What is really happening in Retail...

The Media are clearly relishing this recession. The current news flow is all about how a national retail chain is going bust every day at the moment: MFI, Woolies, Officers Club, Zavvi, Whittards, Adams...etc. Each is accompanied by headlines about how many people work for them, whose jobs are potentially under threat...etc There is undoubtedly more pain to come over the winter months and even dominant players like Carpetright are likely to suffer pain in the short term but they should benefit from the demise of weaker competitors in the long run. Following on from the jobs losses in the casino economy of finance and property, the playground of leisure and retail is always vulnerable. However, most of the retailers that are going bust have some things in common, they are all highly leveraged. In many cases, the format is old, the products no longer desirable, or have been more than compensated by online sales or supermarket sales...Woolworths UK being the classic example as their music and DVD sales have been hoovered up by Amazon and Tesco's.


We know that retailers should not be going bust in December, as the majority of turnover is in the run up to Christmas. To go bust before Christmas says that the business is non-viable. Retailers don't go broke at this time of the year particularly: but they do have the rug pulled by creditors and banks because when cash is high and stock sold it's a good time to get the money out. Shop rents paid quarterly in advance is a bit of a red herring and suggests a business is not managing well because if it cannot afford 3 months up front it makes you think it's run on a knife edge; and all this 'we're doing okay' stuff is just hype.

VAT bills at end of January are however huge. So early Jan is the time when the weak go tits up. It's obvious at that stage that the retailer won't survive the Spring (when turnover drops by three quarters). The biggest risk month is March, as the rent is also due and turnover is lowest. Therefore, we will see more retail businesses going bust until the spring. This all relates to cash flow...and two specific strains on it that are particular to this time of year. In simple terms, most businesses peak sales come in December and January, and they invest in stock through the Autumn to build for this peak. Working Capital debt is typically at a 'peak' in mid-November, and at its best point in January. This is why so many Retailers have January year-ends...to portray their cash in the best light. The fact that store rents are paid quarterly in advance only adds to the pain...and the December payment comes at a time when working capital debt is already high. This 'double witching hour' is what sends so many Retailers bust at this specific time of the year...and we will continue to see more go over the first few week of a financial year. However, it does not mean that it will continue at anything like the same rate after that.

Administration and Pre-Pack Arrangements

Once a Retailer goes into Administration, it is usually bought back out again..often in a 'Pre Pack' arrangement. MFI have already done this, and Whittards, Officers Club and Adams all look likely to continue. Most Retailers find that 70-80% of their total store contribution comes from the best 20-30% of their stores...with a long tail of unprofitable stores. The main reason 20-30% stores are best is that retailers over-expand (and overpay for shops) to reach economies of scale but then can't get enough of the right staff which consequently means not enough of the right sort of customer. In my opinion, that's a sign of a badly run business in the first place: chasing market share regardless of profitability. In normal circumstances, these poor stores may be on 25 year leases, with no prospect of getting out unless you pay a huge "Reverse Premium" to someone else to take on the lease. When a business goes into administration and then comes back out, the Creditors will have been rogered, but so will the Landlords of these loss making stores. The new 'post administraion' company takes only the leases it wants, renegotiates on some marginal ones, and the rest go back to the Landlord without impunity. The company continues, and most jobs are saved It may sound like a panacea, but it's not that easy. There is no guarantee the landlords of the properties would agree to the assignments of the leases to the new company at least not without onerous conditions; in any event, it's a costly process. The shops that revert to the landlord can also be re-let to similar types of businesses, which can add to the competition for the pre-pack operation. And clearly, the retailer's reputation is damaged..and suppliers will be wary of trading with them on any terms of credit.

On the other hand retailers like Woolworths UK go into Administration and nothing can be saved of the business. The Media talk of the 30,000 job losses. However, when the dust settles, it is likely that most of the stores will be 're-let' to Supermarkets like Tesco and Aldi, who will take 'packages' from the Administrator. If a Woolworths store becomes a Tesco, I should expect job losses to be minimal, possibly none. But what is going on at present is not new: Per Retail Week (8 May 1998), based on a report by Ernst & Young, 88 companies - 17% of all quoted retailers - issued profit warnings in the first quarter of the year. So while 30,000 may be the sum of the 'gross' jobs lost, the 'net' number will be much, much lower.

The Credit and Rents Problem

There is also the problem that the UK is shopped out. Remove the oxygen of credit and all of a sudden retail sales fall. We had become a nation of shopaholics and much of what we were buying wasn't really needed or adding real value to the UK economy as it was made overseas. Add to that the problem that rents have got too high. This is another symptom of the credit bubble as speculators fuelled on leverage have driven up property valuations. The rent quarters are in fact the catalyst that causes many cashflow difficulties and if you're struggling to start with, it can be impossible to find the cash, and with landlords rights so much higher than other creditors, it can be difficult to make ends meet.

Rents need to half for any health to return to UK high streets. Rents were chased up when times were good, and in order to get on the high street at all, 25 year leases, upward only reviews, long break clauses were the sort of conditions a retailer had to accept if they wanted a lease. IME, landlords are still not being flexible when it comes to negotiations when times are tight, and in many cases are happy to take their chances with voids than do a deal to reduce rent. MFI tried to negotiate and were told to sod off...

Take this as an example I've just been into my local town (Altrincham, Cheshire). The main shopping street is Market Street. At one end, there's a major development taking place with WH Smith, House of Fraser, Boots, Waterstones, Debenhams and Marks & Spencer. At the other end, Woolies and a fashion-house are closing together with a couple of other family run businesses. After new year, they'll be 5 charity shops and a bookies....and and void units including a very large ex-Woolworth's one. It'll be interesting to see how/if they can re-let any of those....

Another point is the role of credit insurers. Many large retailers have found their suppliers have been unable to insure their sales. What this means is that credit is reigned in, often at incredibly short notice, and the retailer's cashflow is decimated as a result of credit terms being withdrawn. This has happened to both Woolworths UK and MFI to my knowledge, so when the rent and VAT bills come around, there's nothing left to pay for them.


My view is that the (few) retailers who are taking on new units right now should take this opportunity to change the landlord/tenant relationship once and for all. It's always been a thorny problem. In fact quarterly rents up-front are the single biggest headache for any retail finance director. You have to pay 3-months rent, on the entire store portfolio, up-front, in late Mar, Jun, Jul & Dec. It's a total nightmare but I don't think that it will be until 2011 that landlords start to see some sense, as I feel that rents have to fall a long way to allow independent retailers to thrive. It not just a case of giving 6 months rent free, rents need to fall to levels that allow a healthy profits for independent entrepreneurs.

Well-run retailers have been pruning dead-wood and unprofitable branches for years and they should benefit from the demise of weaker competitors although they will still suffer pain in the short term. The best time for spring-cleaning is when there's a consumer boom, because many retailers are either too dim or rarely stop to think about what'll happen 5-10 years down the line. Imo, this recession will serve to highlight that customers are not spending enough money to support profitably so many different retailers; and are not spreading their money around by going to lots of different shopping centres, but are concentrating on a few centres to the exclusion of all else.

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