Retail Operations

Six success factors for a tough market

Contents
Introduction

Complexity = cost ... simple operating models are lean

Staff are your biggest non-product cost and your biggest asset 4
Fixed store costs should still be actively managed

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

Get the level of capital expenditure right

10

Online is not a bolt on

12

Contacts

13

Introduction

The roll call of retail failure has become longer in the past few months. Many well-known
retail brands in the UK and Europe have got into financial difficulty and changed hands
in distressed sales or have been wound up and disappeared altogether. But, however
bleak the consumer outlook may appear to be, the picture is not uniform across the retail
landscape. Some retailers are weathering the storm and even prospering in the face of
general downturn on the high street.
Undeniably, much of the impact we have seen has been the result of irreversible
technological change and the rise of online shopping. Also, the governments austerity
measures have driven sharp reductions in discretionary consumer spending. However, our
experience of working on many retail deals over the past five years indicates that some of
the pain may be self-inflicted.
A successful senior executive in the grocery trade once told us: The retail game is not
complicated: all you have to do is understand what your customer wants to buy, offer it at
a 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, in
an otherwise benign consumer environment, that is probably true. Our view is that in the
current 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 efficiency and
integrating their online channel, to ensure that you can do those three things and be
profitable. We have distilled these observations into six operational success factors, which
we think help both retail investors and retail bosses in challenging or validating current
practices and performance.

Retail Operations Six success factors for a tough market

Complexity = cost ... simple operating models

are lean

A grocery retailer we
worked with a few
years ago introduced
huge efficiencies
to the organisation
by cutting its SKU
count from 12,000
toc.6,000.

A key driver of complexity in a retail

environment is the number of unique
Stock Keeping Units (SKUs) and the
number of formats and fascias. Whilst
offering a large number of SKUs may
seem to be offering customers what they
want, it adds cost to the operation. High
SKU counts result in larger distribution
centres, higher stock levels, more suppliers
to manage, and more effort to maintain
productavailability.
A grocery retailer we worked with a few
years ago introduced huge efficiencies to
the organisation by cutting its SKU count
from 12,000 to c. 6,000. This allowed
them to eliminate national distribution
centres and to reduce the total number of
regional distribution centres, all without
compromising service levels, or on-shelf
availability. This was accomplished by
changing the balance of A-brand and
private label, and de-listing B-brands,
whilst maintaining the perception of
customer choice.
The same retailer eliminated fascias and
size formats which were inconsistent with
its core demographic and value proposition
(re-branding certain stores and closing
others). The removal of this complexity
enabled a 50% reduction in central costs.
Levers for headcount reduction included
process simplification, consolidation of
central functions and outsourcing of
non-core functions.

Retail Operations Six success factors for a tough market

Another very successful food retailer takes

this successful approach a step further,
adhering strictly to a single-format model
and a very small, targeted SKU range
which is managed carefully to prevent
SKU-creep.
This complexity reduction principle is
applicable to general and fashion retail too.
For example, a multichannel fashion and
general retailer was underperforming its
competitors post-financial crisis. One of
the principal drivers of underperformance
was a long tail of under-performing SKUs.
This had come about due to undisciplined
range and stock management and led to
a large amount of slow-moving and aged
stock, which in turn generated additional
overhead. The combination of these
factors was putting pressure on liquidity.
The retailer was able to improve
this by improving range and stock
management policies (e.g., ABC inventory
management). This was accomplished
without compromising customer range
perceptions or lead time. The charts below
illustrate the reduction in SKU achievable
with negligible impact on margin, but with
positive impact on cash and cost.
To support this complexity reduction
in retail operations, warehousing and
merchandising IT systems should be
integrated and not reliant on human
intervention to transfer information from
one system to another.

25,000
21,682

Questions to ask yourself:

(13,729)

SKU count

20,000

Is the complexity of my range/format justified

for the margin I am achieving?

15,000
1,517

10,000

9,470

5,000

What additional central and supply chain cost is

this complexity driving?
How can I reduce complexity and cost without
impacting my customer experience?

0
Total SKU
count

Not meeting
criteria

Add-backs

Optimised
SKU count

Source: EY analysis 2012

Gross Margin (000)

60,000
50,000
40,000
30,000
20,000
0
Total SKU
count

Optimised
SKU count

Source: EY analysis 2012

Staff are your biggest non-product cost and

your biggest asset

The grocery retailer

we mentioned drove
through a major
simplification in staff
terms and conditions
and reduced overall
staff costs by one
percentage point
of sales.

Store labour is the largest category

of controllable non-product cost for
retailers. For this reason, major retailers
have invested heavily in labour planning
software to ensure that appropriate
labour hours are deployed to support
plannedsales.
However, more important to survival in the
current tough retail environment is labour
flexibility that is, not the total number
of hours per week, but the distribution of
those hours throughout the week. A major
grocery retailer (Retailer 6 in the chart
below) achieved major improvements
in labour flexibility by harmonising staff
terms and conditions and aligning these
with customer needs. This meant that
stores had sufficient staff on the floor at
non-overtime pay rates when needed on
Bank Holidays and evenings, and were not
overstaffed in quiet periods.
Although cost control and flexibility are
important, store staff shape the experience
of the end customer and enforce the store
standards that, in turn, drive footfall and
on-shelf product availability. Retailers
should therefore pay close attention to the
satisfaction, engagement and pay-rates
ofstore staff.

Retail Operations Six success factors for a tough market

The grocery retailer we mentioned above

drove through a major simplification in
staff terms and conditions and reduced
overall staff costs by one percentage point
of sales. During the same period they kept
staff churn below sector benchmark levels,
reduced sickness payments and achieved
80% positive responses on staff surveys.
This was achieved through better training,
listening to staff suggestions and rewarding
team performance.
Technology can provide opportunities to
train and develop staff in stores. Short
eLearning modules delivered over the
network allow staff to train during quiet
periods in store. This also lowers the cost of
training substantially.
Given their lower sales densities, fashion
retailers find it harder to achieve the
same store staff cost ratios as grocery
retailers. However, some do better than
others: Retailer 1 and Retailer 2 were
very similar fashion businesses. However,
Retailer 1 had significantly higher labour
costs, driven by less sophisticated labour
planning and control capability. This was
a significant factor in its eventual collapse
into administration.

20

% of revenue

15

10

0
Retailer 1

Retailer 2

Retailer 3

Retailer 6

Retailer 5

Store staff costs %

Source: EY analysis 2012

Questions to ask yourself:

How competitive are my store staff costs
and could I be more efficient in how labour
isplanned?
Do I have the flexibility to put in store staff when
I need them without incurring undue extra cost?
Are my store staff engaged and how is a possible
lack of engagement impacting store standards?

Fixed store costs should still be

actively managed

Store overheads and costs (including

utilities, rent and rates) are often treated
as an uncontrollable fixed cost. It is often
the notorious quarterly rent payment that
pushes an ailing UK retailer into insolvency.
These costs may be fixed, but they are
certainly controllable in the medium to
long term.
The best retail operations have strong
(but not necessarily large) central
property management functions that are
responsible for central negotiation of rents
and rates as well as utility, outsourced
maintenance and other service contracts.
These departments also actively manage
these costs, for example, by implementing
energy saving technology across the
estate to reduce utility bills. A certain
retailer we worked with, rolled out tablet
PCs with 3G connections instead of
a fixed network to reduce fixed store
telecommunications costs.
Rent is usually by far the largest of these
fixed occupancy costs and the best
retailers devote resources to managing
this cost, for example, by trying to
negotiate monthly rather than quarterly
rent payments, as well as lower rent
levels to help liquidity. However, leverage
to negotiate will vary: Store locations
remain vital to the operations of a retailer
and must be appropriately aligned to
the customer base in order to maximise
sales. This extends to both geographical
distribution (where local demographics
are key) and the pitch, either prime or

secondary, within a given retailing area.

Both will have a determining impact on
the level of fixed costs incurred by a
retailer, but more importantly, will strongly
influence store revenue.
At time of writing, the prime Central
London market remains good, with demand
sufficiently outstripping supply to put
upward pressure on rents. Demand also
remains reasonable for a small number of
other prime south eastern towns. Rents
elsewhere, however, are still contracting
or remain static. With institutional lease
structures providing for upward-only
rent reviews, many stores have become
over-rented (rent above market rates).
This represents a substantial additional
fixed cost for many retailers, and therefore
many are seeking to re-gear their leases:
secure a rent reduction in exchange for an
extension of the lease term. The tenants
negotiating position depends on the
strength of the town and pitch in which the
store is situated. Occupancy of low-demand
secondary locations, short remaining lease
terms and good tenant covenant strength
will all give the tenant greater negotiating
leverage, as the landlord will be keen for
the tenant to remain in occupation.
The make-up of retail portfolios is likely
to change further in the medium to long
term as internet retailing gains an even
greater proportion of market share (see
our views on multichannel retailing below).
This, combined with the current economic
uncertainty, makes it essential that retail

Retail Operations Six success factors for a tough market

tenants have the flexibility to change and

adapt to future market trends.
Prime retail units will typically be subject
to leases in excess of 10 years, whereas
landlords of secondary assets increasingly
have to concede on shorter terms, in
order to secure a tenant. Retailers should
however ensure that leases do not unduly
restrict their future ability to make
changes to their estate, by placing onerous
restrictions on the tenant in assigning the
lease of a store (alienation clauses).
The nature of store portfolios must also
be considered. Many retailers have a
presence not only on the High Street, but
also in out-of-town parks and shopping
centres. The mix of these units will clearly
be specific to the individual retailer but
when expansion into different formats is
pursued, flexibility is again vital in avoiding
liquidity issues arising from unprofitable
stores. For example, Retailer 3 in the
chart below demonstrates the highest level
of store overheads and occupancy costs in
our group. This was driven by an ambitious
expansion strategy, concentrating on
upscale store locations. The sales densities
achieved did not justify the costs, which
was a factor in the financial difficulties
itexperienced.

15

% of revenue

10

0
Retailer 3

Retailer 5

Retailer 1

Retailer 6

Retailer 2

Occupancy plus overhead %

Source: EY analysis 2012

Questions to ask yourself:

How tightly am I managing store overheads and
occupancy costs? Do I have the right mix of
insourced and outsourced cost?
Is there scope for me to re-gear leases on
underperforming stores?
How flexible is my estate and does it offer the
right mix to address future demand?

Supply chain is a core competency ...

even if you outsource

The best retailers

do not surrender
control or oversight
of warehouse and
transport operations
but still maintain
an integrated,
constructive
relationship with
their 3PL.

Management of the retail supply chain is a

key element of a retailers central mission
of getting the right amount of product
onto the shelves in a cost-effective way.
Some of the most successful retailers
have outsourced secondary distribution
(warehouse to store) to third party
logistics providers (3PLs). A high profile
high street fashion retailer recently moved
to a 3PL model, after problems with a
new warehouse management IT system
caused stock shortages, which resulted
in a multi-million pound hit to the bottom
line. This put the business under even more
cash pressure at a time of soft demand.
However, outsourcing the operation of
warehousing and/or transport doesnt
mean that you should outsource the
overall supply chain competency in
your organisation. On the contrary, the
negotiation and management of 3PL
contracts requires dedicated management
skill and focus in order to keep availability
up and distribution costs down.
A 3PL contract should be set up to reflect
the key priorities of the retailers specific
operating model e.g., in-store availability
of key offers and seasonality. It should also
make provision for the clear measurement
of Key Performance Indicators (KPIs) and
have a system of penalties and incentives
for maintaining and exceeding target
levels on KPIs such as Cost per Case and
Picking Accuracy.

Retail Operations Six success factors for a tough market

The best retailers do not surrender control

or oversight of warehouse and transport
operations but still maintain an integrated,
constructive relationship with their 3PL
that allows them to benefit from their
expertise in day-to-day warehousing and
transport operations. For example, in
recent years there have been significant
cost reductions to be had from new
technologies such as voice picking and
fleet telematics both retailer and 3PL can
benefit from their introduction.
Whether in-house or outsourced, efficient
retail supply chain operations remain a
moving target, with cost benchmarks
continually moving downwards. The best
retailers devote management resource to
this area even in the current challenging
market environment. The chart above
demonstrates how even a moderately
sized operator (Retailer 5) is able to
be competitive on distribution cost with
larger players (Retailer 1014) due to
the simplicity of its operating model and
efficiency of its outsourced distribution.
From a technology standpoint,
understanding and monitoring the
end-to-end information flow is vitally
important when considering supply chain
systems. Retailers need to know where
their goods are at all times.
Taking the time to develop end-to-end
information needs reduces the design
risk of the solution, whilst ensuring that
the solution will produce the information
needed to control the business.

Distribution costs (% of sales)

8
0
4
3
2
1
r5
r6
r7
r9
r
r1
r1
r1
r1
r1
le
le
le
le
ile
ai
ai
ai
ai
ile
ile
ile
ile
ile
a
t
t
t
t
t
a
a
a
a
a
t
t
t
t
t
Re
Re
Re
Re
Re
Re
Re
Re
Re
Re

Source: EY analysis 2012

Questions to ask yourself:

How competitive are my distribution costs and
are they moving in the right direction?
Should I be operating warehousing and logistics
myself or should I use a 3PL?
Do I have the skills in place to manage my 3PL
provider and drive continuous improvement?

Get the level of capital expenditure right

A key question
is how much
capex successful
retailers should
be spending in the
current challenging
environment.

The major component of retail capital

expenditure (capex) generally relates
to the fit-out of new stores and the
refurbishment of existing stores.
A key question is how much capex
successful retailers should be spending in
the current challenging environment. New
store and refurbishment capex need to be
analysed separately to yield any meaningful
comparison. However, it can be difficult to
reach firm conclusions on this due to the
different profiles and fit-out requirements
of different demographics and sectors.
A comparative analysis of new store capex
can highlight some interesting results. For
example, the US operations of high street
(Retailer 3 US) show a significantly
higher new store fit-out spend than its
European operations (Retailer 3 EU) or
a competitor European high street fashion
retailer (Retail 15). This high level of
spend was, however, not matched by a high
contribution per square foot. As a result,
the implied payback period of this spend is
around four years on average, compared
to other higher performing retailers, which
show a payback in the range 12 years.
As mentioned above, these low returns
on capital investment were a factor in
Retailer 3s liquidity problems.

10

Retail Operations Six success factors for a tough market

Refurbishment capex is the most difficult

to benchmark, as it depends on the nature
and size of the retail estate. Suffice to
say, the common characteristic of the
retail survivors we have seen is that
refurbishment capex is appropriately
balanced against the demographic served,
the cachet of the brand and the local
competitive situation.
We have frequently heard from successful
retail bosses that refurbishment capex
does not usually deliver any immediate
appreciable pay-back in terms of
increased like-for-like sales, but that
neglect will lead to slow decline (and
catch-up capex for an unwary purchaser).
The answer is to keep to a sensible
refurbishment cycle and then to focus
spend on the areas that have the most
noticeable impact on the customer
experience e.g., the changing rooms for a
fashion retail outlet.
Retailers shouldnt neglect IT capex
either. One fashion retailer recently faced
the prospect of open heart surgery in
replacing its core merchandising and
supply chain systems simultaneously as
both were over 20 years old and no longer
supported. This introduced a significant
execution risk to the organisation.

Years

0
Retailer 3 - US

Retailer 3 - EU

Retailer 15

Retailer 5

Average revenue per sq ft ()

Average contribution per sq ft ()

Average capex per sq ft ()

Payback period (yr)

Source: EY analysis 2012

Questions to ask yourself:

How can my return on new store capex
beimproved?
What is an appropriate refurbishment cycle and
spend for my existing estate and what areas
should I focus spend on?
Have I invested sufficiently in my retail systems
to avoid the execution risk of simultaneous key IT
system replacement or upgrade?

11

Online is not a bolt-on

With the advent of pure-play online

retailers, traditional high street retailers
have had to launch online channels to
complement their existing business model.
Some bricks-and-mortar retail
businesses have invested heavily in
setting up online retail channels to gain
competitive advantage, only for this new
channel to remain autonomous from
the core business. In the early days of
online retailing this might have been
due to a conscious decision not to divert
management attention from core business
operations. However, as online retailing
has grown to be comparable in magnitude
to traditional operations, this can result
in wasteful and disruptive duplication of
functions in areas such as marketing and
supply chain.

Another retailer insisted on separate

product strategies for its autonomous
online and traditional businesses. This
resulted in massive duplication across
the supply chain with dis-synergies in
everything from third party management
to procurement.
Traditional retailers will need to recognise
that they may need to make significant
investments in IT when looking to become
a multichannel retailer. This may well
represent a step change from how they
have operated before, with requirements
for 24/7 reliability, availability and security
of customer data. The best retailers are
integrating their offline and online supply
chains and investing in versatile supply
chain systems and scalable, flexible
onlineplatforms.

One retailer we worked with had an

online order fulfilment process that
was not integrated with the warehouse
management and fulfilment systems of
the traditional business. As a result of
this separation of the supply chain, the
business began to lose track of its stock,
resulting in an inability to fulfil online
orders which, in turn, had a negative
impact on sales.

This integration will impact not just

systems, but also the physical estate, with
online retailing increasingly becoming
incorporated into the concept through
click-and-collect stores where customers
can touch and feel physical merchandise
before buying.

12

Retail Operations Six success factors for a tough market

Questions to ask
yourself:
Are my online sales going to
be bigger than offline in the
near future? If not, why not?
How can I integrate online
and offline supply chain?
What do my organisation
and cost base need to look
like in order to support my
multichannel ambitions?

Contacts

Authors

Other Retail Contacts

Nick Neil-Boss
Director, Operational Transaction Services
(Operations Due Diligence
Ops and Supply Chain)
Office: + 44 20 7951 1815

Julie Carlyle
Partner, Strategic Growth Markets
Office: + 44 20 7951 0480
[email protected]

Mobile: + 44 7770 335 408

[email protected]
Justin Duffy
Director, Operational Transaction Services
(Operations Due Diligence IT)

Stuart Gregory
Partner, Transaction Advisory Services
(Financial Due Diligence Private Equity)

Office: + 44 20 7951 4939

Office: + 44 20 7951 1467

Mobile: + 44 7748 805 710

[email protected]

[email protected]

Ian Watson
Director, Valuation and Business Modelling
(Real Estate)

Harry Nicholson
Partner, Commercial Advisory Services
(Commercial Due Diligence)

Office: +44 20 7951 1950

Direct: + 44 20 7951 5707

Mobile: +44 7971 447 391

Mobile: + 44 7786 334 607

[email protected]

[email protected]

Jessica Clayton
Partner, Restructuring
Office: + 44 20 7951 6415
Mobile: + 44 7932 085 144
[email protected]

Christian Mole
Executive Director, Transaction Advisory
Services (Financial Due Diligence)
Office: + 44 20 7951 3034
Mobile: + 44 7970 122 009
[email protected]

Retail Operations Six success factors for a tough market

13

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