Golden rules for keeping a retail business on track

With the economy tightening, retailers are really starting to feel the heat. Barry Knight of Smith & Williamson explains why UK retailers are suffering and highlights 5 golden rules for keeping a retail business on track.

There are numerous reasons why the UK's retail sector should be taking stock, both literally and figuratively. The economy has been relatively benign for years and this has masked inefficiencies. But now things are heating up, leaving some retailers potentially exposed - as evidenced by the problems at Ethel Austin, MK One and JJB Sports.

So accepting that retailers are more at risk from the vagaries of the economy than other sectors, careful management is key and it is essential that any difficulties are addressed promptly (see Golden Rules, below). But why do so many retailers get into difficulties? There are of course a million reasons, but let's focus on the three major ones in my view.

Retail businesses have low barriers to entry

First, barriers to entry into the UK's retail sector are very low. With an investment of about £40,000, most people can probably set up a shop on a typical high street within a month. Go into any city, town or village in the UK and you will find a row (or more) of shops. There are thousands of small retailers all competing against themselves. This tends not to occur in other countries.

A good example is to compare London with Dusseldorf, a city not unlike many others in Europe and both with a similar ‘retail' population to target. Dusseldorf has a population of around half a million and has three distinct large shopping areas. The retail offering is far in excess of what is required by a population of its size and the shopping areas pull in shoppers from all over the Rhine-Rhur valley. A potential customer base of ten million plus. When you drive out of Dusseldorf, very soon you are in residential areas and then countryside. In contrast the roads leading out of London are nothing more than glorified high streets. In summary, there is a chronic over-supply of retail space in the UK.

The second factor is over-expansion. Anyone setting up a shop with long-term chances of success - that is of attracting footfall and selling the right product - has probably found a specific niche or point of differentiation. If you get it right, the retailer can very quickly generate substantial cash flow. This allows the acquisition of a second site, a third, fifth, tenth and so on. But there is enormous temptation at this point to expand aggressively.

Rapid expansion can cause problems in the supply chain

In my experience, the tipping point is between 15 and 20 stores. At this stage, a number of factors become critical. The infrastructure can start to creak, and in particular supply chains and systems, with their huge number of moving parts, come under extreme stress. The retailer may not have the necessary expertise to manage what is now a reasonable sized business.

In addition to this, the novelty factor of the product offering may start to wear off. Established retailers may spot the opportunity and set themselves up as competitors, offering the product more cheaply or, these days, developing an online offer. Under such external threats, unless the business can quickly restructure to adopt a ‘best practice' model, footfall can drop suddenly and business simply evaporates.

Close monitoring of sales, costs and cash is essential

Third, and most importantly, businesses ultimately go bust for one reason; they run out of cash. Good cash forecasting and bank facility management are fundamental. Retail has many parts and the phrase ‘retail is detail' is extremely valid. Once you have stripped out the glamour areas of buying, design and visual merchandising, the rest is ‘boring' - but hugely important.

Any retailer must sell above cost and overheads to survive whilst maintaining sufficient liquidity. For sales, it boils down to making sure that the right quantities of stock are in the right store, at the right time and at the right price. For costs and liquidity, the management of cash collection and constant monitoring of cost of sales and overheads are vital. I consider these areas risk management and measurement. Get them right, and problems can be identified and rectified at an early stage. Get them wrong, and you suffer.

These aspects of management are applicable to most sectors of the economy, but they are crucial for a retailer. Given the ease with which the consumer can stop or reduce spending and the current pressures on inflation and house prices, retailers are arguably more vulnerable than other sectors. If any cracks appear, the pain will be felt remarkably quickly.

Five golden rules to help keep your retail business on track
 

1. Produce regular forecasts. These should be at least quarterly, and preferably monthly, with cash flow being the most important. Run sensitivity analysis to compare cash position and bank facilities. Make sure that items of capital expenditure are identified well in advance. Remember that you only go bust when you run out of money!
2. Set realistic banking covenants. These should reflect the true risk of the business and should not simply be intended to achieve the cheapest cost of borrowing. Anyone who breaches banking covenants rapidly loses the confidence of their banker.
3. Don't hold on to old stock. Old stock ties up working capital, so if it isn't selling, discount the price and get rid of it. If stock doesn't sell this year, it's unlikely to sell next.
4. Check out the competition. Keep a watchful eye on competitors and if you are doing something different (including buying), make sure that you are right and they are wrong. Adjust your business model when required. (The topical example is the drive of the food retailers into non-food. It is very unlikely that a small business can compete on price. It needs to differentiate on other aspects).
5. Stay alert. If you realise there is a problem, act on it and work out a solution that can be presented to creditors. Don't just assume you can trade your way out of problems, more remedial action may be required. Recognise that banks, in particular, don't like shocks.

Ethel Austin - a discount clothing group now in administration.

Observers believe that Ethel Austin's management team overlooked the growth of Primark and the supermarkets in selling value clothing. In addition, many of their shops were ‘tertiary pitches' (for example, located in residential areas). While such locations demand lower rents they get a lower footfall. How effectively was the impact of changing shopping trends measured?

JJB Sports, closure of stores

Excess stock was allowed to build up without clearing over a controlled period. Were problems identified early enough?

The Works - a discount book retailer, now in administration

These stores could not respond to price pressure from supermarkets, WH Smith and Waterstones which, in turn, are competing against internet retailers.

Dolcis - shoe store chain, now in administration.

This chain has found it difficult to adapt to changing trends whereby footwear is increasingly bought at the same time as clothing. In contrast, New Look is a perfect example of successfully combining the two retail offerings.

Ponden Mill - soft furnishings, now in administration

Sales have held up over recent years, while distribution and warehousing costs have increased out of line with turnover. The company failed to address its rising cost base early enough.

Barry Knight is a director at Smith & Williamson and Head of Retail Advisory and Restructuring