The Post Recession Role of Company Stores

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When a brand said, “We’re just going to open a few flag ship stores to build the brand image and collect some good consumer information,” I was okay with that. Made sense.
When it said, “We’re just going to open a few outlet stores to keep stuff that didn’t sell well out of the wrong channels,” I was okay with that too. In both these instances, I even bought into the idea that it wouldn’t hurt, and might even support, their specialty retail customers.
But when opening stores started to evolve into a vertical integration growth strategy, I got worried. It suggested saturation of the market and a lack of other growth opportunities. It was like the canary in the coal mine for the distribution issue. It might turn out to be good for consumers (if price, rather than any kind of “specialness” was the main purchase driver for them) but it certainly wasn’t good for the industry. Not for a moment did I think that somehow it was good for specialty retailers. I don’t think anybody actually did.
That’s not to say I think opening retail stores was a bad decisions for some brands. No more than I think it’s a bad decision for a retailer to decide to stop carrying a popular brand when they realize they can’t make any money on it because of how it’s distributed. One of my business mantras is that every company does what it perceives to be in its own best interest. That’s the way it should be. The interests of “the industry” come in second.
Well, wherever you go, there you’ll be. And here we are.
The market has changed. Some brands have closed stores, and certainly they are all thinking long and hard about how quickly and how many to open. Sales increases are going to be harder to come by. Gross margin dollars and expense control are going to be where businesses look to increase their profits. What does this suggest for the role of company stores?
By the way, I consider a brand’s internet sales another type of company store, and I think what I’m discussing here applies to the internet as well.     
Why Brands Open Stores
As a brand, the traditional ways to grow are by taking market share, by getting your piece of a growing market, by acquisition, by adding products, and by extending your brand franchise, under which I guess opening retail stores might fit.
When times were good and the cash was flowing, brands could look at all of those. Though of course, only larger brands generally had the capability to make acquisitions and open stores. From a strict financial perspective, having your own retail stores looks like a no brainer. If Gertrude’s Skate Shop can make money selling $1 million of product, they have to buy it from us (and other brands), and they carry lower margin hard goods, can’t we make even more? We can probably control certain expenses better, we can merchandise our stuff the way we want and, with luck, we won’t have any trouble collecting receivables from ourselves.
Now, I trust the actual analysis was a bit more sophisticated than that, but you can see that the initial financial analysis would be compelling—especially if you needed some more growth and didn’t know where else to get it. And if you figured times were so good and sales growth and cash flow so robust that the “fat and happy” syndrome, from which we all suffered and would no doubt like to suffer from again, meant that any business blowback, including dissatisfaction from your specialty retail customers, would be minimal.
Like managers at winter resorts who believe themselves to be great managers when the snowfall is good, we were all a bit deluded by many years of good times.
It’s Not Quite That Easy Any More
In the same way that no battle plan long survives contact with the enemy, no business plan gets far into implementation unscathed.
In the first place, you have to find people to manage and work in your new stores. I don’t care how well you know the product and the industry—running a retail store takes a different skill set than running a brand. How hard is it to get and keep good people? Look at the effort Zumiez puts into finding, training, and keeping good people for their stores. It’s one of their top priorities and never something they take for granted.
The best retail managers, of course, are already working at retail stores; stores that probably buy product from your brand. Call me mean spirited, but I’m just not seeing specialty retailers being happy about a brand they have worked to build hiring their people to work in the brand’s new store. Though perhaps there are now some good people available from retailers that have closed.
Next, you’ve got to stock your new store. VF Corporation has enough brands to comfortably diversify its store offerings, if you believe that enough of their brands belong in the same retail environment. Other companies may not, depending on what you believe about consumers’ retail preferences. Do they want to shop regularly in a store with only one or a few brands even if the assortment is very broad? Should you carry brands you don’t own in your stores?
What’s the impact on your overall sales? Will you increase sales, or will you just cannibalize sales from other places now that sales increases are harder to come by? Perhaps you’ll be happy if you just hold your sales levels, as this would improve your profitability based on the much higher margins you earn at your stores.
Assuming we’re not talking about an outlet store, how do you handle pricing? As an image store, you want to hold full retail. In fact, you’ve probably assured your other retail customers that you will. That’s all fine until those specialty retailers start discounting your product. Now what? Do you truly not care if nobody buys the stuff in your company owned stores because it’s cheaper in other specialty retailers? Tempting, in this environment, to cut those prices but still make a great margin, isn’t it? Maybe those stores you own become part of your strategy for reducing the excess inventory you got caught with last fall.
Before our economic circumstances changed, company stores posed some issues, but they somehow seemed manageable. Now, they require some harder decisions.
Like, for example, what is a brand’s relationship with specialty retailers? There are, of course, fewer specialty retailers, and fewer retailers in general. Though this was starting to be true long before the economy went south, big brands with wide distribution are and will find themselves getting a smaller percentage of sales and profits from specialty retailers.
The surviving specialty retailers aren’t going to be that excited about selling brands they really can’t compete and differentiate themselves with due to that brand’s broad distribution. I had an email from a specialty retailer a couple of weeks ago telling me about a certain brand he could buy at a big multi store retailer at their discounted retail price cheaper than he could order it directly from the brand. If that’s true, it’s hard to imagine him carrying that brand for long.
Specialty retailers will have no choice but to focus on smaller brands, or limited distribution offerings from large brands that give them enough margin and differentiation to survive. You just don’t stay in business by selling stuff you lose money on, no matter how cool it may be.
Specialty retailers and company stores are going to have less competition because of the decline in retailer numbers. Whether this makes up for the decline, or at least slower growth, in overall sales we’ll have to wait and see. If you’re a large brand looking to maximize your gross margins dollars in a period of slower sales growth, company stores can make a lot of sense-—if you can manage the (admittedly incomplete) list of issues I outlined above.
A large brand may tend to look at specialty retailers as a place where you want to be well represented, but not as the source of a lot of growth and profitability. Years ago, I suggested that brands should have a list of the 50 or 100 specialty stores they thought they just had to be in for brand integrity and credibility and make sure they were in them. I still think they should be doing that.
The corollary is that larger brands may have a preference for their own stores over smaller retailers that the brands perceive can be hard to work with and offer limited opportunities for growth. After this recession ends (whenever that is), and the associated retrenchment, I expect to see more company stores selling the more widely distributed brands.
The numbers almost demand it.

A Tale of Two Surf Shops. Kind Of.

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I grew up spending all my summers on Long Beach Island, New Jersey. That’s where I learned to surf. And just before anybody makes the comment yes, the surf is generally lousy and for anything really good we have to pray for hurricanes and a change in the prevailing south winds.

We still have a family beach house there, and I was back last week on vacation. We left, naturally, on Friday, the day before Hurricane Bill hit. So instead of getting surf, I got stuck with a five hour weather delay in the airport. Life is not fair.

Enough bitching and moaning and explaining. Naturally, since I was on vacation, I took the best part of a day and visited surf shops and I wanted to contrast two of them.
 
The first is Farias, which has been on the island for 35 years and has three locations. I was in the largest location in Ship Bottom. It’s open all year. It was attractive, well merchandised and well lit. The large selection of boards was upstairs.
 
It’s a big store and they carry, well, all the soft goods brands you would expect them to carry. Go look at the list on their web site here. http://www.fariassurf.com/products/surf-gear/ Even though Farias was large and carried all the requisite stuff you have to carry when you’re on the main street of a summer vacation town, it did a good job feeling surf focused- because it is.
 
The second shop was the Brighton Beach Surf Shop. According to Michael Lisiewski (who’s business card says, “Owner/ Surf Instructor,” the shop was opened in 1962, giving them 47 years under their belt. I’m assuming it was his father who started it- either that or Michael is the best preserved guy I’ve ever seen. They also started Matador Surf Boards around the same time.
 
Here’s the link to their web site. http://brightonbeachsurfshop.com/   Check out the list of soft good brands they carry- oh wait, they don’t have one. That’s because they don’t carry any of the usual soft goods brands. Not one of the 22 industry standards that Farias carries are sold at Brighton Beach. Of course they have some soft goods- sweat and hats and t-shirts. Many of them say Long Beach Island on them. There are probably some store t-shirts as well, but I don’t specifically remember them. Hey, I was supposed to be on vacation.
Why don’t they carry them? First, because merchandising just one of these brands the way Farias can do it might come close to filling the whole Brighton Beach store. If I’m exaggerating, it’s not by much. The place is a bit small.
 
Second, that’s not what their focus is. As I stood there, the kids came in and went out asking about surf boards and surfing. According to Mike, these are his key customers.
 
At Brighton you can get “Everything you need for a day at the beach.” You can get that at Farias too. Like Farias Ship Bottom store, Brighton Beach Surf Shop is open all year around. Unless Mike is out surfing or isn’t there for some other excellent reason. 
So we’ve got two surf shops, both focused on surfing, but very different in terms of how they do business and where they make money. Is one better than the other one? Nope. At 35 and 47 years, it’s pretty clear that they both have strong business models.
But what fell on me like a sack of hammers after my tour was that you can’t be Brighton Beach Surf Shop if you try and carry even one or two of the brands that Farias carries. And you can’t be Farias if you carry only one or two of those brands either.
 
Maybe I just don’t get out often enough, but it suddenly occurred to me that there might no longer be room for shops caught in the middle. You either carry a large assortment of brands (or you’ve got to figure out which ones to carry and that’s a crap shoot) or you carry few to none of the broadly distributed brands (because you can’t merchandise them well or compete on price).
Perhaps that’s already been obvious to everybody but me. Who says you don’t learn anything on vacation?

 

 

Billabong’s Annual Report for Year Ended June 30, 2008

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I’m supposed to crunch a bunch of numbers when I do these things, but first I’d like to highlight Billabong’s Operating Principles from its Corporate Governance Statement. There are eight of them and they are:

1.       Lay solid foundations for management and oversight.

2.       Structure the board to add value.

3.       Promote ethical and responsible decision making.
4.       Safeguard integrity in financial reporting.
5.       Make timely and balance disclosure.
6.       Shareholder communication.
7.       Recognize and manage risk.
8.       Remunerate fairly and responsibly.
 
They discuss in some detail how they try to accomplish each of these. You can see the discussion on pages 30-36 of their financial report here. http://www.billabongbiz.com/documents/20090821_Appendix4EFullFinancial_ReportWebsite.pdf
I’m sure it’s not easy, and I imagine you’re always working to get it right, but you can’t go too far wrong in running your business if you follow those eight principles.
 
Net profit fell from $176.4 million to $152.8 million Australian Dollars. That includes a noncash after tax impairment charge of $7.4 million on retail assets (all numbers in this article are in Australian Dollars unless otherwise noted. At June 30, 2009, it took 1.243 Australian Dollars to buy one U.S. Dollar). The profit decline came on a 23.6% increase in total revenue from $1.354 billion to $1.674 billion.
 
Sales grew by 9.1% in constant currency terms (that is, assuming the exchange rate was the same all year). Without the Dakine acquisition, constant currency sales grew only 2.8%. The date of the Sector 9 acquisition was July 1, 2008 so it was included in the results for the whole year. Billabong is projecting net profit after taxes to be flat in the fiscal year ending June 30, 2010. What happened? The recession, particularly in the United States, happened.
 
“Excluding the acquisitions of DaKine and Sector 9, as well as the Quiet Flight retail business which was acquired in June 2008, sales in North America were down approximately 13% in USD terms.” This was the result of generally poor economic conditions and retailers changing their traditional buying patterns to minimize inventory risk, as well as the company’s decision to hold prices.
“…sales to chain retailer Pacific Sunwear continued to decline and accounted for less than 10% of the Group’s sales in the Americas. This followed the Group’s reluctance to endorse Pacific Sunwear’s shift into a value price driven retail offer.”
 
Gross profit margins were 53.2% compared to 54.9% the previous year. Their ability to hold the margin decline to 1.7% reflects the company’s strategic decision to minimize discounting with the goal of maintaining brand equity. What discounting they did was mostly in the U.S. The margin decline also reflects Dakine’s and Sector 9’s use of third party distributors.
 
The sales increase means that gross margin dollars earned rose from $746 million to $894 million, but increasing expenses below this line meant that pretax profit fell 16% from $246 to $206 million. Selling, general and administrative expenses rose $126 million, or 31.6%, from $399 to $525 million. $75 million of that increase was employee benefit expense. The Sector 9 and Dakine acquisitions were going to increase those expenses. As percentage of total revenues, it rose from 29.5% to 31.4%.
 
Company owned retail was responsible for approximately 21% of revenue during the year. EBITDA (earnings before interest, taxes, depreciation and amortization) for the retail sector fell from 10% to 10.2% “…due to a marked decline in comparative store sales from October 2008 to the end of the financial year.” At year end, Billabong had 335 company owned stores.
 
The most important thing that happened over on the balance sheet was the raising of $290.8 million in new equity (before transaction costs) last May. As a result, net debt decreased by 36.6% to $225 million. Interest coverage is 7.1 times, down from 11.1 the previous year.
 
The new capital improved Billabong’s current ratio from 3.07 to 3.30, and its total liabilities to equity improved from 1.04 times to 0.89. It’s an especially good time to strengthen your balance sheet.
 
Intangible assets rose from $800 million to $1 billion, representing 45% of their total assets. That includes a $117 million increase in goodwill mostly, I expect, as a result of the Sector 9 and Dakine acquisitions.
 
During the conference call on the annual report, management noted that they were dealing with 10% less accounts than in the previous year because the account was no longer in business or due to credit risk. Receivables over six months past due have risen from $11 to $21 million. They noted that they were working hard on collections, and had slowed their payments to suppliers to compensate for their customers not paying them.
 
They indicated that they expected to see some product shortages during the holiday season due to retailer caution in placing orders. They have been meeting with retailers to discuss the product cycle and make it clear that while Billabong will do everything it can to respond to retailer and customer requirements, production times (especially for technical, seasonal products) can only be reduced so much.
 
Billabong has done a lot of things right. They have bought good brands (the only kind to own these days) at fair prices. They have managed their inventory and expenses in response to economic conditions. They have resisted discounting to maintain brand image and retailer support. They are reducing sales to customers who can’t support that brand image and the pricing it implies. They have raised capital to build their balance sheet. The decline in income (they still had a 15% return on equity) is in line to better than what other brands are experiencing and they are certainly well positioned for a recovery, though of course it depends on what form that recovery takes.
 
But you know what? The most important thing I’ve talked about in this article is probably those eight principals. If you do that, the rest will probably fall into place.  

 

 

Volcom’s Quarter Ended June 30, 2009

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Volcom filed their 10Q in the last couple of days. There’s some good news here, though of course Volcom’s income statement for the quarter and six months reflects the impact of the recession. And the issue of how to manage their PacSun business is an interesting one.

Let’s start with the balance sheet. The filing includes balance sheets for June 30, 2009 and December 31, 2008. I went back and plucked out the June 30, 2008 balance sheet to make a better comparison to June 30, 2009.

I should start by saying that their balance sheet was already strong last June, and it’s strengthened further. Cash and short term investments rose from $71 to $96 million. Accounts receivable and inventories fell by 20% and 18% respectively. Accrued payables and expenses were down 18% from a year ago. Those changes are consistent with the recession and how you manage in it.
 
Volcom’s current ratio rose from 4.78 to 6.22 while total debt to equity fell from 0.20 to 0.15. Those are both good things. They had no drawings under their line of credit (though $1.6 million in letters of credit were outstanding). Availability under the line was $38.4 million. Volcom has a balance sheet that allows it to continue to pursue its strategy and take advantage of competitor weaknesses during a tough economy. I may have mentioned a time or two that having a strong balance sheet right now is a real advantage for any company.
 
Revenues, to nobody’s surprise, declined. They fell 25% for the quarter to $54 million and 20% for six months to $123 million. Gross profit margin for the quarter actually rose from 48% to 48.6%. For six months it fell from 50.3% to 49.6%. Selling, general and administrative expenses fell 7.4% for the quarter, reflecting careful management of expenses and compensation. I’d note that these declines are not as dramatic as I’ve heard about in some other companies. Again, Volcom has the balance sheet to maintain its initiatives.
 
Net income, however, fell 82% in the quarter from $4.8 million to $872 thousand. For six months, it was down 64% from $14.2 to $5.1 million. Revenues and gross profit dollars were down for the quarter in Volcom’s three operating segments- United States, Europe, and Electric.
 
 Volcom reported that sales to PacSun decreased 23.7%, or $5.4 million, during the six months ended June 30, 2009 compared to the same six months the prior year. $5.4 million is approximately 18% of their total sales drop of $30 million from the first six months of 2008 compared to the first six months of 2009. They don’t say what the drop was for the quarter ended June 30 compared to the same quarter last year.
 
They say that PacSun represented 16% of product revenues in 2008 (I assume they mean the whole year), and 14% for the six months ended June 30, 2009. That would be $17 million.
    
Let’s try playing around with the numbers a bit more. If $5.4 million is a 23.7% drop, what were total sales to PacSun for the six months of the prior year? A little less than $23 million. That’s about 15% of total sales during that period.
 
Volcom “…expects a decrease in 2009 revenue from Pacific Sunwear when compared to 2008.” They go on to say, “Pacific Sunwear remains an important customer for us and we are working both internally and with Pacific Sunwear to maximize our business with them. We believe our brand continues to be an important part of the Pacific Sunwear business. We also recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear.”
 
How can Volcom maximize their business with PacSun while lessening their concentration with them? Can you maximize your business while you decrease it? They seem to think so since 2009 revenue from PacSun will be less than 2008. You can lessen concentration either by selling PacSun less or by selling everybody else more. Those are the only two choices I can see.
 
Only from public companies who are required to focus on quarterly results can you get these kinds of semi-contradictory statements. Volcom has to figure out how to replace sales from PacSun in an environment where finding sales growth isn’t easy. They are “assessing strategies” for accomplishing this but don’t have it solved. Oh well- not even the best companies are having an easy time right now. 

 

 

Boardshorts from a Vending Machine

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If you read this http://www.nbcnewyork.com/blogs/the-thread/Swimsuit-Vending-Machines-to-be-Stocked-in-Hotel-52089002.html you’ll see that Quik has partnered with Standard Hotels to sell cobranded swim suits at boutiques and poolside vending machines for $75 a pair.

I’m not writing this to express an opinion (though I’m usually not loathe to do that) but just to let you know it’s happening and to talk about the general implications.

Just when you think there are no new distribution channels, up pops another one. I don’t know where the next one will come from, but I know it will appear. Is it at the expense of some other distribution channel? Sure. To some extent. But might it also create some new customers? Sure. To some extent.
 
Sales at resorts or hotel shops and pools are often to people who need something they need right now. I’d say you fit into that category if you want to swim and don’t have a suit.
 
Every time you choose a new way to distribute your product- each time it can be found somewhere different-, you change your customer base and the market’s perception of your brand. To some extent. Can you manage that so you get more customers than you lose? How many different distribution channels, partners, products and price tiers can you have before your brand evolves from what it started as to what it needs to be to attract those new customers you need for growth? Can you keep the old customers? To some extent. Figuring this kind of stuff out is what the best executives do.
 
I lied. I do have an opinion. I might not go as far as the writer of the linked article and say its “brilliant,” but I think it’s a good idea which might grow and is consistent with how Quik has evolved their brand. Even if it grows, it doesn’t feel like it will have much downside for other parts of their distribution. I imagine there are some specialty retailers already shell shocked by the recession and distribution issues that might disagree. But Quik, like all brands and all retailers, has to do what it perceives to be in its own best interest. I think they made a good decision.