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3 26 2009
»Wholesale Changes

Wholesale ChangesRetailers were being forced to rethink their fundamental business models before the recession. Now, shifting demographics, over expansion and debt-weary consumers plague the sector.

By Eric Krell

Not to discount a bruising recession, but the economy represents only one of several major challenges shoving the retail industry into a period of wholesale changes. Big box retailers are opening smaller stores in malls. Microsoft is entering the retail business. Saks is slashing prices.

“The way retailers operated in past is not yielding results any more,” notes Fred Balboni, IBM Global Business Services partner and the firm’s global retail industry leader. “The old business models are not creating value the way they used to.”

The U.S. retail sector has thrived for the past quarter century as it enjoyed steady (and, more recently, breakneck) expansion, relatively inexpensive energy prices, minimal trade restrictions and an ever-expanding population of shopaholics. This beneficial climate crashed with the economy last year. However, other forces besides the plummeting global economy—including shifting demographics, volatile energy prices and the industry’s own insatiable appetite for new retail space—also lined up to force the “over-stored” retail industry to address a new reality.

“Consumers are of the mindset that credit-based consumption is out while personal savings, debt reduction and value shopping are in,” notes John Karonis, president of Kurt Salmon Associates’ (KSA) consumer products division. “More and more consumers are shopping in their closets and cupboards… Simply put, there are less consumer dollars being spent on retail goods. It sounds obvious, but that’s the root issue that retailers are dealing with.”

Other issues pose additional obstacles. “Look at the demographics,” suggests John Rooney, retail sector lead for Deloitte Consulting. “As baby boomers move into their 60s and start to consume less, there just aren’t enough people behind them to pick up the slack of their consumption.” Discussions and insights you hear from the next generation of consumers, Rooney adds, indicate that “large-scale consumption is becoming less popular.”

A significant contraction in retail consumption along with a major change in how consumers shop represents the sort of fundamental disruption that gets the consulting juices flowing. And it has. Veteran retail consultants sound genuinely excited—even optimistic—about the approaches and solutions they’re selling to retail companies, which, as Balboni points out, “are not engineered to take the kind of body blows” the current economy is dishing out.

Balboni and his team surveyed 30,000 shoppers late last year to identify how retail clients can better leverage business processes and performance analytics to retain advocates (loyal shoppers) and lure shifters (high-spending free agents).

At Deloitte, Rooney is focused on helping clients weather the downturn while also preparing to compete in a fundamentally different consumer landscape once the economic skies clear. KSA (localization), Accenture (a new retail outsourcing model) and other firms and retail practices recently have hatched similarly innovative and ambitious approaches (see Could the Worst of Times Bring Out the Best Ideas? on page 15).

In fact, there may be no better bargain in the retail industry right now than external consulting services. Oliver Wyman partner Paul Beswick describes the importance of delivering a “powerful and unarguable value case for each project” to retail clients right now. “It isn’t even going to be about ROI on the projects,” he asserts. “The real issue is how many months until the project pays for itself and how can it be made a risk-free proposition for clients.”

A Consumer Balance Sheet Crisis
The demand on consultants to deliver near-perfect (self-funding and risk-free?) solutions reflects the tough conditions confronting many retailers. The U.S. retail industry, the country’s largest collection of private employers, cut more than half a million jobs in 2008. Consumer confidence has plummeted in Europe and the U.S., where it recently hit its lowest point in four decades. And the industry’s golden metric, comparable store sales (“comps”) has dropped like lead weight—as much as 25 percent in an industry that has rarely endured comps declines of more than a few percentage points, even during previous recessions.

Are there any retail bright spots in the current economy? Consultants prefer to identify the “least affected” sub-sectors, such as grocers, drug stores and large discounters such as Wal-Mart and Costco. After all, consumers still need food, medicine and inexpensive goods during downturns. A handful of other companies, including Amazon, Apple and Aeropostale, also receive high marks from consultants for their strong performance in the weak economy.

The fundamental difference between the current economic crisis and previous tough times, in terms of their impact on the industry, boils down to depth and severity. In previous recessions, Karonis explains, consumers suffered a “P&L crisis.” They were short on cash, but could summon enough credit so that they did not need to curtail spending too much. As a result, consumers helped shop the country out of recent recessions. “This time it’s a balance-sheet crisis for the individual consumer,” Karonis notes. “This is really cut to the core of the psyche of the consumer.” The savings, equity funds, retirement funds and other material assets that consumers tapped in previous recessions have significantly decreased in value. 

“Our existing retail model is built on infinite consumer demand,” Balboni explains. In past downturns, retailers asked, “At what price does our product sell?” Today, a retailer can slash prices by 50 percent, and their products remain glued to the shelves. “We did not see that in the last couple of downturns,” Balboni continues, noting that many retailers are having difficulty converting products sitting on shelves into cash to pay for the next round of merchandise they have ordered. “That’s what makes the existing situation pretty breathtaking,” he notes. “It’s unlike anything we’ve seen in our lives.”

This unknown terrain creates uncertainty that retailers need to address in their strategic plans. Most retailers appear to believe that an economic turnaround is 12 months to 18 months away. If relief materializes sooner, though, retailers need to be prepared to capitalize on the holiday season. Many retail companies are planning for a “possible hockey-stick recovery in the fall,” Balboni reports. “That’s really wild because you’ve never built plans based on these [economic] conditions.”

Cash Resumes Its Throne
The primary challenges confronting retailers right now relate to cash—maximizing revenue, minimizing costs and freeing up every last cent lingering in inventories. Retailers want to boost incremental sales while simultaneously cutting costs, which marks a delicate two-step to execute. “There is not a lot of fat to cut in retail,” notes Janet Hoffman, managing director of Accenture’s North American retail practice. “Retailers have been very frugal with their investments in infrastructure services and back-office operations.”

Hoffman and other leading retail consultants identify three major challenges retailers confront during the downturn:

1. Customer Retention

According to the IBM survey, 45 percent of consumers currently are buying lower-cost products from their favorite retailer. As this trading-down trend intensifies, retailers will need to ensure that their customers do not start buying lower-cost products from other retailers. “Getting ahead of this trend is a key challenge,” Beswick stresses. “Retailers should be ensuring that they have trade-down paths in place that will help them keep their customers and they should be making sure that they are using this trend to their advantage. An obvious opportunity is to really focus on driving up private-label share which can result in better value for customers, better margins and a weakening of the long-term bargaining power of vendors.”

Retail consultants emphasize that customer-retention requires a balancing act. “Retailers need to drive real or perceived value offerings in the eyes of consumers without destroying the store’s profit potential or brand positioning,” Karonis asserts. “This is not just about cutting prices.”

Maintaining service levels, customer satisfaction and brand integrity requires a mix of customer insights and processes that transform those insights into revenue. The question, Rooney points out, is “how do I use analytical technologies to better understand my customers at a more granular level, so that I can understand the products, product mixes and promotional activities that will drive demand and more granular segments to my customer base?”

The processes need not be expensive or terribly intrusive, says Hoffman. She points to an Accenture engagement that resulted in a retail client redistributing its workforce so that more employees operate on the shop floor with customers (and fewer operate behind the scenes). The client had been suffering a loss of 4 percent to 7 percent in comps during the six months prior to the project. The stores in which Accenture’s labor redistribution plans were introduced subsequently enjoyed a 2 percent to 4 percent increase in comps, according to Hoffman. “That’s just huge in these times,” she asserts. “I think service is often the easiest lever to pull.”

2. Liquidity Management
Merchandising and pricing also qualify as crucial levers, albeit ones that require more time and money to effectively pull, says Hoffman. “Cash is king,” Karonis emphasizes. “Keeping inventory under control is absolutely essential right now.” In fact, the current economy represents a rare time when retailers may be better served by being out of stock occasionally rather than holding on to too much inventory and needing to resort to large markdowns. The key questions retailers confront are familiar ones, but they have taken on greater significance as bankruptcies and liquidations increase: How much product is in store? How much product is in the pipeline to come to the store? And, ultimately, what is the ideal amount of inventory to maintain? Pricing represents a subset of inventory management: How do retailers price and distribute the inventory they have?

The answers, increasingly, involve analytics. “Every single retailer I’ve talked to has confronted the fact that it’s raining outside, and they are doing something about it,” Balboni reports. Many retailers use analytical technology and processes, Balboni adds, to look at the business so they can figure out how to “squeeze the lime and grate the rinds—I mean, they want to get every last bit of juice out of it. This is about identifying the veins of gold that exists in business, whether it involves their shoppers, their supply chain or their merchandising.”

3. Cost Reduction
As Hoffman notes, most retailers have operated in a lean fashion for years, but current economic conditions demand more. Cost reduction initiatives therefore should be creative and quick. Retailers and their consultants are focusing on areas such as outsourcing (primarily HR, IT, accounting processes), advertising effectiveness and what Hoffman describes as “goods not for resale,” which includes cash registers, shelving, clothes racks and all of the materials retailers use to run their stores.

The trick, Karonis says, is to “manage the right costs without being silly.” Areas with high labor costs and areas that are ripe for shared services, for example, represent savvy cost-reduction opportunities. As more than one retail consultant points out, “It would be a shame to let a good crisis go to waste.”

At the same time, retailers should remain vigilant about protecting their brand integrity in the face of cost-reduction efforts as well as inventory and pricing-management efforts. “When all is said and done, we’ll get through this and all you will have left is integrity of brand,” Karonis notes. “If you sacrifice the brand by marking down and de-valuing service, that’s a tough road to hoe to get back.”

Forget ROI, Winners Want Cash Now
Given the challenges confronting the industry, retailers are hungry for consulting projects that can deliver a clear cash benefit in the short-term. Longer-term infrastructure engagements are not exactly selling like hotcakes right now.

“Projects need to be self-funding in year one—if not sooner,” says Beswick. “Cost reduction projects are an obvious area, but there are also opportunities to improve margins by making sure important levers like pricing and promotions are not wastefully managed.” Consumers aren’t the only ones snapping their wallets shut. Prying open retailers’ wallets will require “more than slick pitch decks,” Beswick continues. “The consulting industry needs to focus much more on developing a powerful and unarguable value case for each project. It isn’t even going to be about ROI on the projects. The real issue is how many months until the project pays for itself and how can it be made a risk-free proposition for clients.”

In that way, “consulting is much like retail,” says Hoffman. “Retailers need to know their customers and make an offer that the customer wants right here, right now. And the same is true with consulting. You have to know your clients, know what it is that will help them make their business better. Being agile and ready to bring your best thinking into their environment is what will differentiate between the consulting firms that grow in the coming months and those that do not.”

And retail consulting practices and firms that do grow will likely help their clients take advantage of an historic opportunity during a time of historic risk. In fact, the most recent earning reports suggest that retailers have accepted the realities of the current economy; a growing number of companies, including Macy’s, Home Depot and Target, appear to be focusing less on making excuses for declining sales and more on outsmarting competitors with new approaches and tactics.

That mindset represents a bright spot for consultants during dark times. “On the one hand, capital is scarce,” Beswick says. “On the other prime sites are becoming available. There is a tremendous opportunity for cash-rich retailers to make big gains.”

Could the Worst of Times Bring out the Best IdeasCould the Worst of Times Bring Out the Best Ideas?

Despite the economy—or because of it—retail companies that effectively manage the downturn have a unique opportunity to excel once the turnaround commences. “The companies that are very good sticking to execution, focusing on value, keeping their costs under control, and can survive without going into a bankruptcy that turns into a liquidation will come out at the other end with opportunities to acquire better space that becomes available from the companies that don’t survive,” says John Rooney, retail sector lead for Deloitte Consulting. “These companies will also emerge in a market with fewer competitors for the products that they offer.”

This risk-opportunity dynamic also appears to be stimulating retail firms and consultants to develop highly innovative approaches for clients. Nearly every retail practice head contacted identified a unique solution designed to help retailers not only weather the current economic storm, but also thrive in the new climate once the clouds clear. Kurt Salmon Associates, for example, has developed an analytics-based game plan to help clients tailor their stores’ approaches to “attack weak competitors locally.”

Other approaches include:

Extending Outsourcing: Accenture recently unveiled an alternative outsourcing model. “We’re doing inventory management for number of different retailers where we do planning and forecasting and they make purchases,” reports Janet Hoffman, managing director of the firm’s North American retail practice. “And then we ensure that the distribution centers are always full. That’s something that heretofore has never been done as an outsourcing service.”

Concentrating Retention: “The retailers who are winning right now recognize that there are two types of shoppers coming into their stores: advocates and shifters,” notes Fred Balboni, IBM Global Business Services partner and the firm’s global retail industry leader. Advocates are loyal and highly valuable shoppers while shifters refer to power shoppers who remain free agents or who are looking for a retailer where they can become advocates. IBM research indicates that 97 percent of shifters have increased their spending during the past 24 months. By helping clients understand and identify these two categories of shoppers, IBM enables clients to concentrate “recruiting” and retention efforts on the most valuable consumers.

Adapting to Demographics: The current downturn may cripple retailers who fail to adapt declining consumption patterns among aging Baby Boomers. As a result, retailers “need to have a cost structure that is not just temporarily lowered,” says John Rooney, retail sector lead for Deloitte Consulting, “but they need to adjust their cost structure for what the market is going to look like when we come out of this recession. Large-scale consumption is becoming less popular.” Rooney and his team work with retail clients to make better use of their virtual space while using less physical space. “One of the primary things we talk about with clients is having an online channel that’s fully integrated with your store,” he says. “It’s a way of getting out of the mindset that the only way to grow my business is having more stores.

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