Date December 2016
By the numbers
- Black Friday broke a record in 2016, with $3.34 billion in online sales according to Adobe Digital Insights. It also was the first day mobile revenue topped $1 billion, a 33 percent growth year-over-year. Cyber Monday then marked itself as the largest online shopping day in history just a few days later, with $3.39 billion in sales. These numbers underscore just how important the e-commerce channel has become and how fast it’s evolving.
- On an adjusted basis, the estimate of U.S. retail e-commerce sales for the third quarter of 2016 totaled $93.7 billion, an increase of 15.6 percent over the same period the prior year, while total retail sales increased just 2.3 percent during the same period. While this growth is fast, e-commerce still comprised just 8.4 percent of sales in the third quarter, meaning this transformation in retail sales is still at its beginning.
- The dominant internet player remains Amazon, who accounted for around 60 percent of total online retail sales growth in the U.S. in 2015, according to Forrester Research.
Key e-commerce metrics: Common sales and inventory metrics include website traffic, sales transactions, inventory turnover and weeks of supply, return and charge back rates, and fulfillment rates. But some metrics gain greater importance when managing online retailers’ portfolios. For example, fulfillment rate (number of placed orders versus shipped orders) is crucial. It is entirely dependent on a company’s system accuracy and reflects its ability to fulfill orders. Typically 95 percent or higher in a well-managed inventory system, a rate of 90 percent or less would be cause for concern. Rates at these levels could indicate a system capability issue that may have a negative impact on appraisal values or, ultimately, Going-out-of-Business (“GOB”) sales results.
E-commerce companies’ more sophisticated systems may also provide opportunities to understand inventory at the SKU rather than department level. This could drive more precise insights by helping identify potential problems, such as small quantities, broken size runs, or slow-moving goods that may generate lower gross recoveries in a disposition scenario. With this information, borrowers and lenders can work together to determine appropriate guidelines for initiating Borrowing Base reserves on low recovering buckets of inventory. This inventory would likely need to be wholesaled at significantly lower recovery values at the conclusion of the sale.
Analyze returns: Another key metric is return rates. It is an important indicator of the success and quality of a particular SKU and helps gauge customer confidence in products. A company’s normal course return rate has a direct impact on sales capacity projections; a return rate in excess of 20 percent can indicate that a reserve may be needed to mitigate risk associated with a loss of customer confidence in the retailer.
A returns allowance off of gross sales is important when planning disposition strategies, especially for internet retailers. In a traditional brick-and-mortar GOB sales event, a “No Returns / All Sales Final” policy is commonplace. However, the rate of returns from web sales tends to be higher than in-store purchases, meaning customers may expect the option to return merchandise in spite of an “All Sales Final” policy. Discussions on how returns are considered are a key component of an exit strategy. Depending on the nature of the business, the disposition agent may permit them for a period of time; however, that may not always be possible or practical. Be aware that in situations where returns are not allowed, higher discounting may be needed.
Consider effects of promotional pricing on final value: Asset-based lenders and borrowers should work to develop a clear understanding of the incentives needed to drive sales while remaining mindful of the potential impacts of various discounting options. Free shipping promotions, for example, may be something that customers are accustomed to. While continuing the promotion may be important to consumers, it also increases the expense burden. It is not uncommon for free shipping to average $4.00 to $10.00 per transaction. As GOB sales multipliers for internet retailers are typically closer to normal course selling rates (or lower) for brick-and-mortar retailers, a free shipping offer has the potential to represent a significant expense based on the level of inventory, number of units, and average transaction size. Look to your appraiser to help you understand shipping expense assumptions in valuation reports.
Customer service is still king: Internet shoppers tend to have high expectations when it comes to ease of customer service, which is why maintaining consistency is critical during GOB sales. Throughout the process, retailers should adhere to the same standards of authenticity, transparency, and consistency that they would use in the normal course of operations to maximize recovery. Lenders must recognize that this comes at a cost; maintaining core customer service functions could represent a significant expense during a 60-day GOB sale. Additionally, weak systems or return policy restrictions can cause significant customer service issues resulting in lost sales. Therefore, maintaining adequate customer service personnel may become a critical component to protecting the brand’s reputation for either ongoing stores or a potential post-liquidation sale of the brand. Make sure your appraisal considers these critical costs.
Secure agreements to utilize available third-party services: In cases where a third-party manages e-commerce functions, lenders should examine all related legal agreements to ensure inventory can be sold through all relevant channels. The ability to utilize third-party services to maintain normal course sales and fulfillment operations is essential. As an example, contract agreements may dictate that certain payment thresholds be met, even in the case of a total liquidation of assets. While appraisals typically assume the ongoing use of third-party services, this could pose a major stumbling block if overlooked.
Digital infrastructure crucial: Maintaining a strong connection to existing customers and a reliable platform for servicing orders is essential to maximizing value in a disposition. Intangibles such as websites, customer email lists, social media presence, brand equity, customer goodwill, and sales generated through referral networks and attendant economics have an important bearing on recovery values. They can also indicate a retailer’s strength in the marketplace. It is imperative to work with legal counsel to gain and retain the rights to use all associated digital assets to market the inventory of the company. Lenders should work in advance to develop a clear understanding of any terms governing ownership, control, or usage of critical intellectual property (“IP”) in a GOB sale scenario.
Beyond its critical role in executing internet sales, IP can also add value to internet retailers. Increasingly, brands, domains, customer lists, and other intangible assets are marketed separately from the inventory. It may be worthwhile to independently appraise the expected value these assets could bring in a sale. There may be an opportunity to partner with a secondary finance company comfortable lending against IP, and could add value to a loan.