich is managed carefully to preventSKU-creep.

This complexity reduction principle isapplicable to general and fashion retail too.For example, a multichannel fashion andgeneral retailer was underperforming itscompetitors post- nancial crisis. One ofthe principal drivers of underperformancewas a long tail of under-performing SKUs.This had come about due to undisciplinedrange and stock management and led toa large amount of slow-moving and agedstock, which in turn generated additionaloverhead. The combination of these

factors was putting pressure on liquidity.The retailer was able to improvethis by improving range and stockmanagement policies (e.g., ABC inventorymanagement). This was accomplishedwithout compromising customer rangeperceptions or lead time. The charts belowillustrate the reduction in SKU achievablewith negligible impact on margin, but withpositive impact on cash and cost.

To support this complexity reductionin retail operations, warehousing andmerchandising IT systems should beintegrated and not reliant on humanintervention to transfer information fromone system to another.

A grocery retailer weworked with a fewyears ago introduced

huge ef cienciesto the organisationby cutting its SKUcount from 12,000to c. 6,000.


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3

Questions to ask yourself: Is the complexity of my range/format justi edfor the margin I am achieving?

What additional central and supply chain cost isthis complexity driving?

How can I reduce complexity and cost withoutimpacting my customer experience?

60,000

Total SKUcount

OptimisedSKU count

50,000

40,000

30,000

20,000

0

G r o s s

M a r g

i n ( 0 0 0 )

25,000

21,682

1,517 9,470

(13,729)

Total SKUcount

Not meetingcriteria

Add-backs OptimisedSKU count

S K

U c

o u n

t

20,000

15,000

10,000

5,000

0

Source: EY analysis 2012



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Store labour is the largest categoryof controllable non-product cost forretailers. For this reason, major retailershave invested heavily in labour planningsoftware to ensure that appropriatelabour hours are deployed to support

planned sales.However, more important to survival in thecurrent tough retail environment is labourexibility that is, not the total numberof hours per week, but the distribution ofthose hours throughout the week. A majorgrocery retailer (Retailer 6 in the chartbelow) achieved major improvementsin labour exibility by harmonising staffterms and conditions and aligning thesewith customer needs. This meant thatstores had suf cient staff on the oor at

non-overtime pay rates when needed onBank Holidays and evenings, and were notoverstaffed in quiet periods.

Although cost control and exibility areimportant, store staff shape the experienceof the end customer and enforce the storestandards that, in turn, drive footfall andon-shelf product availability. Retailersshould therefore pay close attention to thesatisfaction, engagement and pay-ratesof store staff.

The grocery retailer we mentioned abovedrove through a major simpli cation instaff terms and conditions and reducedoverall staff costs by one percentage pointof sales. During the same period they keptstaff churn below sector benchmark levels,

reduced sickness payments and achieved80% positive responses on staff surveys.This was achieved through better training,listening to staff suggestions and rewardingteam performance.

Technology can provide opportunities totrain and develop staff in stores. ShorteLearning modules delivered over thenetwork allow staff to train during quietperiods in store. This also lowers the cost oftraining substantially.

Given their lower sales densities, fashionretailers nd it harder to achieve thesame store staff cost ratios as groceryretailers. However, some do better thanothers: Retailer 1 and Retailer 2 werevery similar fashion businesses. However,Retailer 1 had signi cantly higher labourcosts, driven by less sophisticated labourplanning and control capability. This wasa signi cant factor in its eventual collapseinto administration.

Staff are your biggest non-product cost andyour biggest asset

The grocery retailerwe mentioned drovethrough a major

simpli cation in staffterms and conditionsand reduced overallstaff costs by onepercentage pointof sales.


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Questions to ask yourself: How competitive are my store staff costsand could I be more ef cient in how labouris planned?

Do I have the exibility to put in store staff whenI need them without incurring undue extra cost?

Are my store staff engaged and how is a possiblelack of engagement impacting store standards?

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Retailer 1 Retailer 2

Store staff costs %

Retailer 3 Retailer 6 Retailer 5

% o

f r e v e n u e

15

10

5

0



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Store overheads and costs (includingutilities, rent and rates) are often treatedas an uncontrollable xed cost. It is oftenthe notorious quarterly rent payment thatpushes an ailing UK retailer into insolvency.These costs may be xed, but they are

certainly controllable in the medium tolong term.

The best retail operations have strong(but not necessarily large) centralproperty management functions that areresponsible for central negotiation of rentsand rates as well as utility, outsourcedmaintenance and other service contracts.These departments also actively managethese costs, for example, by implementingenergy saving technology across theestate to reduce utility bills. A certain

retailer we worked with, rolled out tabletPCs with 3G connections instead ofa xed network to reduce xed storetelecommunications costs.

Rent is usually by far the largest of thesexed occupancy costs and the bestretailers devote resources to managingthis cost, for example, by trying tonegotiate monthly rather than quarterlyrent payments, as well as lower rentlevels to help liquidity. However, leverageto negotiate will vary: Store locations

remain vital to the operations of a retailerand must be appropriately aligned tothe customer base in order to maximisesales. This extends to both geographicaldistribution (where local demographicsare key) and the pitch, either prime or

secondary, within a given retailing area.Both will have a determining impact onthe level of xed costs incurred by aretailer, but more importantly, will stronglyin uence store revenue.

At time of writing, the prime Central

London market remains good, with demandsuf ciently outstripping supply to putupward pressure on rents. Demand alsoremains reasonable for a small number ofother prime south eastern towns. Rentselsewhere, however, are still contractingor remain static. With institutional leasestructures providing for upward-onlyrent reviews, many stores have becomeover-rented (rent above market rates).This represents a substantial additionalxed cost for many retailers, and therefore

many are seeking to re-gear their leases:secure a rent reduction in exchange for anextension of the lease term. The tenantsnegotiating position depends on thestrength of the town and pitch in which thestore is situated. Occupancy of low-demandsecondary locations, short remaining leaseterms and good tenant covenant strengthwill all give the tenant greater negotiatingleverage, as the landlord will be keen forthe tenant to remain in occupation.

The make-up of retail portfolios is likely

to change further in the medium to longterm as internet retailing gains an evengreater proportion of market share (seeour views on multichannel retailing below).This, combined with the current economicuncertainty, makes it essential that retail

tenants have the exibility to change andadapt to future market trends.

Prime retail units will typically be subjectto leases in excess of 10 years, whereaslandlords of secondary assets increasinglyhave to concede on shorter terms, in

order to secure a tenant. Retailers shouldhowever ensure that leases do not undulyrestrict their future ability to makechanges to their estate, by placing onerousrestrictions on the tenant in assigning thelease of a store (alienation clauses).

The nature of store portfolios must alsobe considered. Many retailers have apresence not only on the High Street, butalso in out-of-town parks and shoppingcentres. The mix of these units will clearlybe speci c to the individual retailer butwhen expansion into different formats ispursued, exibility is again vital in avoidingliquidity issues arising from unpro tablestores. For example, Retailer 3 in thechart below demonstrates the highest levelof store overheads and occupancy costs inour group. This was driven by an ambitiousexpansion strategy, concentrating onupscale store locations. The sales densitiesachieved did not justify the costs, whichwas a factor in the nancial dif cultiesit experienced.

Fixed store costs should still beactively managed


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7

15

Retailer 3 Retailer 5

Occupancy plus overhead %

Retailer 1 Retailer 6 Retailer 2

% o

f r e v e n u e

10

5

0

Questions to ask yourself: How tightly am I managing store overheads andoccupancy costs? Do I have the right mix ofinsourced and outsourced cost?

Is there scope for me to re-gear leases onunderperforming stores?

How exible is my estate and does it offer theright mix to address future demand?


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Management of the retail supply chain is akey element of a retailers central missionof getting the right amount of productonto the shelves in a cost-effective way.Some of the most successful retailershave outsourced secondary distribution

(warehouse to store) to third partylogistics providers (3PLs). A high pro lehigh street fashion retailer recently movedto a 3PL model, after problems with anew warehouse management IT systemcaused stock shortages, which resultedin a multi-million pound hit to the bottomline. This put the business under even morecash pressure at a time of soft demand.

However, outsourcing the operation ofwarehousing and/or transport doesntmean that you should outsource the

overall supply chain competency inyour organisation. On the contrary, thenegotiation and management of 3PLcontracts requires dedicated managementskill and focus in order to keep availabilityup and distribution costs down.

A 3PL contract should be set up to re ectthe key priorities of the retailers speci coperating model e.g., in-store availabilityof key offers and seasonality. It should alsomake provision for the clear measurementof Key Performance Indicators (KPIs) and

have a system of penalties and incentivesfor maintaining and exceeding targetlevels on KPIs such as Cost per Case andPicking Accuracy.

The best retailers do not surrender controlor oversight of warehouse and transportoperations but still maintain an integrated,constructive relationship with their 3PLthat allows them to bene t from theirexpertise in day-to-day warehousing and

transport operations. For example, inrecent years there have been signi cantcost reductions to be had from newtechnologies such as voice picking andeet telematics both retailer and 3PL canbene t from their introduction.

Whether in-house or outsourced, ef cientretail supply chain operations remain amoving target, with cost benchmarkscontinually moving downwards. The bestretailers devote management resource tothis area even in the current challenging

market environment. The chart abovedemonstrates how even a moderatelysized operator (Retailer 5) is able tobe competitive on distribution cost withlarger players (Retailer 1014) due tothe simplicity of its operating model andef ciency of its outsourced distribution.

From a technology standpoint,understanding and monitoring theend-to-end information ow is vitallyimportant when considering supply chainsystems. Retailers need to know where

their goods are at all times.Taking the time to develop end-to-endinformation needs reduces the designrisk of the solution, whilst ensuring thatthe solution will produce the informationneeded to control the business.

Supply chain is a core competency ...even if you outsource

The best retailersdo not surrendercontrol or oversight

of warehouse andtransport operationsbut still maintainan integrated,constructiverelationship withtheir 3PL.


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Questions to ask yourself: How competitive are my distribution costs andare they moving in the right direction?

Should I be operating warehousing and logisticsmyself or should I use a 3PL?

Do I have the skills in place to manage my 3PLprovider and drive continuous improvement?

8

R e t a

i l e r 7

R e t a

i l e r

8

R e t a

i l e r 9

R e t a

i l e r 5

R e t a

i l e r 6

R e t a

i l e r 1

0

R e t a

i l e r 1

1

R e t a

i l e r 1

2

R e t a

i l e r 1

3

R e t a

i l e r 1

4

D i s t r i b u

t i o n

c o s

t s ( % o

f s a

l e s

)

4

6

2

0



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The major component of retail capitalexpenditure (capex) generally relatesto the t-out of new stores and therefurbishment of existing stores.

A key question is how much capexsuccessful retailers should be spending in

the current challenging environment. Newstore and refurbishment capex need to beanalysed separately to yield any meaningfulcomparison. However, it can be dif cult toreach rm conclusions on this due to thedifferent pro les and t-out requirementsof different demographics and sectors.

A comparative analysis of new store capexcan highlight some interesting results. Forexample, the US operations of high street(Retailer 3 US) show a signi cantlyhigher new store t-out spend than itsEuropean operations (Retailer 3 EU) ora competitor European high street fashionretailer (Retail 15). This high level ofspend was, however, not matched by a highcontribution per square foot. As a result,the implied payback period of this spend isaround four years on average, comparedto other higher performing retailers, whichshow a payback in the range 12 years.

As mentioned above, these low returnson capital investment were a factor inRetailer 3s liquidity problems.

Refurbishment capex is the most dif cultto benchmark, as it depends on the natureand size of the retail estate. Suf ce tosay, the common characteristic of theretail survivors we have seen is thatrefurbishment capex is appropriately

balanced against the demographic served,the cachet of the brand and the localcompetitive situation.

We have frequently heard from successfulretail bosses that refurbishment capexdoes not usually deliver any immediateappreciable pay-back in terms ofincreased like-for-like sales, but thatneglect will lead to slow decline (andcatch-up capex for an unwary purchaser).The answer is to keep to a sensiblerefurbishment cycle and then to focus

spend on the areas that have the mostnoticeable impact on the customerexperience e.g., the changing rooms for afashion retail outlet.

Retailers shouldnt neglect IT capexeither. One fashion retailer recently facedthe prospect of open heart surgery inreplacing its core merchandising andsupply chain systems simultaneously asboth were over 20 years old and no longersupported. This introduced a signi cantexecution risk to the organisation.

Get the level of capital expenditure right

A key questionis how muchcapex successful

retailers shouldbe spending in thecurrent challengingenvironment.


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Questions to ask yourself: How can my return on new store capexbe improved?

What is an appropriate refurbishment cycle andspend for my existing estate and what areasshould I focus spend on?

Have I invested suf ciently in my retail systemsto avoid the execution risk of simultaneous key IT

system replacement or upgrade?

Retailer 3 - US Retailer 3 - EU Retailer 15 Retailer 5

Average revenue per sq ft ()

Average capex per sq ft ()

Average contribution per sq ft ()

Payback period (yr)

4

Y e a r s

3

1

2

0



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EY Retail Operations - Six Success Factors for a Tough Market