consensus on retail

Consensus Advisors just released their 2009-2010 Retailer Health Ratings (RHRs) reportrhrThe RHRs measure and compare retailers over a five-year period on:

  • healthy growth
  • asset utilization
  • pricing power
  • balance sheet strength

The report and webinar were really interesting and so I thought I’d share some of the insights and my reactions.

1.    weaknesses of comparable store sales as a measure of retail performance

I wrote a post about this awhile ago and so I was pleased to discover Consensus shares my concern with comp store sales, which indicate the growth or decline of sales of stores that have been open for a year or more compared to the same period the year before.

Although they are the primary means of reporting retail results, “’Comps’ are short-term focused and potentially misleading when viewed out of context as they can be driven by unhealthy margins, inventory levels, advertising spend and consumer credit practices. Comps also say nothing about a retailer’s financial leverage, brand strength or ability to manage efficiently the assets on its balance sheet.

The RHRs, in contrast, provide a more balanced and longer-term evaluation of a retailers’ performance.  Consensus uses 15 different measurements and weights them according to their correlation to the retailers’ results on commonly used financial metrics such as return on assets, net income margin, total investment return and return on invested capital.

For example, they don’t just look at the sales growth of a retailer – they also take into account sales volatility, cannibalization, and sales momentum.  And then they adjust that result to reflect operating profitability.  With this more detailed view, I find the strengths and weaknesses of a company relative to its competitors become much clearer.

2.    pricing power as a measure of brand strength

By looking at change in gross margin as well as gross margin volatility, Consensus claims they assess the strength of a company’s brand.  They explain, “As a brand distinguishes itself first from commodity competitors and then from branded competitors, its desirability to its customers can command a price premium.  Sometimes this premium is reflected in an increased price to the consumer; sometimes it is reflected in a stable selling price which does not go down as costs are reduced. Healthy companies enjoy brands that command steadily improving gross margins.

I agree pricing power generally reflects brand strength from the consumer point of view – I’ve made this point myself.  But I wonder about how the Free economy changes this.

As Chris Anderson points out, “Virtually everything Google does is free to consumers” and yet one could argue that Google is one of the strongest brands today.  (BusinessWeek/Interbrand’s 2009 Best Global Brands report ranked Google as the #7 brand in the world and estimated its brand value at nearly $32BB — an increase of 25% from the prior year.)

For free offerings, user preference, perceived differentiation, esteem, etc. are probably the best measures of brand strength – and publicly available financial metrics such as the ones tracked by the RHRs may be limited in their ability to fully or accurately reflect brand strength.

3.    brand focus vs. product focus

Pointing to the recent struggles of youth apparel brands Pacific Sunwear, Hot Topic, and Zumiez, Michael O’Hara, Chief Executive Officer of Consensus, remarked about the risk associated with too specific of a focus.  After I submitted a question about this, he clarified his point saying that retailers need to have a flexible store concept that gives them the ability to migrate away from something that once was not but is no longer.

Pac Sun,” he explained, “will always have to be about the beach, but to the extent that the beach goes out of style, then I wouldn’t want to be Pac Sun.”  He contrasted this with lululemon athletica which he perceives is more flexible because they’re associated with exceptionally high quality, high performance fashion apparel.  And so while right now they are into yoga apparel, he argues, if women suddenly got into ice hockey for example (but let’s hope they never do), lululemon can go there too.

While I don’t necessarily agree with him because I believe yoga defines lululemon, I do think he makes an important distinction.  In my mind the difference between these two examples is brand vs. product.   If your brand is tied to too narrow of a product assortment, it’s harder to evolve your offering as trends come and go.  But if your brand is defined more by values and personality attributes, you have more flexibility.

This is a particularly important point for apparel retailers where product demand changes so quickly.  Brand focus is indeed important but so is the ability to shift product focus — within the brand context — between categories and types.

There are lots of other juicy insights in the report so I encourage you to take a look (purchase required) or at least download the webinar presentation.

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