Knock, Knock, Knockin' on Heaven’s Door
The managements of most retailers in the United States are not prepared for $1.3 trillion less consumer spending per year. Their little expansion models were built upon an existing over inflated demand extrapolated at 5% or greater growth for eternity. We know how well bank models worked out. The good news is that retailer expansion models will not bring down the financial system. The bad news is that thousands of retailers will go bankrupt because they planned their businesses based upon false assumptions. Any retailer that used leverage to expand based on faulty pie in the sky assumptions is headed to retail heaven.
Retail top management is notorious for copying the strategy of other successful retailers. Wal-Mart (WMT) created the concentration strategy of dominating a market with multiple stores. Every retailer in America dreamed of replicating Wal-Mart’s success. Home Depot (HD), Bed, Bath & Beyond (BBBY), Target (TGT), and Lowe's (LOW), among others, have followed this same strategy. Every retailer does the same thing. They know how many households are in a market and they multiply that number by the expected spending per household. There are three major errors that have been committed by every retailer in America. They failed to recognize that the spending per household was 30% over inflated due to debt financed demand. They then extrapolated the spending per household using a 5% to 10% growth rate. Lastly, they ignored the fact that their competitors had the same strategy.
I consider Lowe's to be one of the best run retailers in the U.S., with beautiful stores and good service. But, its top management was clearly irrationally exuberant regarding its expansion plans. Lowe's has annual sales of $45 billion with approximately 1,500 stores. This averages out to $30 million of annual sales per store. Its operating margin has been 10%. It opened a store in Plymouth Meeting, 20 minutes south of my home. Since it was the 1st store in the market, it likely generated annual sales of $40 million with a $4 million profit. Next it opened a store in Montgomeryville, 20 minutes northeast of my home. This store likely generated $30 million in sales, while reducing the sales of the Plymouth Meeting store by 15%. Next it opened a store in Oaks, 20 minutes west of my home. This store likely generated $25 million in sales, while reducing the sales of the Plymouth Meeting store by 10% and the Montgomeryville store by 10%. Now for the final nail in the coffin. It will open a 4th store in Hatfield, 5 minutes from my home in April. It will cannibalize the sales of all three other stores. Below is an analysis of the likely profit implications for Lowe's.
000’s Omitted
This chart shows that Lowe's likely generated more annual profit with two stores than with four stores. These figures don’t take into account that Lowe's likely spent $20 million to build each of those stores. It has sunk $40 million into building the 3rd and 4th stores, while reducing annual profits. These figures have also not taken into account the future reduction in consumer spending. If Lowe's has replicated this error across the country, their future will not be bright. The hubris and overconfidence of top retail executives will result in thousands of store closings and retail layoffs.
I have experienced the incompetence and shortsightedness of retail executives firsthand. It is amazing to me that supposedly intelligent executives could gamble with a $100 million investment based on ridiculous assumptions and blatant lies. Many retailers have a winning concept, but few have top executives who do not get caught up in their own press clippings. When executives are driven by ego and diversity agendas, while disregarding unequivocal facts, that retailer is destined to fall. Understanding your external environment, your competitors and changing trends are essential to long-term success. These executives forget that Montgomery Ward and K-Mart were once premier retailers. The accumulation of bad strategic decisions by management will eventually bankrupt even the best retail concept. Bad decisions by retail executives destroy the lives of long-time employees when they are forced to close stores and fire staff. I’ve dealt with executives who couldn’t spell strategic let alone think strategically. The retailers listed below have either collapsed or scaled back in the last year. The worrisome fact is that the decline in retail spending has only just begun.
A smart retail executive should be analyzing the current situation with a critical eye. Any executive who is planning for an upturn in spending by consumers next year is in for a rude awakening. The environment has changed forever and if they don’t adapt immediately, their companies will die. Based on the balance sheets and cash flows of the retailers in the following chart, I’ve categorized them according to their risk level. Most of the information is prior to the dreadful holiday sales season. Balance sheets and cash flows continue to deteriorate. Some of the retailers on this list will be a surprise. Those with huge short-term debt obligations run the risk of not being able to rollover that debt. Banks in the U.S. no longer lend money they just beg the government for more capital. Many of these retailers will not be in business five years from now. Others will need to close hundreds of stores to survive.
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