Transformation and restructuring in the retail sector
July 2023 | TALKINGPOINT | SECTOR ANALYSIS
Financier Worldwide Magazine
July 2023 Issue
FW discusses transformation and restructuring in the retail sector with Ralph Fernando, Dave Phillips, Ben Hughes and Mike Axtell at FTI Consulting LLP.
FW: Could you provide an overview of the key trends and developments impacting the retail sector in recent months? To what extent is the sector under pressure to transform and restructure?
Fernando: The UK retail market is currently a very mixed bag, but there are areas where there is cautious optimism to be found. First, consumer confidence is rising, albeit technically still negative. Second, according to the Lloyds Business Barometer for April 2023, business confidence rose to an 11-month high of 33 percent, above the 28 percent long-term average, albeit with retail confidence falling slightly to 24 percent after three months of sharp growth. Finally, retail sales grew more than expected in April, rebounding after a bad March. However, retail sales volumes were 3 percent down compared with April 2022, although shoppers spent 4.7 percent more. That said, strains in the market are clearly visible. For example, the price of food and non-alcoholic drinks rose at the fastest rate in more than 45 years in the 12 months to March 2023. Despite the pace of food price inflation easing slightly since then, overall UK shop price inflation hit its highest rate for 18 years in May 2023. In addition, early that month, the Bank of England increased interest rates to 4.5 percent, the 12th consecutive rise and its highest level since 2008. For the moment, however, there is a familiar roll call of market drivers. Macroeconomic pressures include inflation, the cost of living and political volatility. Demand shifts include low, but recently improving, consumer confidence, along with the rise of buy now, pay later (BNPL) uptake. Competitive dynamics include new bases of competition, such as marketplaces and ‘real-time retail’. Regulatory claims include the Competition and Markets Authority (CMA) scrutinising green claims in fashion, AI regulation and BNPL reviews. In addition, we have technology, such as smart displays, facial recognition, personalisation, and predictive and real-time analytics. Historically, easy classifications – such as the ‘middle’ being squeezed at the expense of luxury and value – no longer sit comfortably with what is a more nuanced picture. For example, consider the strong performances of Hugo Boss, Zara and Primark in their respective value positioning for apparel, in a market where some of each of their competitors have struggled.
Phillips: There are a number of key trends impacting retail. First, inflation is impacting operational costs, in particular labour and energy. Second, input price increases due to inflation is putting pressure on margins due to nervousness to pass on those price increases to consumers. Third, pressure on consumer spending is impacting the topline and creating more volatility in demand. Fourth, channel preferences post-coronavirus (COVID-19) pandemic have yet to stabilise. The pandemic generated massive growth online, forcing many to experiment with online channels. As high streets reopened, retail benefitted in the short term but traffic remains uncertain and much less predictable than in the pre-COVID-19 world. Fifth, changes to working practices have led to more people working from home and hybrid working is changing where people shop. This benefits many small towns and local shops but impacts city and large town centres. Sixth, supply chain disruption persists and is being supplemented by supplier and distributor failures. Thus, we can no longer assume suppliers will remain solvent. Finally, digitalisation and artificial intelligence (AI) are creating new opportunities for retailers to monetise the data they have, and generate efficiencies – for example in targeted marketing – in ways not possible previously. Moreover, these trends are driving a need to reshape and transform retail operations dramatically. Changes in channel preferences with the move to online, and changes to shopping locations, are resulting in the need to rework retail footprints. Online growth is also forcing an acceleration in retailers transforming to true, integrated omnichannels. There is also pressure on costs, with changing channel requirements and the pressure on margins forcing retailers to restructure their overhead model for a more online business, with leaner structures. Growth in home delivery means distribution centres are becoming the new storefront, driving transformation of supply chains with a greater emphasis on supply chain performance. Digitalisation and AI are also driving many retailers to transform how data is generated and used throughout the business, from automation of back office functions to targeted consumer marketing and problem resolution using AI.
“Company voluntary arrangements (CVAs) have been commonly used by retailers to exit underperforming stores and restructure rent profiles.”
FW: What factors are driving transformation and restructuring activity for both online and brick-and-mortar retailers?
Fernando: Inflationary costs, including those driven by a tight labour market, higher debt costs and cost-of-living dampeners on demand, particularly food inflation, are putting pressure on retailers to rethink and revise their business and operating models. Furthermore, the ability to offset these cost pressures through price rises is often limited due to the very competitive nature of many sectors, and the increasing price sensitivity of customers, particularly at the lower end of the market where food essentials comprise a bigger proportion of their spend. In addition to the pressures facing retail as a whole, online retail is experiencing additional pressure as the market continues its post-pandemic readjustment and channel rebalancing. The latest Confederation of British Industry’s ‘Distributive Trades Survey’ shows that internet sales fell in the year to May 2023 – from 28 percent to 9 percent – while stock remains a challenge, with retailers reporting stocks as “elevated” relative to expected sales – plus 25 percent from minus 2 percent in April. Furthermore, returns remain persistently high and retailers have had to respond with a range of constraints, incentives and policy changes. And these pressures are not only financial. The CMA’s review of green claims in the fashion retail sector has forced many retailers to create new levels of transparency across their supply chains.
Phillips: We are seeing pressure on profitability at all levels, including topline growth slowing as consumer spending eases. Costs are increasing as a result of inflationary pressures. Rents are no longer aligned with historic brick-and-mortar returns. Margins are being compressed due to an inability to pass on cost increases.
FW: How would you compare and contrast retailers that have rapidly embraced technology in response to the challenges facing the sector, compared to those that have failed to innovate?
Fernando: While speed is important, the most critical technology adoption point is relevance. Where retail technology innovation has succeeded, it has done so because it addresses a genuinely underserved, unmet or emerging customer need. This might include, for example, creating new or enhanced experiences through the application of technology, such as visualising an item in a room through augmented reality, or synchronising instore recommendations with shoppers’ online profiles, as is being done by Clinique Great Skin Lab, or online customer video consultations. It may also include reducing friction along the customer journey through better omnichannel integration, as seen with Nike. Another example is conveniently bringing together customers’ favourite brands through marketplaces, as demonstrated by Next. Or it may involve improving customer experience and access through partnerships, including delivery tie-ups such as Boots and Deliveroo or M&S and Ocado. The pandemic essentially kick-started a period of accelerated experimentation. Those retailers that had the vision and resources required to test new business models or value propositions, and subsequently refine them to make them profitable, had the advantage as the world opened back up. To capitalise on this advantage, however, has not meant simply continuing the COVID-19 pandemic proposition, but rather continuing to experiment and adjust to changing customer needs.
Phillips: Those retailers that were advanced with technology and online pre-pandemic clearly had a major advantage but still had to adapt rapidly. However, many retailers have now caught up, or are rapidly investing in new technologies that will provide a more flexible platform for the future.
“By starting the process of assessing strategic options early, there will be more options on the table and a longer runway in which to implement the preferred strategy.”
FW: How should retailers go about assessing their various strategic options?
Fernando: There are several different perspectives a retailer should consider when exploring strategic options, but three are obvious. The first is market sector attractiveness, which means accessing the profitability, growth, resilience and competitive dynamics of currently served sectors, and the ability to extend into and serve attractive adjacencies. The second is competitiveness and distinctiveness. Maintaining ‘continuous differentiating relevance’ – the ability to identify and satisfy customer needs or wants consistently better than the competition – is critical in the fast-moving retail market. Strategies that strengthen this muscle are key, for example the emergence of ‘real-time retail’ by proponents such as Shein. And the third is organisational resilience. Maintaining cash reserves, reducing reliance on any one revenue source, market or channel and ensuring stock does not stagnate are key considerations.
Phillips: The trends impacting the market today mean that the ability to predict the future is now more challenging than ever. The days of relative stability which allowed forecasting based on prior years and lean operations are long gone. Companies now need to be more agile to sense and respond to trends, and therefore strategic options need to be assessed in a different light. The question of whether a particular decision is the right one under a number of alternative scenarios that could play out in the market, is now far more relevant than determining what the payback period is, which assumes certain market conditions will be maintained.
Hughes: By starting the process of assessing strategic options early, there will be more options on the table and a longer runway in which to implement the preferred strategy.
FW: For retailers that are underperforming or in distress, what restructuring options are available in today’s market? Are we likely to see a rise in bankruptcy filings?
Axtell: Company voluntary arrangements (CVAs) have been commonly used by retailers to exit underperforming stores and restructure rent profiles. However, a CVA alone is not the answer and only typically succeeds when it is part of a broader operational transformation along with new investment. A restructuring plan is a new restructuring tool that was introduced in the UK in 2020, which is a formal plan, sanctioned by the court, between a company and its creditors and could become a regular alternative to a CVA.
Hughes: If a consensual restructuring cannot be delivered and additional funding cannot be raised, a sale of the business will need to be explored, with the timetable for the sale process dictated by the pending liquidity event. In situations involving distressed companies, the sale is typically executed via a pre-pack administration which allows the purchaser to leave behind unwanted assets and liabilities.
“The retail sector will remain challenging and unpredictable for the next few years until the volatility stabilises.”
FW: What best practices should retailers follow when creating and negotiating a reorganisation plan?
Fernando: To state the obvious, retailers should ensure that they reorganise for where the market is heading, not where it has been. This involves taking the following actions. First, developing the right omnichannel mode to reflect the acceleration to online, and a rebalancing to store in certain sectors, thus rethinking its role. Second, increasing operational speed, flexibility and efficiency to manage volatile demand. Third, delivering on the promise of experiential retail and personalisation, rethinking how and where the brand engages with customers. Fourth, reorganising to face-off new competitive dynamics, such as the race to dominate through marketplaces or vertically integrate for real-time retail. Finally, creating greater supply chain transparency. A reorganisation is a rare opportunity to ‘re-platform’ the business – by being thorough and using data to understand what is really driving the business, what is critical to its future and what needs to be left behind. Retailers should prioritise the transformative activities that will deliver step-changes in the business, such as the customer offer, channels to market, operational improvements, and system and data integration. Management must also consult and communicate clearly with staff – acting as a responsible employer. Wellbeing in retail has once again come to the fore and a recent Retail Trust report saw 83 percent of retail employees report a deterioration in their mental health, with 43 percent seeing the decrease in their general wellbeing going beyond a manageable level. Reorganisations are challenging for everyone, and need to be run responsibly.
FW: What essential advice would you offer to retailers on transforming their operations to maximise value and mitigate liabilities?
Fernando: As always in retail, it is essential to start with the customer. Two specific areas on which to focus are optimising for omnichannel, which means enabling frictionless flows of customers, goods and data across channels, and strengthening the customer experience, particularly in terms of personalisation where AI is transforming the art of the possible and drawing significant investment. For both cost and environmental, social and governance (ESG) reasons, supply chain transparency will also be a key focus area for transformation – potentially incorporating blockchain, AI, machine learning and data analytics. A third area is increasing the agility of the organisation to manage volatile peaks and troughs. This could include, for example, further embracing Gig Customer Service – using gig-based people to unlock greater flexibility and rapid scalability in customer service functions – and enhanced combinations of AI and automation.
Phillips: The key advice would be: do not wait. Review how the trends are impacting the business and create alternative scenarios for how they will impact it in the future. Challenge the cost base and operations, eliminating activities that are no longer relevant or of value in the new post-COVID-19 world, and invest in flexibility and agility to create a business model that will better deal with inevitable future unknowns.
“Retailers should prioritise the transformative activities that will deliver step-changes in the business.”
FW: Looking ahead, what are your overarching predictions for the retail sector in the coming months and years? To what extent are we likely to see greater levels of transformative activity?
Fernando: The near term is characterised by continued tentativeness. For example, with consumer sentiment improving, a UK recession forecast to be narrowly avoided and household energy bills set to decline from July, the resultant boost should help support overall retail sales, albeit with further increases to interest rates expected to create downward pressure. Additionally, the trend for headcount reduction, to offset these pressures, has meant that retail employment in the year to May 2023 fell for the third quarter running, and at the fastest rate since February 2009. This reduction in headcount is likely to persist in the near term, albeit at a slowing rate and enabled by technology-driven alternatives. Longer term, the application of AI to improve decision making across a range of areas – from inventory optimisation and customer support through to merchandising optimisation and personalisation – will provide the next wave of customer experience improvements, organisational efficiencies and marketing innovations.
Phillips: The retail sector will remain challenging and unpredictable for the next few years until the volatility stabilises. There will always be disruptions, however, and the last three years has seen the perfect storm of disruptive trends. We will see more changes on high streets with more retailers dipping into distress, as these trends take their toll on those less prepared and less agile. However, there will be winners as well. Retailers that embrace uncertainty and create a more agile business, fit for an omnichannel world that exploits data and digitalisation to delight consumers and to lower costs, have a strong future.
Hughes: The sector has been far more resilient as we have come out of the pandemic than many expected, with the wave of insolvencies predicted by some yet to materialise. That said, continued cost pressures combined with consumers becoming increasingly conscious about their outgoings could well lead to more retailers exploring restructuring or M&A options as a solution to their problems.
Ralph Fernando has 25 years’ experience supporting consumer-focused organisations and their investors to transform performance through innovative strategies and the application of data, technology and new ways of working. Operating at the intersection between strategy, operations and technology, he has led a wide range of projects both in the UK and internationally, in areas including strategy and growth, proposition and channel development, customer experience, performance improvement, digital transformation and data. He can be contacted on +44 (0)7815 156 901 or by email: ralph.fernando@fticonsulting.com.
Dave Phillips is a specialist in retail and consumer goods, with more than 17 years of hands-on consulting experience and 12 years of industry experience in operations, strategy, sales and marketing roles. He has led large scale cost transformations covering multiple functions, business units and geographies in Europe, Africa, Asia and the US for large corporate clients. His transformation work typically focuses as much on strategy, topline and margin as it does on cost. He can be contacted on +44 (0)7900 163 715 or by email: dave.phillips@fticonsulting.com.
Ben Hughes leads FTI Consulting’s special situations M&A practice in the UK, where he acts as an adviser to help clients achieve their goals through M&A activity. He provides the full suite of special situations M&A services, including lead sell-side and buy-side advisory, fundraisings, strategic option reviews and sale process monitoring. He has worked on a number of mandates in the retail sector on both the sell-side and buy-side. He can be contacted on +44 (0)7795 640 462 or by email: ben.hughes@fticonsulting.com.
Mike Axtell has vast experience in working with stakeholders in distressed situations, undertaking a liquidity review and new money request of a listed greetings card retailer as well as leading the debt restructuring of a UK shopping centre. He can be contacted on +44 (0)20 7269 7175or by email: mike.axtell@fticonsulting.com.
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