Market Forces on Retail Turnarounds
Most practitioners are familiar with the technical aspects of identifying and analyzing an underperforming retail company. A quintessential "red flag" of a company headed toward distress is comparable store sales below average when compared to industry financial benchmarks or norms. Other factors indicating a possible restructuring could be high turnover at senior management levels or corporate strategic obsolescence. The analyst should absorb these telling, albeit fairly transparent, factors not only during the process of a turnaround, but also when targeting a good turnaround prospect.
An initial analysis of some essential characteristics of the target would include, but not be limited to:
- the target's financial position;
- SWOT (strength, weaknesses, opportunities and threats) analysis of the industry and competition;
- a summary of the target's history; and
- an understanding of its management and products.
While important, these factors are but the beginning point. There are often many overlooked demographic, statistical and economic factors that are critical components of any thorough analysis.
In this article we identify three factors that should be considered when forecasting the future performance and health of a retail organization or industry. The factors will, of course, be specific to the particular retail segment in which the target company is located.
An analysis of gross leaseable square feet in the target's respective geographic areas is critical in any retail turnaround. On the whole, America today has much more retail square footage than it can absorb. Retail square footage has grown at aggressive rates from the mid-1980s resulting in an astounding 20 square feet of retail space for every man, woman and child in this country. It is no coincidence that there is a positive correlation between retail bankruptcies and retail square footage.
Any analysis of excess retail square footage needs to be on a more specific level depending on the location of the target and its stores. Over-capacity is proliferate in metropolitan areas but not so in less populated areas. The failure of many discount department stores in a particular area probably points to the strained resources of that area. For example, the average per capita gross leasable space in the Dallas-Ft. Worth area is 28.5 compared to a national average of 20. At this saturation point, the only survivable competitive advantage would be a significant image of differentiation. The failure of Venture discount stores in this market was a direct result of not addressing over-capacity concerns. A fundamental question to ask is whether the target company is located in areas of over-capacity or is it targeting less saturated markets. If these factors are ignored, then a unique specialty retailing concept will be necessary to stand out and be noticed.
An often overlooked aspect of forecasting is the determination of a significant positive correlation between an economic indicator and the target's business. Economic indicators are a frequent subject of forecasts and are readily accessible. The healthy projection of an economic indicator, which is closely tied to the target company's performance, further supports a good forecast for the target. The indicator can be either very broad in nature or more specific to the target. For example, consumer debt is a very broad economic statistic, but it has a high positive correlation with sales of consumer electronic products. A more readily recognizable and specific correlation would be that of housing starts to sales of Home Depot.
Other general indicators that have proven useful in retail forecasting are:
- consumer savings;
- personal income;
- effective tax rates;
- average home prices;
- consumer credit availability; and
- the Commerce Department's composite of leading economic indicators (CLI)—the catch all.
It is not enough that retailers simply look to "survive until the next holiday season." The retail environment is far too competitive for that naive and short-term elusion. There are broad demographic changes occurring in the retail market for which retailers must strategically plan. Any retailer forecast would be incomplete if it did not compensate for the company's awareness (or lack thereof) and planned tactics to address fundamental demographic shifts in its markets.
Most demographic shifts are considered too "macro" and long-term by many business analysts when forecasting a troubled company's performance over the next two to three years. On the contrary, the analyst should determine how educated the company is to these shifts and what effect its strategies will have on compensating for them. This analysis will give additional insight into management's sophistication and ability to adapt to the ever-changing retail environment and to survive the first few critical years.
Some retail trends of particular importance, along with associated implications, are:
- "Greying" of America: increased savings rate and decreased spending rate, fewer purchases of durable goods, less home starts, less trendy goods, increased health care and pharmaceutical needs;
- increased usage of "business casual" throughout the corporate world: reduced spending on formal business attire, increased conservative casual attire;
- highest immigration levels for more than 100 years: specifically target fast-growing minority pockets (both geographically and through product line modifications), micro-marketing;
- geographical re-distribution to the mountain and western states: target growth areas in terms of population and household income, avoid over-stored areas;
- "value" and "precision" shopping: cater to the customers' increasing need for speed and service; and
- electronic shopping: decreasing in-store purchases.
As retailers have historically looked to demographics as their destiny, corporate turnaround specialists often overlook demographic and economic indicators while positioning the company for its future. There is a tendency to get "lost in the numbers" and not research external factors that can severely affect the business's future. Not only will a proper analysis of these factors result in more realistic projections, but it will give the analyst a much deeper insight into the company's operations.