How long can you play not to lose before you eventually do?

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1 How long can you play not to lose before you eventually do? For traditional retailers, e-commerce brings opportunities but also challenges from added cost and complexity. To succeed, think long-term and beyond just cuts. For Maria, the Vice President of Operations at a leading retailer, the next fiscal year looks like another delicate balance of priorities. The budget reflects a widening chasm between the e-commerce that is driving growth and the brick-and-mortar past that the business was founded on. Meanwhile, overall profit margins continue to narrow. The better the question. The better the answer. The better the world works. Of special interest to: Chief executive officers Chief operating officers Chief business development/ strategy officers Chief financial officers

2 With stores across Europe and the Americas, Maria s company is a significant player in the market. Some of its locations are thriving; others have been shuttered. In the middle are stores that remain marginally profitable, but the year-over-year figures aren t encouraging. The need for continued investment in the digital component adds its own cost and complexity. To Maria, it feels as though, in the face of these trends, her company is treading water and making cuts instead of crafting a long-term plan to position itself for the future. But what does such a strategy look like? 1 5 insights for executives

3 Traditional retailers are feeling the squeeze as technology rewires consumer habits As buyers increasingly turn to websites and mobile apps for their shopping, traditional retailers have been investing a lot of time and effort into building and growing digital capabilities. Yet much of the sales for digital are taking sales away from the stores, which are a high (and mostly fixed) cost. In turn, this added complexity requires further support from central functions, such as merchandising, logistics and other back-office teams. Given that pure-play digital retailers typically operate with tighter pricing and more frequent promotions than brickand-mortar businesses, the gross margins of traditional retailers are under pressure as they seek to match pure e-commerce competitors pricing. The result: 73% of retail and consumer products companies say profitable growth is much more difficult than it was a decade ago. 1 Many retailers are reporting operating margins lower than just 5 to 10 years ago and are struggling to translate revenue growth into a more robust bottom line. Against this backdrop, zombie stores are proliferating Many retailers have a much greater footprint of stores than they need and, despite extensive efforts to explore alternative uses, they are struggling to put much of this space to good use. We estimate that the amount of excess UK space ranges from 20% to 40%, a steep cost that places an added burden on operating margins. This has given rise to zombie stores : locations that exist but would never be opened in the current environment, and perhaps more worryingly will never reach the returns needed to justify the ongoing capital investment to keep them looking inviting to shoppers. 1. Balance, EY website, accessed 10 May insights for executives 2

4 In the face of significant challenges, there is a danger in small thinking While there is a natural reluctance to change what has been a winning formula, holding onto this inefficient status quo carries an obvious financial cost. But the inertia has wider implications for the ambition and mindset of the business, because, as the market continues to shift rapidly, retailers must be proactive to compete in this era of disruption. This echoes a theme from recent EY research in retail and consumer products, in which a number of the industry s leading executives ominously observed that many in the sector are playing not to lose rather than to win Balance, EY website, accessed 10 May insights for executives

5 Determine how to invest to achieve profitable growth beyond next year With 66% of retail executives telling us their traditional value-creation tactics are increasingly disrupted, what does playing to win look like? 3 It isn t just to get costs out of the business, which can drive a downward spiral if pursued on their own. Those efforts must be coupled with new capabilities that will lead to sustainable growth. 1. Start by taking the perspective of an external investor. To create a business that will be thriving in three to five years, what would you do? Really push your thinking with a transparent and fact-based view of the options, and pinpoint the economic rationale for the decisions and investments you need to make. 2. Determine the operating model (and cost structure) needed. Shaving another thin slice off the cost base within the current model isn t enough. Get to a view of what the business will look like in the early 2020s. For instance, ask yourself: will your stores be driven by the need for convenience, or to provide showrooms for customers to try products in person? Establishing these requirements and the implications for the store network will inform how existing sites and locations fit into your future state, and in turn inform capex decisions and operating choices that help manage costs. 3. Adopt rapidly developing technologies to automate or speed up processes. Developments such as artificial intelligence/machine learning and robotic process automation can help with your repetitive back-office, administrative and some customer-service-facing activities. Such tools can drive self-service for customers and reduce the army of people answering phones. With only 11% of retailers confident they can drive actionable insights from data, sophisticated predictive analytics can also help you determine how and when to best run a promotion Channel the savings into new opportunities in line with your long-term plan and consideration of growth opportunities through inorganic and organic means. Opportunities don t just exist online, although that may be a focus of your short-term strategy. There are different markets, new products and services aligned with future consumer needs, and perhaps completely new offerings and services identified through embracing disruptive innovation. 3. Balance, EY website, accessed 10 May Creating value from customer insight, EY website, accessed 10 May insights for executives 4

6 Retailers must address the challenges of today while looking to tomorrow Retail markets appear likely to grow for the foreseeable future, albeit at a rate in the low single digits. Yet technology and other competitive challenges continue to develop, adding complexity to operations and new costs to budgets. Many retailers have one foot stuck in the past when they need to advance into the future. At Maria s company, she and her team have decided to close some stores, rethink the design layouts in others and capture the benefits of technology in their back office. The savings generated will be used to bolster brand-building efforts in markets with the most growth potential and further accelerate the development of digital and logistics platforms. By looking at the business and cost structure three or more years out, Maria feels her company can start playing to win rather than fighting ever harder not to lose. 5 5 insights for executives

7 Want to learn more? The answers in this issue are supplied by: Helen Merriott Market Segment Lead Consumer Products & Retail Ernst & Young LLP Martin Armistead Associate Partner Performance Improvement Ernst & Young LLP For related thought leadership, visit ey.com/analytics. 5 insights for executives 6

8 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. We want to hear from you! Please let us know if there are subjects you would like 5: insights for executives to cover. You can contact us at: fiveseries.team@ey.com EYGM Limited. All Rights Reserved. EYG no Gbl BMC Agency GA ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com/5