Hong Kong retailers must work out how to manage through an extended crash in sales performance to survive these difficult times.
October retail sales were down 24 per cent year on year due to low traffic in key shopping areas such as Tsim Sha Tsui and Causeway Bay resulting from protests and transportation disruption, as well as the reduction in tourists which normally account for significant retail spending.
These sales are lost – they are not being deferred to be made up at a later date.
Worse, it will take at least six months for visitors to fully return once Hong Kong’s situation is stabilised.
No one could have predicted earlier this year that Hong Kong’s retail industry would be facing its largest decline in 20 years. Sales projections show that the industry is currently on a downward spiral and will surpass the record of -8.1 per cent which occurred in 2016, when the Yuan weakened against Hong Kong dollar and led to a decline in mainland shoppers. This year, with profit warnings from retailers starting in July, Hong Kong retailers are facing a clear sales crisis as they enter their seventh month of double-digit sales declines with protests continuing and bringing with them businesses disruption.
How to manage costs
The challenge Hong Kong retailers face today is how to manage costs during an extended period of sales decline with little certainty when sales levels will return. With retail profitability typically between 1 per cent and 4 per cent of sales, even a small sales decline can tip a retailer into a loss.
Some timely action now can avoid more significant measures in the future.
Critical measure I: cash management
When faced with a significant sales decline, the first question is “what is our cash position?”. Retailers need to get control of their cash situation and ensure they do not trip into insolvency. This not only means understanding the current cash position, but also where it will be over the short and mid-term and the risk level. Building an accurate cash forecast provides a real time business performance view with an immediate understanding of the impact of missed sales. It also supports a “cash culture” within the organisation and focuses leaders on eliminating wasteful or non-critical spending.
A 13-week cash forecast is the key tool in managing cash. This forecast is updated on a weekly basis based on sales receipts and cash disbursements. This allows the retailer to conduct sensitivity testing to cash flows, get a projection towards future cash positions, and set priorities for spending. It can also show the impact of working-capital improvements, for example promoting and selling excess inventory or extending payment terms with suppliers.
Critical measure II: re-negotiate key contracts
Two key cost areas for retailers to focus are store leases and product costs. These are typically the two largest external expenses for any retailer, and both landlords and product suppliers want to maintain their tenants/customers.
Store Leases: While most landlords will push for the retailer to absorb any sales losses, it is also possible to negotiate favourable lease terms with them. Landlords want a stable mix of tenants and empty storefronts impact the property value, especially in malls. Examples of favourable terms can be short-term lease discounts, lease holidays during shutdown periods, or rent restructuring depending on the retailer and the property impact.
Product Costs: Suppliers can also help mitigate sales challenges. This can be in terms of longer payment terms, lower product costs, and/or supporting selling unsold products. Just as landlords want to maintain leased space, suppliers also have existing accounts receivables with the retailer and want to ensure these will be paid.
With landlords and suppliers, it is important to start dialogue early. Without the immediate pressure of a financial distress situation, more options can be considered to solve the short-term financial challenge. However, when a retailer does become financially distressed, landlords and suppliers focus more on limiting their own financial risk than on providing options to the retailer.
Critical measure III: implement operational cost reductions
In additional to lease and product costs, retailers can reduce operational costs across all major functions. These include merchandising, stores, back office functions (legal, HR, finance, and technology), and supply chain. The following table lays out for each of these functions and examples of improvements across expenses, margin, and cost of goods.
Functional Operating Improvements
The key for retailers is not only to identify and prioritise opportunities, but also execute the changes necessary and capture the benefits. Often retailers will identify potential opportunities, but then not see the benefits translate into results. A typical mistake is failing to allocate resources to track, execute, and confirm impact of changes from idea to financial statement and assuming business functions will execute these improvements on their own.
Uncovering opportunities from a crisis
Retailers can gamble and hope they have enough buffer to weather the current and expected future sales declines. At the same time these periods of turbulence and uncertainty provide an opportunity to strengthen operations and improve practices and efficiencies. Establishing a new cost baseline early can have a significant impact on retailer profitability.
Implementing cost reductions, while never easy, if done proactively can be much gentler than waiting, and then finding more significant and drastic reductions are needed.
By monitoring and controlling cash positions, negotiating relief in key contacts, and finding additional operational cash improvements, retailers can position themselves not only to weather the current sales crash, but also have stronger future performance as the market eventually returns.
- Britton Russell is a director at AlixPartners.