Ben T. Nicholson
At a Glance
The challenges are consistent with every retailer in distress - too much debt without an omnichannel strategy, the shift to eCommerce, year-over-year sales are declining, and increased operational expenses are compressing margins.
It is both prudent and imperative to follow Key Performance Metrics directly related to gauging the health of a retailer.
While the frequency of retail liquidations has a natural ebb and flow, in an economy where consumer spending is driving GDP growth it stands to reason that when the market is robust, liquidations would presumably be scarce. However, the recent uptick in brick-and-mortar retail liquidations has been record-setting, and when the economy does take its inevitable turn a resulting velocity in retail liquidations could be precipitous with no end in sight. No matter what size the retailer, when isolating causes leading to liquidation, the similarities so far have been remarkably consistent: The retailer took on too much debt without a sound omnichannel strategy to address changing consumer behavior; the effects of the exponential shift to eCommerce is being felt; year-over-year sales are declining; and the burden of increases in operational expenses are compressing margins.
What poses a unique challenge for lenders, however, is putting a finger on the effects the dynamic market shifts and large retail spillover is having on small-chain regional retailers and single-shingle stores, especially when considering reasonable expectations in financial recovery from a liquidation. Short of localized shock at the news spreading or social media virality, when small retailers face challenges it is not high-profile, and rarely does it generate any press. Furthermore, given the typical ownership structure of small retailers, when the decision is made to liquidate — either voluntarily or involuntarily — it is not only financial but largely emotional. This is part of the reason most small retailers ride a razor’s edge between deciding to liquidate as the market gets more challenging or holding on until the bitter end.
Key Performance Metrics to Monitor
As the retail market gets more challenging, at first sign of distress it is prudent for small retailers and their lenders to continuously track specific performance metrics that could signal potential liquidation triggers. This is especially true when considering promotional and store pare-back strategies versus total liquidation. These key performance metrics can serve as guidance to isolate effective and timely adjustments to be made or ensure effective exit planning:
Sales Revenue — When decline is present, identify how much loss can be absorbed and measure year-to-date and monthly sales before equity is too compromised and cash depleted.
Inventory Value — Small retailers often lack effective systems for tracking inventory accurately. When measuring book value compared to sales, it is prudent to identify swings — annually and monthly — to ensure alignment with normal business activity.
Inventory Turnover/Optimal Turnover — Identify trends in current and optimal turnover to ensure effective sales strategies are employed to keep the merchandise turning. Inventory depreciates in value. The older it gets, the more challenging it may become to sell at a desirable price, even during a liquidation.
Days Inventory Outstanding — Benchmark the trends for the merchandise being sold to identify if obsolete inventory could be growing and not selling in time to clear shelves for new stock.
Operational Expenses — Many small retailers often run on razor-thin margins, therefore it is prudent to stress-test the negative effects of impending rent escalators, wage increases, and other cost increases.
Established Retailers Exiting — Established retailers drive traffic for their small retail neighbors, which can decline when they exit. This is especially true for small in-line retailers at shopping malls.
Distributor Discounts — Distributors offering promotions can indicate they are trying to unload excess inventory themselves as they recognize shifts in the marketplace.
While performance metrics should be measured during the normal course of business, when trouble arises, it is especially prudent to identify unusual variances in the metrics that should be addressed immediately. Not only is the inflection point of when operations should have ceased discovered in hindsight, it can also be the beginning of when measurable capital begins to be left on the table.
Self-Liquidating Versus Hiring Professionals
The goal of a liquidation is to sell each item of merchandise at the highest possible price within a timeframe that ensures additional expenses do not outweigh the benefits. It is pure economics. The strategy, however, is inherently different than day-to-day retailing, especially considering there is a beginning and a definitive ending. The execution of a liquidation plan to help a small retailer is complex and requires an understanding of what strategies can have both positive and negative effects on the outcome. Simply put, there is more driving the success of a small retail liquidation than putting signs in the windows and marking down the merchandise. To begin, there should be no emotional attachment to the business or the merchandise to ensure decisions are made with the singular purpose of selling the inventory for the highest return. This alone can be a great leap for ownership or current management facing the loss of a small retail business.
Furthermore, when considering if executing a small retail liquidation will generate more favorable results than alternative inventory monetization strategies, it is prudent to consider where revenue drivers, combined with small controlled operational nuances, can unlock capital and add value to the overall outcome of a liquidation:
Liquidation marketing is designed to generate increased traffic through messaging and timing that is deliberate and decisive with gorilla-style marketing efforts.
Liquidation budgeting sheds unnecessary operational expenses that are timed to compress through the sale and ensure expense disbursements have only positive effects on the outcome.
Liquidation pricing strategies and timing of markdowns are the science driving the effectiveness of the process. A lack of understanding of when and how to control pricing invariably can lead to sluggish sales, merchandise left over, and compromised returns.
Without a planned pricing strategy in place, efforts to drive additional revenue, including adding additional inventory, can lead to merchandise left over.
When following the aforementioned performance metrics, the best season to liquidate can be determined to ensure the most optimal outcome and prevent additional negative earnings.
Without question, the complexity of large liquidations is very different from small ones. While similar strategies are employed in the process, the model that yields success for a large liquidation may not be as effective when applied to smaller retailers. This is particularly pertinent when considering prior publicity, operational and marketing budgets, fee structures, and liquidation strategies directly conducive to the size retailer and specific challenges present. As small retailers continue to exit the market, however, lenders and borrowers have the resources to make informed and timely decisions in developing effective liquidation strategies specific to small retailers. Reasonable capital generation during recovery should no longer be compromised with money unnecessarily left on the table.