Given the build-up in the global credit-squeeze and the pre-Christmas slowdown in UK retail, 2008 will have to be played very close to the financial edge… This makes it crucial that suppliers quantify and demonstrate key aspects of the risk-reward relationship at the supplier-retailer interface. Creative use of numbers can help.
However, whilst robust calculating methods can often reveal usable insights, the confidence and ability to lead a reluctant buyer to ‘obvious’ conclusions requires a little more… Working confidently at the financial-edge requires a constant willingness to reduce issues and situations to numbers, to the point that the resulting moves seem instinctive. This means building up a repertoire of calculating-tools that can be adapted to most aspects of a trading relationship, and by continuous application, internally and with the customer, a level of confidence and credibility is built up over time.
Essentially, optimising the supplier-retailer relationship is about working towards and maintaining a fair balance of relative risk and reward between trade partners. It is crucial to understand both supplier and retailer business models in terms of how money works within each organisation, using open domain accounts as a basis for comparison. This means isolating every type of financial transaction with the customer, calculating its cost to the supplier, and then its value to the customer based on respective business models.
In other words, a supplier making a net profit of 9% has to achieve incremental sales of £11.1k for every £1k ‘invested’ with the customer. Meanwhile, a retailer making a net profit of 3.5% has to generate incremental sales of £28.6k to generate that same £1k received from the supplier. Thus it can be seen that a £1k investment by supplier is ‘more valuable’ to Sainsbury’s (net profit 2.2%) than to Tesco, with its net profit of 6.2%, thereby requiring differing levels of emphasis and support in negotiation. In this way it is possible to use incremental sales as a measure of the value of trade funds investment to the retailer, thereby impacting two important buyer KPIs, margin and sales growth. In practice, the buyer is measured on gross margin, but is increasingly affected by the resulting net margin as a driver of ROCE and ultimately share price.
Apart from helping in day-to-day negotiation, working the numbers at the supplier-retailer interface is really about identifying relative risk in the total pipeline, and allocating rewards appropriately to all members of the demand-supply chain. Because of a reluctance or inability to factor in different parts of the relative remuneration package over the years, the risk-reward balance has become tilted in favour of the retailer. This means that gross margins, and credit periods currently enjoyed by retailers do not reflect improvements in delivery frequency over the years.
For instance, the current UK milk pricing controversy is focused upon apparent collusion between retailers in fixing the retail prices of milk and other dairy products. However, running the numbers on the raw (Competition Commission, Times 8/12/07) data indicates that the real issue is about the manner in which the retail margin has grown from 1995 (4.5%) to 2005 (30.6%), whilst farmers’ margins have fallen to almost zero over the same period.
This additional insight added to average payment periods of over 20 days, coupled with daily delivery, means that eventually, an indefensible and politically damaging position will emerge. The resulting ‘exposure’ will probably cause more damage to retailers’ share prices than the cost to the major multiples of voluntarily reducing retail margins to say 8% levels and payment periods to say 5 days, before being forced to make these ‘obvious’ moves by government and especially public opinion. Retail prices could also be reduced slightly to satisfy the public, and the margin savings passed back to milk farmers, thereby increasing their margins without a massive distorting of the market.
In practice, the farm-gate prices could be allowed to rise to a point that would restore farmers’ profitability, maintain processors’ current margins and allow retailers’ cost prices to rise to a level that would reduce retail margins to 8%, having incorporated a reduction in shelf prices of say 2%, thus hopefully restoring shopper confidence in multiple retailers in this increasingly emotive category.
Counting the numbers can help in spreading the pain….
