In retail, times have been tough. Over the past several years, more than 100,000 U.S. retailers have filed for bankruptcy protection, many of which were forced to liquidate. Newspapers and the covers of trade magazines bear witness to the demise of retail outlets that once enjoyed a stellar reputation along with high growth and profits. Even household names are not immune in an era of retail malaise: Kmart's troubles have been widely publicized and even Wal-Mart stumbled in 1996, failing to make its 100th consecutive quarter of growth.
Understanding the current retail scene requires a look at the issues underlying this dramatic change over the last few tumultuous years. Above all, the U.S. has been and remains grossly overstored; in the U.S., there are an incredible 18-to-19 square feet of retail space per capita. Common sense dictates that many failures are simply a result of excess capacity. In this sense, the shrinking of the retail market is much like the periodic corrections of Wall Street's bull market - painful, but necessary.
Second, many previously successful players engaged in mergers, acquisitions and heavily leveraged buyouts in the late '80s and early '90s. Rather than build their business base, these retailers built mounds of debt, which diverted cash flow from store modernization and took management attention away from the consumers. Now many are paying or have paid the price.
At the same time, shopper attitudes and spending patterns have irrevocably changed, as consumers continue to focus on value. Brand loyalty is much less likely to drive a purchasing decision than it did only a few years ago. Because so many products are viewed as commodities, price competition is fierce and tends to drive out all but the most efficient vendors. Those that remain often see their margins drastically reduced. Among buyers of higher-priced and durable goods, customer service perceptions have a pervasive influence today. A single unpleasant customer experience can permanently tarnish a retailer's reputation, or even end a longstanding and mutually valuable relationship.
How people shop is also changing. The time-tested pattern in which shoppers bought name-brand goods at a traditional department store, staples at a discount store and groceries at the corner supermarket, is gone. Consumers are increasingly shopping at formats that did not exist until recently, such as superstores, category killers and warehouse clubs. Today's families can buy jeans, a grill, a bicycle and spark plugs at a superstore, then walk a few aisles over and purchase their week's groceries. While still in a fairly experimental state, consumers are starting to look at alternatives - like the Internet and home-shopping networks - while others increasingly use nonstore retailers such as catalog vendors.
All of these conditions have created a troublesome paradox for retailers, not unlike that experienced by such divergent industries as airlines and telecommunications: even as they become more efficient and productive, their business has become less and less profitable. In many cases, dollar savings from productivity improvements have been passed entirely to the consumer in an effort to maintain and grow market share.
Breaks in the clouds
Still, the outlook is not all bad. Despite the inordinately bleak picture painted by many consumer media, Christmas of 1995 was good to many retailers, and Spring 1996 decidedly better. Consumer confidence is holding and gradually growing and there are strong indications of a pentup demand for soft goods. One positive outcome for the strongest retailers is that they can capture a bigger piece of the pie and take market share from weaker competitors.
The principal reason for an upbeat outlook is that many retailers have gotten their houses in order. The first order of business for many retailers was to regain their focus on the customer. A prime example is the "new" Sears under the leadership of CEO Arthur Martinez. Once portrayed on the cover of Fortune as a veritable dinosaur, this American institution currently enjoys sizable growth and an energized, dedicated workforce. Its recent turnaround comes in large part from a comprehensive effort to get closer to its customers. Sears has expended extraordinary effort to better understand who shops there and why, and has made significant changes to serve that target shopper. The results are evident and dramatic.
Additionally, smart retailers are focusing on process improvement. Rather than merely demand across-the-board price cuts and rebates, retailers are partnering with key suppliers to effect needed process change. Quick response (QR) has become the name of the game, ensuring that precisely those products sought by consumers will be on store shelves, in the sizes, colors and varieties they desire. Using point-of-purchase and artificial intelligence systems, retailers are replenishing their stocks and accurately forecasting what will be needed in the days and weeks ahead. Some retailers have moved in the direction of vendor-managed inventory (VMI), obliging suppliers to take on this task as a condition of doing business. Implemented with just-in-time supply chain principles, these systems help retailers drastically reduce their warehousing and distribution costs, and return to a focus on meeting customer needs.
Other technologies play a key, if not central, role in a return to prosperity. Some leading retailers, including WalMart and J.C. Penney, are incentivizing their suppliers to use electronic data interchange (EDI) to receive orders and bill and reconcile transactions, thus improving productivity and reducing the need for administrative staffs. A type of EDI known as advanced shipping notices (ASN) helps retailers verify that a shipment corresponds with the invoice pertaining to it. Using ASN, retailers avoid having to open cartons and check inventory, a laborious, inaccurate and costly process.
Finally, retailers are looking at international markets as a widening avenue for growth. Several major U.S. retailers are expanding in Mexico and a number of large chain stores that ventured north into Canada in the early 1990s, including The Gap and The Home Depot, have seen considerable success. Emerging markets in the Pacific Rim and elsewhere also represent vast potential demand for U.S. consumer goods. Under creative joint venture arrangements, such as the J.C. Penney Collection stores operating in the Middle East, American-based retailers can create new opportunities while sharing the overall costs and risks of global expansion.
The role of asset-based lenders and factors In the midst of all this change, access to capital can prove critical to a retailer's success. For many asset-based lenders in the mid-1980s, retail was viewed as an unknown and esoteric business, with widely varying business cycles and seasons. Most were hesitant to lend to retailers because they did not understand, or were uncomfortable with, their methods of estimating and valuing inventories. These entail complex inventory counting models and calculations involving markups, markdowns and shrinkage. General retail conditions and practices added to lenders' uneasiness, too, like the proliferation of retail stock-keeping units (SKUs) into the tens of thousands and an ever-expanding number of inventory locations. In addition, because of the perceived impact on the availability of trade support, retailers themselves were loathe to pledge inventory as collateral.
Yet for cash-starved and overleveraged retailers, asset-based loans were their only potential source of funds, because banks had neither the expertise nor the desire to monitor and value the collateral. Trade credit provided by suppliers and factoring companies also tightened up, albeit with good reason in many cases.
A higher level of comfort
In the past 10-to-12 years, asset-based lenders have embraced the retail industry liberally. The same point-ofpurchase systems and other technologies that helped retailers improve their business results also gave lenders a much clearer and more accurate picture of retail inventories. This allows higher advance rates while providing vital information.
In addition, asset-based lenders are often partnering with factors to create innovative financing that shares the risks and benefits of the relationship with retailers. This is an important change from the past, when factors would often not extend credit if their retail customer had pledged its inventory as collateral.
Some asset-based lenders have clearly focused on the retail market, often teaming with outside consultants who have particular expertise in appraising and liquidating inventories. Depending on their capabilities and experience, these firms can help remove much or all of the uncertainty relating to the value of collateral and the lender's exposure in the face of a retailer's failure. Lenders that wish to enter or expand their retail business should consider talking to one or more consultants.
Some retailers are quick to point out that an assetbased retail loan generally costs more than bank financing, with additional charges for commitment and maintenance. However, commercial finance companies and asset-based lenders typically offer retailers much more flexibility on loan covenants and payment schedules than banks.
Making the relationship work
As the asset-based lending community makes great strides to support the retail industry, the importance of open and frequent communication between the lender and retailer cannot be overemphasized. As in any borrower-lender relationship, there will be both bad and good news. Both parties must work together to ensure the free flow of information, particularly about collateral, to achieve the best result.
Asset-based lenders do not want to collect on their collateral by liquidation. Yet, in the absence of an ongoing dialogue, many lenders have made the specter of liquidation a self-fulfilling prophecy by not getting involved in a deteriorating situation until it was too late, or by pulling the plug prematurely. When dealing with retailers, a panicked reaction to unpleasant developments is the surest way for a lender to create an equally panicked, and poorly focused, retailer.
Lenders always evaluate a borrower's management team. In retail today, one finds many shortcomings in management skills and experience because the tremendous growth of and changes in the industry have outpaced the development of seasoned executive talent. This is perhaps the largest single problem faced by individual retailers.
Typically, these same executives also lack experience in dealing with lenders - they are not familiar with what lenders want, or when and in what form they want it. Retail executives are often unfamiliar with the obligation to deliver news and are naturally reluctant to deliver bad news. These things, important as they are, can only be learned over time in the practical, day-to-day environment.
For their part, lenders can encourage frank and open communications by creating a climate of trust and confidence, rather than hanging a Damocles sword over the retailer's head. And when crises and bankruptcy situations occur, as they will in some cases, the lender should take a detailed and careful look at the retailer's situation to see what might be done to help. For example, in case of bankruptcy, lenders may also be able to offer DIP financing that gives the retailer a new lease on life and the lender a 100 percent return on its investment.
Looking forward and upward
Many retailers are far from out of the woods but some have shown a remarkable and sustained turnaround. Those retailers that prevail will be strongly positioned for the future, as long as they continue to focus on meeting customer needs, and do not give in to the urge to expand at the expense of profitability.
Asset-based lenders can provide valuable support for the retail community, and a supportive lender may truly be a white knight to a retailer in trouble. But even for retailers that are relatively healthy yet not strongly capitalized, such a loan may provide the catalyst for growth, expansion and improved profits. And for secured lenders, the retail market offers significant opportunities to expand their loan portfolios, with manageable risk and potentially higher returns. A
[Author Affiliation]
Charles G. Johnson is senior vice president and regional manager of the Southeastern Division of Heller Financial 's Current Asset Management Group and Heller Business Credit, Atlanta, GA.
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