Primark tightens belt as High Street suffers
Physical retail has absolutely and definitively taken a complete beating in the last month.
John Lewis has furloughed thousands of staff (some 2,000 have moved to Waitrose to cope with increased demand there), fashion retailer Cath Kidston said it has closed its stores for good, Oasis and Warehouse have also permanently closed with a loss of 1,800 jobs (guess who bought the brands – none other than Hilco, the turnaround specialists involved in the HMV rise…and err…fall).
But while many other retailers have shifted their focus to e-commerce to maintain some stream of revenues and cash inflows, one high-street giant, in particular, has not had that luxury.
If you didn’t know, fast-fashion store Primark does not actually operate a transactional website. What? Yes, that’s right – one of the biggest names on the high-street does not have an e-commerce store you can buy from. Sure, you can browse online, you can see how much products cost, and you can find your nearest store, but you can’t actually click and ship.
So, while the entire country is in lockdown and most businesses are desperately trying to pivot to some form of online or remote service, Primark has both its doors and business firmly closed, resulting in lost sales of £650m per month.
What does this mean for Primark and its stakeholders? And what you can you learn from it?
A brief history
A missed digital opportunity?
I’ve written about business models previously, and specifically the click vs brick models of HMV and Marks and Spencer. So, the big question here is, why do they not operate a transactional website? Surely, it’s a missed opportunity – both the opportunity cost of no online sales and missing out on all that rich customer data?
Well, not to get too technical, but if you’re not familiar with ecommerce metrics, two of the most important ones to focus on are:
- customer acquisition cost (CAC) and
- customer lifetime value (LTV).
In fact, they become even more relevant when you compare the two of them together to create LTV to CAC ratio (LTV:CAC). Those that are more familiar with SaaS or other subscription businesses will be familiar with this metric too (along with churn and negative churn). In ecommerce, it’s typical that your LTV is calculated from your gross margin, whereas in a SaaS business it’s typically the top-line subscription fee.
You should aim for a positive LTV:CAC ratio which implies you are ultimately making more from your customer than you are paying to acquire them. There is an optimum ratio to have – too low and you will be losing money on every customer, too high and you’re not investing in growing your customer base as aggressively as you could.
However, you need to consider the length of the period you are assessing as the lifetime. For example, if your repeat order stretches out to three years you may be burning too much cash to sustain that cycle. The cost of acquiring the customer is vital when assessing unit economics and overall viability for running an online store.
The snag here is that Primark has extremely low average price points. However, let’s assume Primark doesn’t need to spend a penny on acquiring their customers digitally. After all, they have a huge number of customers wading through their stores so chances are they would have a huge organic following. There is still the cost of delivery to factor in. Scrolling through their online showroom, they have many products that are priced at only a few pounds. Delivery would cost more than the product.
However, let’s assume they charge delivery on top of their product price. There is still the cost of returns, and a returns rate could be anywhere between 30 – 40%. But it’s not just the cost of the return delivery but also the associated costs of processing, cleaning, folding and repackaging along with a percentage of waste too.
So, all these factors would turn a very relatively small margin into quite a sizeable loss margin per unit.
And that is one of the primary reasons Primark doesn’t operate a transactional website which means, right now, they are firmly closed for business and losing £650m sales per month.
Navigating the storm
So, when you have 68,000 employees and over 350 stores but zero revenue, how do you go about managing that and minimising your cost base and most importantly, your cash burn?
Well, probably not too dissimilar to most businesses across the world. They looked at their largest overheads; people and location costs.
- Staff – furlough and pay cuts
68,000 people are receiving furlough payments from governments across Europe, without which they would have been forced to make most redundant. Additionally, they have introduced a 20% reduction in pay for senior executives, a temporary 10% cut for the remainder of colleagues across head office, and the leadership team is due to take a temporary 30% salary cut and no bonuses are to be issued for this year.
- Rent and rates
The retailer has written to landlords informing them it will be holding the quarterly rent payments on its 110 leaseholds stores. The letter asked landlords for their support on lease agreements going forward to mitigate the financial impact of coronavirus on the business. Additionally, in the UK they have the welcome relief from business rates for 2020/2021.
Across the group, they took immediate action to stop nonessential capital and discretionary operating expenditure. As a result of all these cost mitigation measures, they currently estimate being able to recover some 50% of Primark’s total operating costs but still leaking a monthly cash outflow of some £100m, while the stores remain closed.
There is also the downstream impact on their supply-chain too. With sales ceasing immediately and an inbound supply chain continuing for several weeks they had stock in transit to the tune of £600m which they agreed to pay for. To prevent further cash outflows and further inventory building up, they’ve cancelled all future orders until further notice.
Of course, stock is seasonal, especially in a fast-fashion store, so they’ve also had to write down their stock by £284m. There is likely to be one big sale coming out of lockdown.
And the one that will hit shareholders hardest (other than the fall in share price) is that the Board of their parent has decided not to declare an interim dividend.
What other measures would you put in place?
The fail-safe of a diversified portfolio
While no one could have predicted the cataclysmic shift in society due to Covid-19, it has long been a good business practice to diversify. So much so, that in general society we’ve developed the common idiom “don’t put all your eggs in one basket”. Now clearly, not every business can be a global conglomerate spanning sectors or geographies but it’s a stark lesson in business and a good reminder to look for multiple ‘baskets’ to diversify and de-risk.
Primark is actually owned by Associated British Foods plc, which is the world’s second-largest producer of sugar and baker’s yeast and a major producer of other ingredients. It has a market cap of nearly £14bn (as of 5 May 2020) and consolidated revenues for 2019 were £15bn. It operates in grocery, sugar, agriculture, ingredients and, of course, retail markets. Some of the more famous brands are Ovaltine, Ryvita, and Twinings.
Associated British Foods plc (of which Primark is a subsidiary) share price:
Retail (Primark) accounts for approximately 50% of ABF plc £15.4bn group revenues.
While the overall ABF plc share price has taken a tumble, the cliff-drop of Primark activity has been balanced out with the increase activity of their other markets, which has actually shown an increase in demand over the past month.
“Our food businesses, and in particular our food factories and depots and drivers, have equally been put under intense pressure since this pandemic began, but in very different ways. ABF businesses produce more food in the UK than any other organisation and we are significant producers of food in other countries too…Indeed, during the weeks of panic buying, they had to produce more than ever before.” George Weston – chief executive, ABF plc.
A little known fact, owners of Primark, Associated British Foods plc is owned by Wittington Investments, which also owns Fortnum & Mason, the upmarket department store. They really do have a diverse portfolio with both ends of the consumer budget.
A new business model?
It’s not just the lack of a transactional website that will hamper Primark sales this year. Once we’re eased out of lockdown, it’s difficult to predict how consumers will react when stores reopen – they could very well be hesitant about too many people in a confined space.
Chief Executive of ABF plc, Weston said: “When we are allowed to reopen we must make our Primark stores safe for our staff and our customers, even if that means ensuring there are fewer people shopping at any one time and so accepting lower sales at least until the remaining risk is minimal.”
So, even during this reintegration phase, Primark is bracing for a much lower level of activity than they ordinarily would cram into their stores.
On the flip side, shoppers may well be more conscious of excess spending for the foreseeable future, which would be a boost for value retailers like Primark.
So, should Primark chiefs be taking this time to reconsider their business model?
It continues to be a challenge for Primark to make its “high-volume, low intake margin, low selling price” model to work on a transactional website for the reasons previously mentioned. However, concerns about physical contact and a potential second wave of social distancing measures in colder months may make them reconsider their business model.
They obviously value the upsell experience they have instore much more than the power of the digital algorithm on an electronic basket, “Customers enjoy looking online at the latest offers, and then come to stores on the high street to buy. The in-store design and experience is part of Primark’s attraction to customers,” said Weston.
Investors have a balanced portfolio for a reason; they don’t “put all their eggs all in one basket”, and that, right now, is a huge saving grace for Primark. While Primark has no transactional website that could minimise some of the lost store revenue, ABF plc has an FMCG division that has been relatively unaffected from the pandemic thanks to soaring demand in grocery.
On the very few occasions I have been in a Primark store, I find it cluttered, frustrating and messy. Personally, I would far rather shop online than experience that…but then, again, I’m probably not their target customer.
Surely there is a way for Primark to develop a digital model to complement their normally busy physical retail store. Creating more resilient and flexible business models to weather retail’s new challenges will be a top priority for all retailers – not just Primark, and we will certainly see others invest more in this.
What you would do if you were the CFO advising the CEO at Primark?