A series of high-profile CVAs and administrations in recent months are a powerful reminder of the tough conditions currently facing the UK high street. The fall in the value of the pound post-Brexit, combined with squeezed consumer spending and recent hikes in business rates have brought many retailers to breaking point.
In these tough trading conditions, many retailers are examining their cost base closely with a view to cutting back where they can. To do this effectively, they need to distinguish between ‘good’ or flexible costs and ‘bad’ or fixed costs so they can make informed decisions and build a more sustainable business.
Cost is gaining new significance among retailers as a strategic lever, allowing them to deliver their strategic objectives and stay ahead of the curve when it comes to importing key technologies. Rather than implementing a ‘slash and burn’ approach to cost reduction, it is important for businesses to determine the relative value different elements deliver, alongside a consideration of their flexibility. Some key principles to guide business owners are as follows:
- Good costs – are high-margin costs that deliver measurable value to the business. They are essentially flexible, so they can be increased or decreased as business requirements alter. They also tend to be focused on driving value in key areas of growth.
- Bad costs – are low-margin, fixed costs that are inflexible and drive little value. They may be focused in areas of the business that are in decline or performing at a loss.
When cost reduction is being considered, non-core, back-office functions, such as marketing and HR, can come under threat quickly. For example, some retailers may be spending large amounts of money on social media campaigns or advertising and these budgets are likely to be top of list when looking for opportunities to reduce spend.
However, for online retailers in particular, such marketing activity may be essential for driving traffic to the company’s website and boosting sales. Similarly, while areas such as sales commission may be perceived as a non-core spend, the value it delivers might be far in excess of any outlay. In all cases, it is essential to quantify return on investment before making cuts.
For retailers, property costs are a classic example of ‘bad costs’. Many struggling retailers have chosen to enter into a CVA in order to re-negotiate payment terms with landlords, whilst they continue to trade.
Rather than being allowed to weigh the business down financially, adopting an innovative approach to retail establishments could prove the solution to making property pay. This essentially means transforming ‘bad costs’ into ‘good costs’ in order to drive value back into the business. One example of this is clothing retailer Next’s decision to introduce Costa Coffee shops into its stores.
Before things get this far however, it may be possible for retailers to release pressure on their cash flow by adapting their cost base. For example, subletting part of a store or offering additional concessions could be ways of generating additional value by increasing sales. Such a strategy could be particularly effective given the decline in footfall and the growing importance of creating a positive in-store experience. Retailers may be reluctant to close their flagship stores, but they should stay objective and keep sight of which outlets deliver the best returns.
Similarly, an analytical approach to cost reduction can help retailers to make decisions about product lines. In an attempt to emulate the Amazon model, many retailers have diversified quickly, expanding their product ranges and increasing inventory. However, in doing so they could run the risk of losing their identity.
By evaluating the profitability of individual product lines and staying focused on their brand proposition, businesses will be able to cut costs without damaging their business models. For example, retailers will be equipped to distinguish between those products that are generating the strongest sales and those that are making the most profit.
At a time when many retailers are facing cash flow difficulties, it is vital to adopt a bold approach to cost reduction. By assessing the value of their cost base and considering how to transform bad costs into good ones wherever possible, retailers can gain a key advantage over their competitors and ensure their place on the high street of the future.
By Ben Bird, a partner and cost-modelling specialist at management consultancy, Vendigital.