With Andy Higginson at Morrisons admitting that the major multiples made a mistake by raising prices in the recession, causing shoppers to vote with their feet, trust will have to be rebuilt via genuine price reductions for the remainder of the decade, at least.
Whilst suppliers will try to pass these price constraints back up the supply-chain, it is unlikely that they will be able to support retailers’ price reductions. Moreover, there will be little scope for increasing suppliers’ trade investment, or improving service levels, in order to reduce retailers’ cost of doing business.
Meanwhile, the stock market has been losing patience with the squeezed middle’s loss of market share and is applying pressure via share price reductions.
This combination of factors has to put increasing pressure on UK retailers’ net margins for the next five years. In addition, if Mike Coupe at Sainsbury’s is acknowledging the end of 5% net margins in UK grocery margins, and implying a more likely 3% going forward, the issues for suppliers have to be:
- Can 3% Net Margins work in UK retail?
- How can my brand help?
Essentially, as you know, the driver of share price increases is ROCE, and given that ROCE is a multiple of Return/Sales and Sales/Capital Employed i.e. Net Margin x Capital Rotation, then it matters little whether a business chooses to operate a high margin, low rotation, or a low margin, high rotation business model. From a stakeholder’s point of view, it is the combination that counts, and 15% ROCE provides an acceptable reward for risk…
The ‘easy’ way for retailers to deliver an improved ROCE was traditionally via a focus on increasing their net margin. This meant demanding reduced buying-in prices, increasingly causing issues in terms of being seen as abuse of suppliers, demands for more trade investment, now attracting the unwelcome attention of auditors and the SFO, ramping up deductions that caused the GCA to check for possible GSCOP breaches – all of these routes to profitability are being effectively closed off…
This means that, without increases in shelf-prices, operating on reduced net margins is the only option remaining. Therefore, if a 3% net margin is the retail ‘norm’ going forward, then the multiples need to focus on increasing their capital rotation – with the help of suppliers – in order to compensate for the lower margin in producing an ‘acceptable’ 15% ROCE.
However, the key problem for suppliers is that any increase in the cost of serving customers can result in reductions in the supplier’s ROCE. This is because reducing a retailer’s stock levels safely – without jeopardising on-shelf availability – means making smaller, more frequent deliveries, thus hiking up the cost of distribution and impacting the supplier’s bottom line.
Therefore, it is imperative that NAMs concentrate on helping the retailer to make more use of monies already being invested by the supplier, and be able to demonstrate the impact on the customer’s bottom line. In practice this means increasing the customer’s Capital rotation i.e. Sales/Capital Employed, i.e. increasing Sales and/or reducing Capital Employed.
Given that a customer’s capital is mainly tied up in space and stock, the NAM needs to focus on space and stock optimisation. This means persuading the retailer to optimise the supplier’s existing level of service by converting demand-based forecasts into firm orders, collaborating in on-time information exchange, and co-ordinating in-store activities with supplier promotion, and reducing the need for compliance-monitoring to a minimum.
In other words, doing a little more of what you are already doing, but relating it more to the top-of-mind concerns of the buyer in the future, in terms of its direct impact on the retailer’s ROCE and thus the share price…
However, building a NAM’s confidence in the value of an ROCE approach to negotiation means having a full understanding of the ROCE model and its drivers, along with the ability to explain it from supplier and retailer perspectives. This means not only being able to explain how it works, but also being able to demonstrate its positive impact on profitability, especially when a buyer’s agenda may be to prove the opposite, for fear of losing power in the negotiation, or even revealing ignorance of what really drives retail profitability…
The main advantage arises from being to work with the ROCE model to build business in this new era, while others turn up the volume on their traditional selling points, as they wait in vain for a return to normal…
