Internet & Catalog Retailers
Date January 2018
By the numbers
- American shoppers spent a record $5 billion in 24 hours on Black Friday, representing a 16.9% increase in online spending compared with 2016, according to data from Adobe Digital Insights
- Cyber Monday sales increased 16.8% to a record $6.6 billion, making it the largest primarily U.S.-based online shopping day in history with nearly $1 billion more spent than in 2016. A record 81 million consumers shopped, with 43% using a mobile device, 13% shopping on computers at work, and the remainder shopping by computer at home
- On an adjusted basis, estimated U.S. retail e-commerce sales for the third quarter of 2017 totaled $115.3 billion, an increase of 15.5% over the same period in 2016, while total retail sales increased only 4.3% during the same period. While growth remains brisk, e-commerce still comprised just 9.1% of sales in the third quarter (compared to 8.2% last year), meaning this retail transformation is still in its early stages
- Consumers are receiving fewer catalogs in the mail: 9.8 billion were sent in 2016 compared to the 2007 peak of 19.6 billion
Continuing evolution of retail: Bloomberg notes that even after the strongest holiday season in a decade, U.S. retailers still have way too many stores. Industry experts at the National Retail Federation’s January 2018 trade show predict that chains will close additional stores as they continue to struggle with heavy debt burdens and shrinking shopper traffic, exacerbated by the continued growth of online shopping as a percentage of total retail sales. E-commerce sales for Q3 2017 increased 15.5 percent over the same period in 2016. Following a few tough years of bankruptcies and liquidations, brick and mortar closures are expected to continue for the next two to five years as expiring leases at underperforming locations are not renewed and more retailers file for bankruptcy. “We’re still vastly over-stored,” says Rod Sides, vice chairman of Deloitte LLP, adding “It’s not that the industry is dying, we’re in a correction.” While healthier chains are welcoming the influx of cash, both from higher sales and from the recent U.S. tax overhaul, they still need to act fast to deploy it or risk getting left behind as industry changes accelerate. “With more niche players cropping up online and in pop-up stores, the pressure on traditional retailers isn’t relenting,” notes Greg Petro, chief executive officer of First Insight Inc., a technology firm that helps retailers improve their operations.
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.
Recognizing 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 e-commerce 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.
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.
Catalogs continue: While paper catalogs have become primarily a marketing tool for many retailers, especially during the holiday season, for many consumers, catalogs remain an important sales channel. Sophisticated retailers are continuously working to build a seamless omni-channel experience that uses catalogs, websites, and physical stores seamlessly and interchangeably to help customers shop and make purchases. Decades ago, generalist catalogs like those from Sears, JCPenney, and Spiegel were physically gigantic and included virtually everything those retailers had in stock. Efficiencies in reaching rural and urban customers as well as the convenience for those who did not want to travel to a physical store defined catalogs into a key sales tool. Speaking to the change from catalogs of old, real estate consulting firm SiteWorks notes that “in a sense, all we’ve really done is transfer a big portion of catalog sales to the internet.” SiteWorks added, “the reasons for that are pretty straight forward, as listing items is cheaper and more efficient on the internet, and assortments and prices can be changed instantly.”
Despite revisions in type and size, the paper catalog remains relevant for many retailers with mature e-commerce businesses and/or brick and mortar stores. Restoration Hardware, Neiman Marcus, Pottery Barn, L.L. Bean, Ikea, Williams-Sonoma, J. Crew, and Bonobos are a few of the retailers still investing in catalogs. Although catalogs have gotten smaller and circulation is down from a peak in 2007, for many pure play retailers catalogs remain an essential way to reach customers, both prospective and current. Catalogs are tactile and can be scanned with minimal effort and attract attention in a way digital images cannot. Per a report by the U.S. Postal Service, millennials, a critical and growing customer demographic, are only 15 percent likely to ignore direct mail, compared to 50 percent who say they ignore digital ads. This bodes well for continuing investment in catalogs as part of an omni-channel retail approach.