Thursday, 27 August 2020 KordaMentha’s Behind Business podcast discusses the most pressing commercial, financial and operational issues facing business today. In this podcast series, hear as respected business journalist Sean Aylmer interviews the KordaMentha experts who are regularly called upon to provide insights and guidance to help organisations to navigate through their most critical situations. Well before the COVID-19 pandemic, retailers were facing multiple competitive threats – online shopping, new offshore players entering the local market, industrial relations challenges, lower foot traffic on High Streets and in malls, and challenges to supply chains. Then coronavirus hit. Remarkably, some retailers have weathered the storm well, with surging online sales and growing revenue. Others have not. In this episode of Behind Business, Sean Aylmer talks with KordaMentha partners Berrick Wilson and Bryan Webster about the retail sector in Australia. Where it’s come from, and where it’s going to beyond 2020. In the episode How we got here (01:31-3:15) Current crisis (3:31-13:46) Looking forward (13:56-23:41) Transcript Sean: Welcome to Behind Business, the podcast where KordaMentha experts discuss the most pressing issues facing business today. I'm Sean Aylmer, an economist and journalist for 25 years, and the host of the Fear and Greed Daily Business podcast. Today, we're talking about retailing. Well before the COVID-19 pandemic, retailers were facing multiple competitive threats, online shopping, new offshore players, industrial relations challenges, lower foot traffic on high streets and in malls, and challenges to supply chains. Then coronavirus hit. Remarkably, some retailers have weathered the storm well, with surging online sales and growing revenue. Others have not. In this episode of Behind Business, I talk to KordaMentha partners, Berrick Wilson and Bryan Webster, about the retail sector in Australia, where it's come from, and where it's going to. One of the recurring themes that we're discussing today is the impact of COVID-19, so it seems appropriate that we're recording this episode remotely with Berrick and Bryan joining me from their home offices. Berrick, Bryan, welcome to Behind Business. How we got here Sean: Now look, the topic today is retail trade, and in Australia, it's worth about $320 billion a year, maybe a little less you see here in 2020, and it's estimated that around 10% of that is online. Let's start with you, Berrick. Can you give us a feel for how retail has changed during the past 20 years? And this is up until February this year, pre COVID-19, so from 2000 to the beginning of 2020. Berrick: Yes. That's a very interesting question, and it's well worth looking backwards, to then look forwards. And I think if you look at how the digital era is impacting consumer behavior, it's really fast tracked globalization of the retail industry. A couple of years ago, people were really looking at online versus bricks and mortar. And the way I look at it is, it's neither. It's just shopping, whenever, wherever, however consumers want, without the pain points. And I think when you look at some of the legacy issues that are in the market, there are a number of legacy retailers that are very much wedded to bricks and mortar, but haven't evolved their eCommerce platforms or their distribution capability. On the flip side, you've got a range of pure play eCommerce retailers, Kogan for example, who have an enormous amount of data and are growing as a platform. When I look at retailing moving forward, I think it's a blend of both. You no longer need stores just for distribution. You need stores to create neurological connectivity with your client or the customer, and you need a very good eCommerce platform and a very efficient distribution channel. But I think a lot of retailers are starting to understand that now and are looking closely at their network of stores and understand what they do need and what they don't need, but there are a number of large space users in particular, that have taken very long-term leases, that are kind of bound by those existing legacy networks. Sean: That's a good spot to leave the past. In a moment, let's look at where retail's at now in the wake of COVID-19. Current crisis Sean: Now, before we get too far into the future, I'd just like to think a little bit about the past six months and how retailing has changed, and very easy, it's sort of acceleration of a trend as much as anything else. From your take, Bryan, what do you think have been the major changes in retailing during the past six months on the back of the COVID-19 pandemic? Bryan: I think, as you say, the challenges for retailers have been there. With COVID-19, it's really thrown up a number of unusual outcomes, with the combination of government stimulus packages, together with stay at home restrictions. And the growth of buy now, pay later lenders has meant that a number of the retailers are actually having a great year. I know we've seen results recently by JB Hi-Fi and Rebel, Kogan you've mentioned, all really having record results, and that's because people are buying discretionary items. I think initially, there was a bit of a shock there. They obviously fled. Consumers fled to supermarkets and bought the essentials, and in some cases, stocked up on essentials, such as toilet paper, a bit of panic buying. But since then, I think things have calmed down and people now can't spend money on international or national travel here in Melbourne, even local travel, and people want to buy things, because they can't actually buy experiences through travel and going out, and it's turning out to be a pretty forgettable year, but I think that's resulted in, as I say, some unusual outcomes. I think these unusual spending patterns and the government support is allowing some businesses, who initially thought, when COVID-19 first hit that, "Hey, I need to really have a look at my business. I need to evolve and I need to potentially bring forward my plans to right size, or restructure the business. My cash is looking okay, but with the government support and the discussions with the landlords, they're saying, well, Job Keeper's helping with my employees. Landlords are giving me rent waivers and deferrals for the time being, and my suppliers, trade creditors, are okay with supplying me potentially a lower level of stuff for my business." Sean: Big opportunity in some ways. Bryan: Yeah, absolutely. And really, the retail, it does provide, with Job Keeper and the government support and some of these unusual, unexpected consumer spending behaviors we're seeing. It's giving certain retailers a time now to be able to plan for what their business needs to look like when that support stops. What are the structural changes that need to be made so that their business is sustainable in the long-term? Sean: Now, it seems to me the two key factors, which you've both mentioned already, are the sales funnels, or your online channels, and then distribution, how you actually fulfill those sales. So maybe we can take each of those, and in terms of the sales channel, Bryan, we'll keep with you on that one. Then I'll come to you about fulfillment, Berrick. So starting with sales channels, have you seen companies actually turn around and improve their online selling ability, be it websites, be it social media, that type of thing? Bryan: Yeah. Look, I think pre-COVID-19, most retailers out there knew that they needed to develop that presence, but with the impact of COVID-19, they have brought forward that focus on the need to improve their online platforms as a relevant sales channel, as Berrick had said. I'm not sure, for some businesses, it's going to work just to be online, but there will at least need to be a combination. I've heard of retailers, who still have a store footprint, acknowledging that where they have that store footprint, the online sales in that particular suburb or area is actually greater than other suburbs, because you've got a brand presence, a physical brand presence there, almost like 24/7 advertising, and an ability for consumers, potentially giving them the option to go into store. But having that development of the online platform has become crucial for all retailers. I think that's well and truly recognized, and the need to develop that and spend money on an appropriate fulfillment warehouse distribution is absolutely crucial to support that and make sure it works. Sean: So, Berrick, I'll ask you about that fulfillment. The Premier Investments are the guys who decided not to pay landlords money upfront when COVID-19 hit. Premier Investments of course include Smiggle, Just Jeans, Portmans, but where they actually did do very well was in fulfillment. They seem to have big warehouses, which they were actually able to switch to when they went online, fulfill orders very quickly. How important, Berrick, is fulfillment? Berrick: Yes, very important. I mean, I think all of these things are important together. You can't be great at one and ordinary at two of the other components. So you need to be good at each part of the process to remove the pain points for your customer. Berrick: And so probably just looking at a couple of things that you've mentioned there, Sean, I think Premier had been pretty vocal in terms of wanting more flexible rental based on turnover, as compared to fixed tenancies with increases over time. That's been a real challenge for a lot of landlords, and the point being, that you really need to have a physical presence and a very good eCommerce platform and your fulfillment piece ready to go. And when we look at some of the challenges that retailers are having, there's a lot of legacy in the system, a lot of legacy in the way that people have done things, the way that boards have operated, and perhaps even legacy in the technological systems that companies have, because things have moved so quickly. But if you think through the sales process and the digitization of that sales process, we first picked it up with online transactions, with things like PayPal, I guess taking away the anxiety of paying online. We then fixed the problem around marketing with social media and online marketing and sales actually being able to happen online. And the final barrier is really efficient fulfillment, and particularly around last mile fulfillment. That's a huge challenge for a lot of retailers at this point, as to how do they get the goods to their customers efficiently and in a timely manner. Sean: Yeah. Just explain that last mile concept, because it's actually not that difficult to get the good out of the warehouse close to the person's home, but it's the last mile that's the challenge, is that right? Berrick: It is. So quite often, they go to major warehouses in industrial locations before they then come from that industrial location to somebody's house. And this is where I think, interestingly, the network of retail stores actually can play a very good important part for retailers, because quite often, the products are very close to people's homes already. The challenge is systems to identify that the stock is, in fact, in stock in store. And then how do you get it from the store to your customer? And we're currently going through quite a test bed of this with COVID. And as you know, in Victoria, the second lockdown for a lot of retailers now is only e-Commerce, so delivery to the customer or click and collect. And so I think we're going to see a huge advancement in this final barrier to meshing physical and digital retail transactions. And you can see groups, for example, like Katmandu, who are trialing the use of Uber, for example, to make deliveries from their stores to their customers to be able to get it there more quickly. Even Amazon is using drivers to be able to move those goods around quickly and fulfill efficiently from their Amazon platforms. Sean: We've talked a lot about technology providing price and availability transparency, but doesn't that put pressure on margins for retailers? Perhaps start with you, Bryan. Bryan: Absolutely. It does put pressure on margins and increased competition. And I guess a more fickle consumer and a more informed consumer is going to mean the business owners, businesses need to be more savvy in terms of understanding their financials, but also looking at ways that they can do what they do the most efficiently, and make sure that there's no, as you say, fat in the business, that all, for example, head office costs are as slimmed down as they can be, and that really, there's that focus on cash because of the pressures that are required in terms of the margins being squeezed with the online platform. Sean: Berrick? Berrick: Yeah. I look at this as probably one of the most important changes in our retail industry over the last decade. Online shopping, 4G enabled mobile phones, have enabled consumers to have instant price and availability transparency, while out shopping. And this has really, I guess, driven the downward pressure on margins, because retailers have been battling for sales volume, but at the expense of margins. And so, when we look then at their ability to be able to pay the existing rents, or even the rents that continue to rise with fixed increases, the occupancy cost as a percentage of gross margin or gross profit, as compared to as a percentage of sales, have been rising significantly over the last five years. And so, we're now at that point where they're getting to an unsustainable level and retailers are saying, "Well, I no longer need a number of these stores," and are starting to slim down their network of stores to transition more towards online. And so, as the demand for stores starts to decrease, you're starting to see more vacancy and more incentives, before you'll then start to see a reduction in rent. But I think if rents adjust and they become down to a more sustainable level, then I think retailers will hold more stores, not as many as they've had in the past because they've got alternative sales channels, but potentially more stores. If retail landlords stay steadfast on existing rents and fixed structures, then I think we'll start to see a significant amount of growth in vacancy rates. But I spent a fair bit of time over in the U.S. and Europe last year just having a look at how some of the retail environments overseas have changed, and I think we can learn quite a few lessons from that to provide a soft landing, rather than a hard landing. The future Sean: All right. Time to look into the future. In a moment, let's figure out where retail is heading. Sean: I just wanted to move on to how rents will be paid in the future. So Premier Investments came out and said we should be paying rents for bricks and mortar on a percentage of turnover. Vicinity chief executive, I think then said, "Well, you can do that, but it needs to be a percentage of physical and online turnover," which of course the tenants didn't like. Berrick, where do you think that debate will go? Berrick: Very interesting one. We need more flexibility. Retailers need more flexibility, because the retailing environment is moving very, very quickly, and the old way of fixed long-term leases with fixed increases are becoming just too draconian for retailers, and they'll vote with their feet. You mentioned Vicinity there. Similarly, I think Ian Bailey, the CEO of Kmart, came out a couple of months ago and suggested that the days of long-term leases with fixed rents and increases only, rather than rents being able to go backwards, are gone, and most retailers now want more flexibility in their terms. So they want flexibility in both the lease term, but also in the way that they pay their rent. It can go a couple of different ways. I don't think it's as simple as just turnover rent or fixed rents. There's the opportunity to have more hybrid type environment, where there might be a lower, more sustainable fixed rent, and then a percentage rent based on turnover to provide some of the upside if the landlord is delivering from their perspective on their tenants are doing well. But equally I think those that don't perform from a retail perspective will also be moved on, because the retail landlord really wants the highest productivity from their physical footprint. Sean: So moving forward, and Bryan, I'll come to you on this, the next couple of months could well be tough for many retailers as some of the government stimulus packages are wound back, not necessarily dropped off totally, but certainly some of the payments to workers and unemployed will reduce. And then over the longer term, the government will certainly cut back on some of its stimulus payments. How do you see the retail industry performing in the new 6 to 12 months, Bryan? Bryan: There's really two main things at a high level for really everyone in all businesses retailers including retailers, and the first is uncertainty. No one knows the impact of COVID-19, the severity of it. We've seen the second wave in Melbourne. We've seen a flare up in New Zealand, and absolutely the new normal is uncertainty. What that means is that businesses are going to find forecasting is extremely challenging, and understanding their cashflow is understanding what the future looks like. But perversely, it's actually even more critical than ever that they focus on what their forecasts are going to look like, what they're going to need, and they're going to need to review them at least monthly, if not weekly, or even daily, where cash is extremely tight. And the second point is, we are in a recession and it's our first recession in 29 years. So looking forward, then there's going to be two competing impacts on the length and severity of the recession that we're currently in. Firstly, as restrictions ease, hopefully over time, that spending should increase back to pre-COVID levels, particularly probably in areas such as food and hospitality, and I guess initially localized travel. That potentially may take away dollars that we're currently seeing being spent in the retail sector away from certain retailers. And secondly, as you say, the government support inevitably will be wound back. Whether that's starting end of September, then again, December, March, that's going to impact consumer spending. It's going to impact the business confidence overall. So for retail, it's going to be really important that they understand their cash position, they understand what they reserves are, where they can get funding from. As I say, their forecast, their optimal footprint to ensure, therefore, space is productive, as Berrick mentioned. And right now, when we talk about the next six months, particularly for apparel retailers, what type of product and how much are they purchasing now for the upcoming Black Friday and Boxing Day sales? And it's going to be really important from a planning perspective. As I said before, they use the time now to work out a plan for when the government support is wound back. What are they going to need from each of their stakeholders? How much money are they going to need and how they can actually pay it back? And if plan A doesn't work, what is their plan B? What does that look like? Sean: And I suppose, start now. Bryan: Yep. Sean: You talked about cashflow and reserves and forecasts, but they can't afford to hold off making those decisions. Bryan: Yes, use the time now wisely. Sean: Now, a couple of comments on the results season suggests that the Black Friday sales, end of November, in July, some of the retailers aren't quite as confident about that, simply because they think people have spent their money now, and you alluded to it just then. Do you think that could be a tough Christmas sales season and Black Friday? Bryan: Yeah, it's interesting. I think that's definitely going to be a risk. Government support is going to start to be wound back. The expectation, over the coming months, is that massive uncertainty around the level of spending that will occur with Black Friday sales and the Boxing Day sales. If restrictions are eased perversely, it will take away, or there's an expectation it may take away from a level of retail sales as people get back into the community and spend money on experiences rather than things. So it is going to be a tough time ahead for a lot of retailers and a lot of uncertainty in terms of what's expected, which is why it's going to be so important for businesses to now understand their financial position, understand their cash, and understand what their at future purchasing requirements are going to be Sean: Now, totally unfair question, but I'm going to ask you both. What's retail going to look like in 12 months time? And I'm going to start with you, Berrick. What do you think that retail sphere will be like in the middle of next year? Berrick: Yeah, that's a tough question. I think we're going to see a significant increase in digital and the adoption of digital moving forward. I think we'll probably have broken down some of the challenges that have been there previously, and you only have to look at how much adoption has happened just in the last six months. I think Australia Post indicated that they thought that we'd get to around 20% of online sales by 2025. I think we're already at 15% by the end of this year. So there's going to be a huge shift towards the digital environment. It's currently a retailer problem, but I suspect that this is going to move to become a retail property problem and a financier problem within the next six to 12 months. Sean: Okay. Bryan? Bryan: As Berrick says, I mean, technology continues to involve, clearly with COVID-19, consumers embracing purchasing online has been accelerated. And I think, when restrictions get eased, there will be a reversion at a level back to consumers going to physical stores, physical shopping centers, particularly those that are able to offer. And we saw this pre-COVID-19, where physical stores and shopping teams are able to offer consumers an experience, and the purchasing of product or services in that shopping center is a byproduct of them being there. But definitely, there will be now, a sustained and ever increasing level of purchasing online and having the product delivered to your door, which is why the likes of Kogan, Amazon, Temple & Webster online stores will just continue to go from strength to strength. It will be critically important that for any retailer to be successful, in addition to them understanding their financial position, they will need to have at least a combination of bricks and mortar and a very, very strong online presence. Sean: Berrick, so why do you think it's so important to make the call early, to ask the experts for help in turning your business around? Berrick: Really, it's the circuit breaker. The turnaround is the circuit breaker to, I guess, admit that things, if they keep going the way they're going, is going to end up in liquidation, and the opportunity for the turnaround is really to identify that somethings got to change, and unfortunately, I think couldn't be achieved consensually because there's probably too much for either party to lose along the ways. So I think by using the circuit breaker to then right size and reposition allows the stakeholders to move forward in a way that's much better than liquidation. Sean: Berrick, Bryan, thanks for being on Behind Business. Bryan: Thanks for having us, Sean. Berrick: Thanks for having me. Sean: That's it for the retail edition of Behind Business. I'd like to thank Berrick Wilson and Bryan Webster for joining me, Sean Aylmer, on the virtual couch. We've learnt that retail is a tough business at the moment, going through enormous change, not just COVID-19 related. And if you're a retailer, focus on cashflow, think about your network portfolio, number of stores you have, e-commerce, and importantly, make the tough decisions early. In the next edition of Behind Business, we'll consider higher education. Now, that's a sector that's insignificant distress due to unprecedented revenue decline from international students. KordaMentha believes there is a way through the current financial hardship that will not only address the revenue shortfall, but strengthen universities and the sector more broadly for a more sustainable future. Thanks for listening to KordaMentha's new podcast series, Behind Business. I'm Sean Aylmer.