The Credit Crunch and Recession seem to be inextricably linked, but the impact of these two economic events is quite different. And this difference applies especially to Retailers, where the Recession will have far greater and more damaging consequences than the Credit Crunch.
If your business depends upon the Retail channel, then you should be taking action now to help your channel whilst, at the same time, protecting your own interests.
Recession versus Credit Crunch
A Recession is something we see on a cyclical basis to a greater or lesser degree and anyone over 30 will have lived through at least one major recession. It is in essence a period when demand weakens as confidence evaoprates. The Credit Crunch by comparison is a much rarer event that last ocurs when the bad lending judgement of the world’s banks come home to roost in such a way as to destroy capital and remove liquidity from the economic system. In this current situation, a combination of dodgy loans based on property and increasingly exotic instruments that leverage the risk have been exposed by a sharp fall in the underlying property values. The effect is to suck credit out of the economy as banks become unwilling to lend to each other and thus to businesses. The two events are linked and feed on each other, but their impacts are very different.
The impact on the Retail channel
Retail is all about making high volumes of sales at good enough margins to cover the overheads of the business. Almost all sales are for cash or cash equivalents (credit card slips turn into cash overnight) whilst suppliers are paid on credit and inventory is kept to a minimum. Many retailers use their huge buying power to extract extended credit so can sit on a cash float for a month or so before paying their suppliers. Tesco for example is sitting on a cash pile of £2bn, Best Buy used to hold around $1.5bn (more on why this has come down to 0.5bn later) and Walmart has $7bn. The fundamental business model is to sell for cash and pay on credit, so the the credit crunch does not put their business at risk in the way that businesses that sell on credit are becoming exposed.
What does affect the Retail business model is the Recession because this damages sales volumes over a longer period. It’s akin to a coastal farmer survivng a Tsunami, but then suffering the effects of losing his home, crops and equipment. The lack of credit in the economy compounds the damage caused to confidence….and an uncertain consumer stops buying. Hence we have seen the shift to thrift as value brands benefit (Aldi, Lidl, Primark) in grocery and apparel, but other sectors such as household, electricals, fast moving consumer goods, consumer electronics, fashion, Do-It-yourself, have seen sales fall off a cliff. Retailers have fixed overhead costs (staff salaries, rents and utilities, distribution and IT systems) that are hard to cut quickly, so falling sales leaves their overhead base exposed like rocks as the tide goes out. This means net profits can quickly turn to net losses, eating into those famous cash piles.
Some costs related to marketing and promotions can be cut quickly but these are the key to another factor – getting customers to the store. In hard times, most businesses look at their order book as a leading indicator of how things are going to go. In other words they can see what is going to happen to sales beforehand. Retailers don’t have order books – they open the doors each day and wait to see who they have enticed into the store. That’s why everyone anxiously watches the daily sales numbers like a hawk – the trouble is this is a lagging indicator. By the time you know what’s happening, it’s happened.
What can Retailers do in a Recession?
There is a fairly familiar pattern to what vulnerable retailers do (none of which they really want to do):
- Cut back on planned store openings (new stores take time to reach profitable sales levels and even longer in a recession). The trouble with this is that it leaves the retailer increasingly in the wrong part of town
- Put pressure on suppliers to help finance more aggressive marketing and promotional activity. Tesco recently announced it was asking its non-food suppliers to make a contribution of up to 5%.
- Trim overheads by making a thousand small cuts while staff hiring is frozen. This means the best staff leave for places that treat them better and tends to harm staff morale, damaging customer service. Both Circuit City and CompUSA were slated for customer service in the period before their demise
- Discount deeply to keep the inventory moving. Lower sales means slower turning inventory, which means holding old or out of season inventory.
- Delay or minimise store refurbishments and resets. This leads to tired looking stores.
- Close Stores (Circuit City closed announced it was closing 20% of its stores a week before it filed for bankruptcy
- Shift promotions to “item and price”, in other words, any emphasis on positioning, value proposition or retail brand values is replaced with simple price-led programs.
On the other hand, strong retailers do the opposite of these things. Look at Walmart: Chief executive Lee Scott said Wal-Mart would be taking a “thoughtfully aggressive” approach to any opportunities, which might include acquiring sites from retailers that have gone out of business. He said under these circumstances there were chances to negotiate “very good rents”. The retailer said it was looking at smaller store formats while focusing more of its efforts on online sales to drive growth, according to The Financial Times.
So it shouldn’t be too hard to work out how well your retail partners are coping with the recession using the seven key points above.