HMV’s demise offers finance directors a salutary lesson

FASHION CHAIN Republic has become the latest retailer to collapse into administration, continuing the trying start to 2013 for the nation’s high street.

Republic – brought down by poor trading results in the autumn as well as a rapid decline in sales in late January – follows the high-profile demises of well-known retailers including Comet, Blockbuster, HMV and Jessops.

Yet it is the failures of HMV and Blockbuster that has delivered the most marked lesson about what happens if business models fail to adapt to changing market forces. Both have struggled in the face of the digital revolution – music downloads and video streaming services changed the market in a fundamental way.

Neither downloads nor streaming are particularly new. The types of services pioneered by Apple and LOVEFiLM have been around since the turn of the century. Given their dominant market position – HMV accounted for 38% of all physical CD sales in the UK – both HMV and Blockbuster were uniquely placed to capitalise on the evolving buying habits. Thirteen years offered plenty of time to get the house in order.

“The insolvencies have been the result of the businesses not moving with the times and competition, rather than the current recessionary climate in which we find ourselves. There is clearly a strong link with people’s technology buying habits and purchases in the recent cases,” says Chris Ratten, head of restructuring at RSM Tenon.

“If businesses do not innovate and change, they will follow the traditional business cycle – birth, growth, maturity, decline and death. To ensure success and continued growth, business owners must ensure they have the market analysis, strategic and management information they need and plan utilising it – as well as do the day job.”

Where the FD comes in is to ensure the business has the data at hand and uses it to drive decision-making. From where are customer sales coming? What is the cost of investment in driving online sales? What is the ROI? What is the cost of online sales as opposed to physical sales?

One retailer, Sainsbury’s, is a case in point. The company noticed its customers were shopping more frequently and locally to reduce food waste, so it pressed ahead with its convenience growth plans.

Last year, the retailer opened 1.4 million square foot of space, adding 19 new supermarkets and 73 new convenience stores to its estate, bringing its total convenience estate to 440. The vast majority of Sainsbury’s investment – core capital expenditure increased by £102m to £1.2bn due to its extensions – is in rolling out those areas of the business that are growing the fastest, CFO John Rogers told Financial Director.

“There is a fantastic return on capital for the investments we make in that area. They are our best returning investments and we want to do more of those and do them quicker,” he says.

Interestingly, rivals are using Blockbuster’s troubles as a way to play catch-up. Supermarket chain Morrisons recently bought 49 of the collapsed retailer’s stores to expand its range of convenience stores.

Online sales

Companies that successfully adapted to online sales have been able to cut distribution costs and slash the high rental cost of floor space. John Lewis is a prime example of a company that has successfully combined online sales with a traditional bricks-and-mortar operation.

Electrical goods are increasingly being purchased online, and more people are happy to buy their groceries without ‘squeezing’ the product. Neither of these changes have been as dramatic as that of digital downloads, yet businesses have still had to change their models to capitalise on the convergence of technology.

The growth in online retail creates some challenges specific to the finance function. On the plus side, online is not very capital-intensive and potentially has a higher return, whereas stores require a lot of working capital investment.

In an interview with Financial Director last year, John Lewis chief finance officer Rachel Osborne predicted that 33% of John Lewis’ markets will go online, with customers used to shopping instore migrating across. Whether money comes through the front door or from a click of the mouse should not matter but, according to Osborne, the migration online matters for the finance function.

“It matters because the financials are different; they are different business models,” she says. “One is high fixed cost, high marginal contribution; one is low fixed cost but lower marginal contribution because the variable costs associated with online are higher.”