Company Stores and Retail Consolidation; What’s a Core Store to Do?

At the Surf Industry Conference last May, I was the last one to ask a question of a panel of very successful specialty retailers. I acknowledged that I was sure they would all continue to be successful, though I doubted they were representative of most retailers out there. And then I asked them, “So what happens in let’s say five years when there are, just to pick a number, 5,000 company owned specialty stores in the United States?”

The panel grew quiet. The microphone was removed from my hand. One panel member finally volunteered the idea that in the normal course of business, some retailers come and some go. The meeting was adjourned.
You know, I have got to stop doing that. Asking people tough questions about real business issues with political overtones in a public forum is simply no way to build a consulting practice. Still, even if I have to say so myself, it’s a hell of a good question and worth exploring further.
Lest anybody be unclear, the question is not if there are going to be more company owned stores or if chains that target the same customers as the core stores will open more stores. There will be and they will. The question is how the role of core stores changes, if it does, and how they respond.
Why is This Happening?
Oh, the usual reason. To grow and make more money. Ho hum. For some reason (and this is worth another article), companies that don’t grow seem to have a hard time surviving in the action sports business. And, come to think of it, that’s true in any business. To grow, you can grow the market, take share from competitors, buy companies, start new brands, or go into new (but usually related) businesses like retail. Those are the only choices I know of.
Leading companies in snow and surf have learned that it’s hard to increase your market share past a certain point. You can get your share of any market growth, but not increase your share. Once you get to a certain point, there seems to be a backlash from your competitors, the retailers and, most importantly, the consumers, that keeps your market share from increasing.
Markets don’t keep growing fast enough to satisfy growth requirements. Acquisitions that make sense, especially if you aren’t a publicly traded company with well valued stock to buy them with, aren’t always easy to come by. New brands take investment, some time to succeed and, at the end of day, are often just another form of trying to take share from competitors- unless you’ve spotted a new market. But meaningful new markets don’t come along every day.
So if you’re a brand, you think about opening retail stores as a new, but related, business which you can maybe grow faster than your existing business. And you notice that while your cost structure is neither better nor worse than any other retailer, your profit structure is a hell of a lot better than core retailers selling your brand. This is simply because you are selling, to a greater or lesser extent, product you, as the brand owner, were already having made.  And you are selling it to your retail outlet at your cost. It’s for this reason that retail chains not owned by brands push their own brands- the gross margin is a lot higher.
It’s also why I expect to see more consolidation of retail stores. Higher margins through private label require a certain volume of business, and unit costs do come down with size as your ability to negotiate with brands increases.
Industry Dynamics
It’s funny, because no matter whom you ask in this business, distribution is an acknowledged issue. At some point, distribution becomes too broad. “It’s not good for the industry,” most will admit, “If you can find everything everywhere.” And margins- look, for sure margins have been under pressure and they need to be higher. Just ask, oh, anybody. Core retailers are for sure important to the industry, and we obviously need new brands to lead the way. “Everybody” thinks so.
But at the end of the day, every manager of every business is going to do what they perceive to be in the best interest of their company. You will. So will I. Every damn day.
We’re going to look for ways to grow and to increase our margins.   We’ll expand our distribution because there just isn’t enough growth in core shops for larger brands. We’ll get stuff made wherever it’s cheaper because all this “me too” product means that differentiation is tough and price is an important way of competing. We’ll open more stores. And as we do this stuff, we are legitimately and seriously and really going to be   worried about the core retailers.  Brands will do some things to help them. But we’re still going to do what we perceive we have to do given a tough, competitive environment.
I’m not saying this is a good thing, though maybe it has benefits for the consumer. I’m not saying I want it to happen. I’m just saying I’ve watched enough business cycles (in action sports and other industries) to be pretty certain this one won’t be any different. Don’t just shoot the messenger- think about the issues and how your business can benefit.
Position of Core Retailers
In its fiscal year ended January 31, 2004, Pacific Sunwear reported a gross margin of 35%. It stated that 32% of its business in the same year was private label. I couldn’t find anywhere what the gross margin on its private label business was. But even with 32% of its business being higher margin private label, its overall gross margin was only 35%.
Quiksilver, obviously a supplier to lots of retailers, in its year ended October 31, 2003, reported a gross margin of 44.4%. Now, there are some retail sales from some of its own stores in there, and probably some other sources of revenues from things besides its core business of making stuff and selling it to other retailers. But let’s just focus on that 44% number and recognize that most of it comes from Quik’s core business.
Retailers look at Quik’s 44% margin and ask themselves, “How can I get some of that?” The answer is private label.   Private label really is not a viable idea to a small, single store, retailer. Okay, you can do some t-shirts, stickers, and decks. But the bigger you are, and the more stores you have, the more valuable it can be to you- not just in terms of the additional gross margin, but in terms of brand recognition.
But remember that we’ve got an awful lot of companies selling an awful lot of product, through an awful lot of retail outlets that’s awfully similar to everybody else’s product. So price matters. And a retail chain (I’m not going to pick on Pac Sun anymore. I admire the hell out of what they’ve accomplished) is probably going to pass some of that extra gross margin they get from being larger and having private label to their customers for competitive and growth reasons.
If you’re a core retailer, and your competition is a big chain, you have a problem. You can not sell the same brands they sell, at the prices they sell, with your comparatively tiny annual turnover and have a financial model that makes sense.  We all know that’s accurate because we’ve seen so many small stores go out of business and so few open.
So if you are a core store, you better make sure you’re positioned so that you’re not competing directly with the chains. Because you can’t.
Well right, Jeff thanks a lot for that useless bolt of wisdom. How do we do that?
First, the days of just opening the store with a few bucks in the bank and your credit card are gone. If you really have a need to get rid of your money, have a big party and please invite me. Invite me? Screw that, just send me the money. You’ll save yourself a whole lot of effort and anxiety.
Second, you need a plan that gets you to a larger turnover quickly. You need the capital to fund that. You’ll need that plan and the capital just to convince the brands you want to carry to sell to you.
Third, from the day you open, you need a quality information system and the ability to use it. There’s not the room for mistakes like there use to be. Focus not just on gross margin, but on total margin dollars. If you don’t know why that is, don’t even think about getting into this business.
Fourth, you need at least a couple of committed and experience management people who can do this right. No learning as you go like you use to be able to do. And they need to like sleeping in the shop.
Fifth, however much capital your plan shows you need, you need more. The only thing we know about your plan is that it’s wrong. Either you will grow faster than projected, or slower. In either case, you’ll need more money. If you don’t understand that, don’t open a shop.
Sixth, you need the right location and strengthening community involvement from day one. If you come from the community and already have recognition in it, so much the better.
All the successful core shops I’ve ever seen that have been around a while have all these things, but they got started when it was easier by orders of magnitude.
So having said all these discouraging things, I’m urging with you to go out and open shops. But I’m urging you to do it right to maximize your chances of success. Shops have an important role to play in identifying trends, making it about the lifestyle and not just the sport, and taking a chance on new brands. They keep the industry from just becoming part of “sporting goods.”
My concern is that chains of smaller stores that look and act somewhat like core shops are going to replace the real thing.   And as a business guy, I’ll congratulate those chains on their success even as I recognize that their actions and motivations aren’t exactly what the industry needs to stay fresh.