Australia’s addiction to discounts is eating into retail margins and pushing many businesses to the brink, warns turnaround specialist Damien Hodgkinson.
The principal of Olvera Advisors – an independent firm specialising in restructuring and performance improvement – says the discount mentality now embedded in Australian retail is one of the biggest contributors to today’s trading challenges.
“Once you start getting into that discount model, it’s very difficult to get out of it, because you’re driving a price-sensitive customer and conditioning them to wait for a discount,” he says.
Hodgkinson argues local retailers have followed global discounting trends in a market that simply lacks the scale to sustain them. “One per cent of the US market equates to around 33 million people – more than Australia’s entire population. When you start adopting US-style retail tactics in a market that lacks scale, retailers are not going to make the returns they need to.”
What began as a clearance strategy has become routine. “Boxing Day sales used to be about clearing excess stock. Now, for Black Friday and Cyber Monday, retailers are cutting prices just weeks out from the prime trading season – and consumers are holding out for it,” he says.
With as much as 65 per cent of sales and profit generated in November and December, Hodgkinson says the impact is obvious. “Unless you’re watching your margins exceptionally well, or bringing in product specifically for BFCM and pricing it accordingly, you’re ripping the base out of your own business. That applies both online and in physical stores.”
“We have followed US retail models without the market scale. Anytime you go down the discounting path, it’s eventually going to fail,” he warns.
One strategy to maintain profitability during the sale seasons is to create a product or range at a competitive price point specifically for the season and resist the pressure to discount mainline stock.
Hodgkinson advocates using it to draw customers into their stores on the basis that they will be likely to buy that discounted product with something that’s at full price, so their basket of goods actually increases.
He also warns of a “two-fold effect” of discounting on customer satisfaction. “If I buy a full-price pair of pants in October and three weeks later, they’re 40 per cent off, I feel like I’ve had a bad experience with the store, even though at the time I bought the pants I wanted at the price I was prepared to pay.”
The discounting trend is compromising the entire business structure of many retailers, Hodgkinson warns.
For example, if your rental outgoing is a combination of base rent and turnover, which most shopping centres charge, and you are discounting your top-line sales to the point where you’re eroding your gross margin, your base rent as a percentage of your profitability is going to be much higher, he explains.
Hodgkinson says retailers should be targeting a rent-to-turnover ratio of less than 13 per cent. If it is running much higher than this, you likely have a looming problem.
While easier said than done, he advises retailers to try to renegotiate lease terms with landlords, moving away from a rental model that is heavily based on turnover to one that is based on margin, so that they are not bearing all of the risk.
Going all-in on the BFCM sales season has another impact on overheads: By stretching the traditionally busy pre-Christmas trading season earlier, retailers usually need to increase their casual staff. Hiring people at Christmas is made easier by school holidays, but those younger casual staff are not available until the end of the school term.
“You end up with labour pressure because there’s a reduced casual labour market during that period. And then you have issues like the cost of returns and managing the returns rate, which doesn’t change just because a product is on discount.”
Retailers are more vulnerable during growth times
Having been brought in to rescue or administer many troubled retail businesses over the years, Hodgkinson has a sharp eye for why some falter. “Everybody thinks businesses fail because something’s gone wrong, that the product wasn’t good enough, the service wasn’t good enough. That’s very rarely the case. Most businesses fail during their growth phase, because they can’t fund the growth.”
Take a retailer ordering stock in May for delivery in September or October. They pay for it in May, thinking they’ll sell 100 units, so they initially order 100, but when customers demand hundreds more units, they cannot fund the elevated stock levels for four months. “The retailers are growing faster than they can afford to fund.”
Retailers are also at the mercy of a market that can turn on a dime. “You cannot know that the product you bought in May is going to sell well in October, especially in fashion retail: If winter is short, or summer is wet, you can easily end up with the wrong stock – too much of one season, too little of another. If it’s fashion-sensitive, you can’t sell the same stock the following season. And the long turnaround times from ordering to delivery won’t help fill gaps.”
Those long lead times – combined with unpredictable weather and shifting consumer moods – only heighten the pressure on Australian retailers. They also expose the contrast between the relatively small local market and the scale advantages of North America and Europe.
Factories in China, for instance, are built to produce 10,000 units a day. An Australian brand ordering 100 or 1000 pieces will find itself well down the queue. The result is a completely different cost structure from a US retailer like Macy’s, which might be buying 100,000 units.
“You don’t have the purchasing power.”
Seek advice at the first warning signs of trouble
For retailers experiencing difficulties, the earlier they seek external advice, the easier they are to rescue and the more likely they are to recover.
Often, a first step is to liquidate stock to recover cash that can be reinvested in new stock. Hodgkinson advises retailers to do it quickly.
“The quicker you convert it into cash, the better you can deal with it, because it doesn’t get less obsolete the longer you leave it sitting in the store or the warehouse. Even if you are selling it at a negative margin, you’re converting it into cash. That negative margin is not going to get less the longer you hold onto it.”
It goes without saying that margins are critical. If the retail margin is 55 per cent, then discounting 40 per cent will still recover the cost of the goods, although you’re unlikely to recover the cost of sales or labour.
“When you get into 70 per cent off, you’re taking a loss on both the goods and the sales costs – but you are freeing up working capital to bring in new stock, and that’s important. Any retailer must have the ability to convert inventory into cash.”