Kurt Salmon Review - October 2013


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Kurt Salmon Review - October 2013

Is the Catalog Dead? Not in an Omnichannel World 6
Why the catalog is key to a successful omnichannel strategy

How a Fragmenting Grocery Market Is Creating New Opportunities for Growth 12
As consumers flee the undifferentiated middle, new opportunities have emerged
Plus: CPGs That Have Avoided an Undifferentiated Death

Why When It Comes to Omnichannel for Mid-Tier Retailers, It Pays to Be a Fast Follower 20
We spoke to consumers and first-mover retailers to find out which omnichannel capabilities mid-tiers need to offer now and which ones they’ll need to offer later

The Masstige Miracle: Building a Bridge to Higher Profits 26
From shampoo to juice, premium-quality products priced for the masses are showing intense growth

The appetite for ethnic foods is growing, providing a sweet spot for private equity investors
Deal Ideas at a Glance 40
Ideas for investing in Tribes of One and Beyond the Suburbs

STRATEGY: Digital Chatter 44
For brands, analyzing the conversations taking place online yields invaluable information

Outlets 50 : Why outlets will continue to drive growth and increase brand loyalty

Shoppers who experience a dopamine surge will quickly turn into loyal customers

DUE DILIGENCE TOOLS: Assessing White Space from Afar 58
Validate management’s forecast or create your own using an outside-in analysis

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Kurt Salmon Review - October 2013

  1. 1. KURT SALMON REVIEW Retail. Consumer Products. Private Equity. Strategy. IN THIS ISSUE Why successful omnichannel strategies include catalogs 6 How just-under-premium products are breathing new life into stagnant categories 26 What you can learn about your brand by analyzing digital chatter 44
  2. 2. From the Editor The retail industry is undergoing an unprecedented period of change. New, rapidly deployed technologies combined with underlying shifts in demographics and income distribution are producing shopping behaviors that are forcing retailers and wholesalers alike to significantly rethink their business models. But the fundamentals of a successful retail proposition remain unchanged. Indeed, as we demonstrate in this second edition of The Kurt Salmon Review, even against the backdrop of this rapidly evolving landscape, there are predictable patterns that can be exploited to build highly attractive investment propositions. For example, the shift in incomes combined with the desire for aspirational products is creating huge demand for the market segment known as masstige and is helping to drive continued growth in outlet stores. And the polarization of income groups is making clear the importance of avoiding the “undifferentiated middle” in retail grocery and consumer packaged goods, while an increasingly diverse population is opening up new opportunities in the ethnic foods category. Meanwhile, as retailers continue to leverage technology by rolling out omnichannel capabilities tailored to the various preferences of their customers, the most traditional of shopping channels—the catalog—still plays a key role. That’s just a sampling of what we have for you in this issue. We hope that you enjoy it as much as you did the first one, and, as always, we look forward to hearing from you. Best regards, Michael Dart Senior Partner and Director, Private Equity and Strategy Practice 3
  3. 3. TABLE OF CONTENTS issue 02 FEATURES IN BRIEF Is the Catalog Dead? Not in an Omnichannel World 6 DEAL OPPORTUNITIES THE NEW RULES OF RETAIL REVISITED Ethnic Foods 34 Strategic Pricing 55 The appetite for ethnic foods is growing, providing a sweet spot for private equity investors Shoppers who experience a dopamine surge will quickly turn into loyal customers Why the catalog is key to a successful omnichannel strategy How a Fragmenting Grocery Market Is Creating New Opportunities for Growth 12 As consumers flee the undifferentiated middle, new opportunities have emerged Plus: CPGs That Have Avoided an Undifferentiated Death Why When It Comes to Omnichannel for Mid-Tier Retailers, It Pays to Be a Fast Follower 20 We spoke to consumers and first-mover retailers to find out which omnichannel capabilities mid-tiers need to offer now and which ones they’ll need to offer later Deal Ideas at a Glance 40 Ideas for investing in Tribes of One and Beyond the Suburbs DUE DILIGENCE TOOLS Assessing White Space from Afar 58 Validate management’s forecast or create your own using an outside-in analysis STRATEGY Digital Chatter 44 For brands, analyzing the conversations taking place online yields invaluable information Outlets 50 Why outlets will continue to drive growth and increase brand loyalty The Masstige Miracle: Building a Bridge to Higher Profits 26 From shampoo to juice, premium-quality products priced for the masses are showing intense growth 4 55 5
  4. 4. One of the most common questions we hear from both investors and retailers alike is whether the print catalog channel is becoming obsolete. IS THE CATALOG DEAD? NOT IN AN OMNICHANNEL WORLD Indeed, according to the Direct Marketing Association, the number of catalogs mailed in the United States fell again last year, to 11.8 billion, the lowest level since the DMA began collecting annual data in 2001 and down from a peak of 19.6 billion in 2007. As digital channels have grown increasingly important, retailers have gone through three distinct phases in managing their catalog businesses: 1. Reducing catalog mailings broadly and indiscriminately 2. Using data to test new catalog formats and targeted catalog mailing reductions and redirections 3. acilitating consumers’ use of catalogs in combination with other channels F Phase 1: Cost-cutting mentality Lands’ End tried the cost-cutting approach in 2000 and saw a $100 million decline in sales. Why? Consumers spend more money when they’re shopping with a catalog in hand—even when they’re shopping online. Women ages 18 to 30 are especially motivated Thus, the oft-overlooked catalog has become a key component in a robust omnichannel strategy. have bought an item after first seeing it in The power of the printed page A full 44% of consumers say they want to receive fewer catalogs in the mail, while just 13% want more of them. Yet in practice, catalogs are a potent source of inspiration: Some 58% of online shoppers say they browse catalogs for ideas, and 31% have a retailer’s catalog with them when they make a purchase online. 6 by catalogs, claiming that they enhance their impression of a retailer. More importantly, 45% say catalogs stimulate their interest in a retailer’s products, and a whopping 86% a catalog. Case in point: After its early catalog misstep, Lands’ End eventually presented a pop-up survey to customers placing orders on its site asking if they had first looked at the catalog, and 75% of them said, “Yes.” Phase 2: Testing the way to moreeffective catalogs Williams-Sonoma is a devoted catalog marketer in large part due to the data it’s 7
  5. 5. Catalogs are effective not only at getting people to spend money. Compared with customers who use only the Web to shop, those who use catalogs spend more money and return more often. uncovered proving how effective its catalogs are at generating sales: Some 55% of purchases made on the specialty retailer’s various websites are catalog-driven. When looking at the purchases made by its customers across all channels, that figure jumps to 70%. Williams-Sonoma began looking for ways to maximize the return on its catalogs long before the proliferation of online shopping, however. It first focused on the physical format, testing modifications that included trimming the weight and size of its paper and reducing the number of pages. In doing so, it discovered that shaving a mere 1/16 of an inch off the width of its catalog pages was the most effective way to cut costs and had zero impact on sales. In the meantime, it reduced the number of pages in catalogs aimed at specific audiences, namely those deemed to be of lower value. But the number of Williams-Sonoma’s catalog pages overall has risen 11% year over year as it’s showcased fewer products but expanded their descriptions. It’s also added related, supplemental content, such as recipes. This “more compelling story,” as one of the company’s former direct marketing managers described it, lifted direct-to-consumer sales by 12% in four years, to 42% of total revenue. 8 Toy retailer FAO Schwarz took a different approach, reducing the total number of catalogs it mailed out each year. Most notably, it ceased distribution of its spring catalog after extensively testing and modeling the effects, instead mailing out a smaller, “teaser” version that highlights the products available on its website. The only full-version catalog it continues to mail each year is for the holiday season. FAO Schwarz says the cost savings have been extensive, with no subsequent loss in revenue. Phase 3: Embracing and encouraging use of the catalog Catalogs are effective not only at getting people to spend money. Compared with customers who use only the Web to shop, those who use catalogs spend more money and return more often. But it is the customers who utilize both channels who are the most valuable of all. Our research has found that the average order size made by customers online is approximately 6% lower than orders placed directly through call centers using catalogs. For example, during one calendar-year period, we observed that Internet-only customers of one specialty retailer placed orders of $80 on average, whereas call center/catalog customers’ average orders totaled approximately $90. Customers who utilized both channels saw their average orders climb even further, to more than $92. Retention rates showed a similar pattern, with Internet-only customers coming in 13% to 32% lower than their call center/catalog counterparts. Meanwhile, the retention rates of customers who combined the two channels outpaced them both. As for those customers who place their first order through a call center using a catalog and later migrate online, from a retailer’s perspective, their attractiveness decreases. The number of orders placed through call centers using catalogs worked out to 1.4 per customer during a recent calendar-year period, for a total of $148 each, but came in at just 1.2 orders per customer for a total of $120 each for those who moved to buying on the Internet. It’s a trend that appears to continue over time. Our data shows that for the call center/catalog-only customer, total spending rose more than 11% to $148 from $133 in a recent year-over-year period, while for those customers who migrated to the Internet, spending edged up to roughly $120 from $118, not even a 2% rise. Despite the ease and ubiquitous availability of online shopping, it turns out that a significant number of people prefer the experience they get through a call center, whether it’s because they believe the service is more helpful or personalized or simply because they would rather interact with another human being. Broadly speaking, a full 24% of shoppers who had recently bought items by way of a catalog said they prefer to make purchases over the phone as opposed to using a website. When viewed through the lens of age, however, we see a strikingly different picture. Of women ages 18 to 30 who bought an item they first saw in a catalog, 64% went to the brick-andmortar location to make their purchase, while 32% bought the item online and just 4% purchased the item over the phone. The behavior of such a critical group of shoppers is a powerful leading indicator. It signals that on one hand, the use of phone-based call centers will likely fade over time, but on the other, use of the catalog will not. It is also a testament to the power of omnichannel, of which the catalog is a critical component. 9
  6. 6. “We’ve learned already that customers who have a multichannel relationship with Nordstrom spend four times as much with us as those who do not.” One retailer that has long sought to leverage that power is Nordstrom. The high-end provider of fashion apparel and accessories revamped its catalog operations, with circulation of 60 million, after spending $1 million annually on testing and analysis. It took half of the resulting $36 million in savings and used it to drive online sales, which boosted total net revenue the following year by 23%. As the company noted in its subsequent annual report, “We’ve learned already that customers who have a multichannel relationship with Nordstrom spend four times as much with us as those who do not.” Restoration Hardware has learned a similar lesson. To that end, the luxury home furnishings retailer’s most recent spring catalogs totaled some 1,600 pages, compared with approximately 1,000 pages in total during the same period the year before. J. Crew has moved to marry its catalog with the ultimate online inspiration hub for shoppers: Pinterest. The retailer posted its entire September catalog on the pinboard-style site, allowing Pinners to pre-order items 10 from the fall line a day before the printed version was released. AUTHORS Michael Dart Senior Partner and Head of Private Equity and Strategy Practice michael.dart@kurtsalmon.com Greg Ellis Director, Private Equity and Strategy Practice greg.ellis@kurtsalmon.com Online-only men’s clothing retailer Bonobos, meanwhile, whose handful of brick-andmortar locations function only as showrooms, started offering print versions of its catalog this summer. The future of retailing is omnichannel and it includes catalogs For consumers, omnichannel means having a seamless brand experience, regardless of how they’re accessing that brand. And as the data makes clear, consumers still want to access their favorite brands with a catalog in hand. For retailers, analytics and data mining are core competencies that are not only necessary for managing catalogs, but also, in a world increasingly powered by big data, for managing their businesses overall. v 11
  7. 7. How a fragmenting grocery market is creating new opportunities for growth The grocery store can no longer be all things to all people. It used to be that grocery shopping behavior was the same regardless of age, income or ethnicity. Everyone shopped once or twice a week at their local grocery store and everyone bought the same brands. But a combination of factors—a renewed interest in healthful, fresh food; an ever-morediverse population; and, most importantly, the polarization of income groups—has led to a new set of shopping behaviors. And with them have emerged a new set of opportunities. Shopping based on income and occasion While the move to more healthful eating and an increasingly diverse population have caused and will continue to produce fundamental changes in the way Americans shop for groceries, it is the growing gap between the rich and the poor that is having the most profound impact. Much in the same way that the country’s increasing income disparity has produced new shopping behaviors for apparel (the rise of high-low fashion) and home improvement (the success of DIY megastores like Home Depot and the steady shift upmarket for home furniture and accessories retailers like Restoration Hardware), when it comes to groceries, the rich shop for different reasons than the poor do. To better illustrate the discrepancy, we have segmented grocery shopping occasions into four types: regular (recipe items needed for 12 preparation that will take place anywhere from that day to up to a week out), convenience (“dinner tonight,” which typically takes the form of freshly prepared meals), stock-up and special (parties, holidays, etc.). As Exhibit 1 illustrates, the rich not only shop for groceries based on convenience and special occasions far more often than the poor—28% and 33%, respectively—they shop at more stores overall. Income- and occasion-based shopping has, in turn, fundamentally altered the grocery landscape itself. As seen in Exhibit 2, upper-income consumers and their frequent convenience-based grocery shopping have helped drive the success of Whole Foods, which offers a rich selection of made-toorder and prepared meals, while high unemployment has forced a growing share of the population to reduce the number of trips it makes for special occasions and instead concentrate on regular grocery shopping 13
  8. 8. Targeting the high-income special-occasion shoppers are stores like BevMo, a regional EXHIBIT 1: Mid- and Upper-Income Grocery Shopping including liquor, soda, gourmet finger food— can select from tanks of live fish and crabs even hostess gifts. And Smart Final is using and have their selection cleaned one of five its large food service–sized SKUs to target the different ways. Great Wall also has an exten- special occasion needs of companies. sive selection of frozen convenience foods owned by Costco, a few ethnic superstores are creating hypermarts targeted at key the Mid-Atlantic region, for example, has a Market, Sprouts, Bristol Farms, New huge format focused on Asian cuisine with Seasons, Great Wall 33% Lower 17% Grocery Walmart Special Stock-Up Regular Convenience Middle 1% 15% Whole Foods Drug Lower 0% 2013 Club 28% Income 14% Club Upper 6% Middle 6% 2005 Upper Upper Convenience Special cook from scratch. High-end grocers to watch: Fresh 14% Stock-Up Asians who lack the time or patience to segments of the population. Great Wall in % more than low income Regular that are attractive to second-generation While the stock-up trip continues to be EXHIBIT 2: Grocery Penetration by Income and Occasion Mid Upper of an Asian wet market, where customers Occasions Shopped % more than low income Mid tures an ever-widening array of party staples Convenience Stores Shopped* imported products and many of the features Special At the high end, grocers are serving the convenience occasion-driven shopper in myriad ways. Regional chains like Fairway and Bi-Rite are offering freshly prepared foods that are near restaurant-like in quality, for example, a model with which Fresh Easy Stores like Sprouts and Fresh Market, meanwhile, are focused on providing an exceptionally personalized, neighborhoodstore style of service, with enough staff to ensure quick counter assistance, short checkout lines and help in carrying groceries out to shoppers’ cars. chain whose core offering is wine but also fea- Stock-Up Emerging opportunities But as both Exhibits 1 and 2 also make clear, the diverging set of grocery shopping behaviors has created new growth opportunities. could have succeeded had their real estate strategy not consisted of too many locations populated with the wrong demographics. Regular at the likes of hard discounters like Aldi and WinCo and, increasingly, dollar stores. Dollar Grocery Walmart/ Target * Excluding traditional grocery 14 15
  9. 9. EXHIBIT 3: Chicago Grocery Market Penetration by Category Total Stores Hard discounters like Aldi, which carries private-label brands and has done away with high-labor perimeter departments, are particularly well positioned to successfully compete for the low-income, regular-occasion shopper. Another contender is WinCo, which boasts employee-centric policies coupled with a regional anti-Walmart bent. A growing number of ethnic grocers, meanwhile, are targeting a low-income customer base that traditionally shops every day and purposely chooses not to buy produce from supercenters like Walmart. Some, like La Michoacana, aren’t designed to be one-stop shops but to augment the needs of people who also shop such supercenters. Low-income grocers to watch: Aldi, Lidl, Northgate González, La Michoacana The growing polarization of income groups and their related changes in shopping behav16 ior are forcing traditional grocers to either shift their offerings upmarket or down or to consolidate in the middle in an effort to increase their share and improve their cost positions. In Chicago, for example, the number of traditional full-service grocers has fallen nearly 3% since 2009, while the number of discount grocers has risen more than 23% and the number of gourmet grocers has more than doubled. (See Exhibit 3.) Among them is Mariano’s Fresh Market, a high-end offering from Wisconsin-based traditional grocery chain Roundy’s. With Mariano’s, whose locations measure some 70,000 square feet each and include the telltale feature of high-end grocers, the attractive perimeter department, Roundy’s chose not to compete with the likes of Dominick’s and Jewel in the shrinking middle, but to instead evolve and grow its footprint in the expanding upper tier. There are now 10 Mariano’s in the region, and Roundy’s plans to open an additional three by the end of 2013. Another threat to the upper end of the regular shopping occasion is AmazonFresh, through which the online retail giant has begun delivering fresh groceries (including produce) to Amazon Prime members in select cities, with same-day and next-day morning delivery free on orders over $35. It remains to be seen how the service will com- 4-Year Change 300 250 (in millions) At the low end, grocers are primarily serving regular-occasion shoppers and in the process are taking customers away from supercenters like Walmart and Target—which are already losing share as the number of low-income shoppers who can afford to stock up on large-format items falls—with lower prices and more convenient locations. Notably, dollar stores have become a favorite of many low-income consumers whose regular-occasion shopping trips depend on cash flow. 200 148 2.6% 94 23.7% 44 120% 152 150 100 50 0 76 20 2013 2009 Gourmet Discount Full-Service Source: Mid-America Real Estate Corp.’s Urban Grocery Study pete with smaller, regional online grocery delivery services, such as FreshDirect in New York City. At the lower end, many grocery stores have become “light” versions of hard discounters. Chains like Food 4 Less, a Kroger banner, keep prices low by using a box format that reduces labor, for example, and Grocery Outlet offers a strong price proposition by purchasing manufacturer closeouts and franchising operations. For those left standing in the middle, what is clear is that survival is becoming increasingly challenging. In the past few months alone, Supervalu sold five grocery chains, including Albertson’s, to a consortium of private equity firms; Kroger agreed to pay $2.4 billion to buy Harris Teeter; and Great Atlantic Pacific Tea Co., which emerged from bankruptcy in 2012, recently put itself on the block. v AUTHORS Bruce Cohen Senior Partner, Private Equity and Strategy Practice bruce.cohen@kurtsalmon.com Peter Hsia Partner, Private Equity and Strategy Practice peter.hsia@kurtsalmon.com 17
  10. 10. Staying Alive in the U.K. and U.S. CPG Markets As consumers continue to migrate away from the undifferentiated middle tier of retail grocery, be, a factor) so much as what that brand purports to represent. In both the United States and they are eschewing the undifferentiated middle tier of consumer products as well, leaving a graveyard the United Kingdom, the macro trends we see currently powering the growth of successful of CPG products in their wake. Increasingly with CPG, however, what drives consumers to buy or CPG brands fall on either end of the differentiation spectrum. By Craig Twyford of Octopus, not to buy a particular brand isn’t solely how much it costs (though price is, and always will a U.K.-based consulting firm CHEAP CONVENIENCE PREMIUM CHOICE SAVE THE WORLD SELF-INDULGENCE ANTI-CORPORATE AFFLUENZA 18 DIFFERENTIATION DIFFERENTIATION 19
  11. 11. Why When It Comes to Omnichannel for Mid-Tier Retailers, It Pays to Be a Fast Follower Consumers, irrespective of where they live, how much money they make or how educated they are, increasingly want from individual retailers a seamlessly integrated shopping experience no matter which channel they’re using to shop. They want, in other words, to be provided with an omnichannel experience. And they’re getting it, courtesy of some of the industry’s top-tier names: electronics retailers such as Best Buy and OfficeMax, broadline behemoths like Target and Walmart, and department stores like Macy’s and Nordstrom. Indeed, Neiman Marcus recently announced it will spend up to $100 million over the next three to five years to expand its omnichannel capabilities. For those mid-tier retailers still charting their omnichannel evolution, marrying the results of our survey with the omnichannel lessons learned by the first movers yields two things: a place to start, and if they’ve already started, a place to go next. 20 email discounts in-store returns deliveries 20% off inventory catalog But while the consumer desire for omnichannel capabilities is more or less equal across geographies, incomes and educational levels, the value that consumers place on individual omnichannel capabilities is not, according to a recent survey conducted by Kurt Salmon. returns 21
  12. 12. Omnichannel may be a buzzword, but it’s more than just a passing fad; it represents a fundamental evolution in the retailing experience. Who cares about what and why Omnichannel may be a buzzword, but it’s more than just a passing fad; it represents a fundamental evolution in the retailing experience. That being said, mid-tier retailers should carefully consider their customers when deciding which omnichannel capabilities to implement. And they need to take the long view, to implement those capabilities that their customers find most valuable now, but lay the groundwork for the ones their customers will find valuable down the road. where to shop are those that offer savings and convenience. Indeed, of all the omnichannel features we asked consumers to rank, email discounts came out on top. They were followed by cross-channel fulfillment features such as the ability to see store inventory online and return purchases made online in stores. Omnichannel features that leverage consumers’ smartphones, on the other hand—the ability to scan products, for example, and self-checkout— were far more likely to be considered important Currently, according to the results of our survey, the omnichannel features consumers consider most important when deciding by those aged 18 to 34, whereas 35- to 54-yearolds didn’t find them as important and those aged 55 and older, even less so. EXHIBIT 1: Most Valued Omnichannel Features Receive Coupons via Email 22 In the same way that the disparity among age groups is a leading indicator for what tomorrow’s consumers will value in omnichannel initiatives, so too are the answers of consumers who identified themselves as early adopters of technology—and to a slightly lesser degree, those who consider themselves “avid shoppers.” Both groups are more likely to follow brands and retailers on social media (~2 to 3 vs. ~0 to 1), for example, and to have brand and retailer apps on their smartphones/ tablets (~2 to 3 vs. ~0 to 1). In fact, when asked how important various omnichannel features were overall, early adopters said they considered them nearly twice as important as those who identified themselves on the tech-averse end of the spectrum, at 7.4 out of 10 vs. just 4.2 out of 10, respectively. EXHIBIT 2: Value of Emerging Omnichannel Features by Age (Index to Median) 1.32 Nearly three times as many consumers aged 18 to 24 use their phones to check prices, read reviews, etc., all the time or more than half the time than do those aged 45 to 54. Survey respondents in the 18- to 34-year-old demographic were also more likely to rank as important omnichannel features that enable personalization, such as suggestions for products they might like based on their previous browsing or purchasing history, either online or in-store. (Index of Importance to 18- to 34-Year-Olds Compared to Those Aged 55 and Older) 1.25 Home Delivery for Out-of-Stocks 12.20 1.00 See Store Inventory Online 0.85 0.74 Reserve Store Inventory Online Return Online Purchases to Store 10.00 8.33 4.25 View Store Map on Phone Interact with Brand on Social Media Self-Checkout on Phone 3.33 Scan Products with Phone In-Store Receive Coupons on Phone When Entering Store 23
  13. 13. According to the results of our survey, the omnichannel features consumers consider most important when deciding where to shop are those that offer savings and convenience. In other words, as the population ages and increasingly uses more technology, the behaviors of the younger, more tech-savvy consumers we heard from will only become more common as time goes on—which means mid-tier retailers need to plan for them now. What the first movers have learned firsthand Consumer surveys, while insightful, are helpful only up to a point. For mid-tier retailers, a more complete roadmap for how to chart your omnichannel course can be gleaned by marrying such insights with the experience of your top-tier counterparts that have already started implementing such capabilities—and, in the process, have learned some valuable lessons. Among them: 1. The ability to offer an omnichannel experience starts with an omnichannel mindset. Channels should not be treated by retailers as individual plants, but as branches of the same tree that wilt—or thrive—together; operational and organizational divisions among channels will translate directly into a fractured customer experience. A unified approach is especially critical when it comes to retailers’ online and in-store offerings; consumers no longer differentiate between the two, so you shouldn’t either. 2. If your customers really want it, give it to them. Follow your customers in the direction they’re headed and do whatever you can to 24 make their journey more enjoyable. If they resist using in-store kiosks to compare prices and check product reviews and instead want to do so on their phones, for example, ditch the kiosks and offer a rich mobile browsing experience. Fighting the urges of your customers will cost you more in the long run— both in terms of revenue and market share. Moreover, it will blind you to the opportunities that such emerging behaviors can enable. Case in point: When your customers use their phones to browse, you log more data about their preferences. By analyzing such data and using it to make personalized promotions, you will increase both your customers’ basket size and brand loyalty. 3. Gather as much consumer data as you can—and use it. As one retail executive put it, “Everything is for sale. The consumer is perfectly willing to sell part of their information if they can get a deal.” Indeed, consumers know that they are giving up a degree of their privacy, and they are doing so willingly—with the expectation they will get something valuable in return. So make it valuable. Make it, in other words, personal. Take the information your customers are giving you—where they are, what they’re looking for, what they’ve already bought—and use it to give them something they, and only they, want. They won’t resent it; they will thank you for it. 4. Roll it out, then iterate. Everyone is different. Not only will some omnichannel capabilities be better suited to, say, women’s apparel than for grocery, but even for individual retailers, what works in one store could fail EXHIBIT 3: Omnichannel Journey Stages of Omnichannel Evolution Multichannel Availability Isolated channel offerings Inconsistencies in brand appearance Online limited to must-have features, services Online assortment less purposefully defined No specific pricing for online market Unconnected marketing Cross-Channel Footprint Aligned brand messages and channel offerings Extended online capabilities Comprehensive assortment concepts Dynamic pricing Focused marketing for specific segments miserably in another. The only way to truly find out which omnichannel initiatives work for you, and where, is to roll them out. And do so with the understanding that what works today may lose its appeal and effectiveness with consumers over time, while other omnichannel capabilities will grow to become must-haves. For example, while broadly speaking most consumers don’t currently expect mobile-enabled omnichannel capabilities, the younger, more tech-savvy among them do, which means it won’t be long before such capabilities come to be expected by everyone. 5. Utilize turnkey solutions wherever possible. It may very well be in your best interest to custom-build omnichannel-enabling technology, and many of the first movers, from Target to Nordstrom to American Eagle, now have in-house labs to do just that. But there are also countless vendors offering turnkey solutions, some of which have already been thoroughly road-tested by first movers. An Complete Omnichannel Experience Brand experience Distinct roles for each channel Assortment strategies aligned with how customer shops Flexible ordering and fulfillment Individualized marketing Personalized customer service Cross-channel organizational structure and metrics example of a one-off, standalone technology is Shopkick. The mobile rewards app sends shoppers redeemable points when they walk into stores, including Best Buy and Macy’s, and recently began enabling in-app purchases from a select group of retailers as well. For mid-tier retailers that want a more complete suite of services, eBay’s omnichannel operations capabilities range from fulfillment to customer support and can be bundled or used on a standalone basis. v AUTHORS Mark Anglin Partner, Private Equity and Strategy Practice mark.anglin@kurtsalmon.com Greg Ellis Director, Private Equity and Strategy Practice greg.ellis@kurtsalmon.com 25
  14. 14. $$$ $ $$$ $$ $ 26 The Masstige Miracle Building a Bridge to Higher Profits As more consumers shop mass channels in an effort to save money, their desire for high-quality, even premium or luxury, items remains firmly entrenched. On the other end of the spectrum, prestige shoppers are only too happy to get what they consider a bargain on products for which they would normally consider paying more. Both groups find what they’re looking for in “masstige.” Masstige products bridge the mass and prestige markets by way of price point and perception. They’re premiumquality products, basking in the halo effect of their luxury counterparts, that mass shoppers find affordable and prestige shoppers view as valuable but not cheap. And they’re showing intense growth in many otherwise stagnant categories of retail. 27
  15. 15. Shampoo One area of health and beauty products that has seen a surge in higher-end demand is hair care. Driven by a new interest in salon products, which have demonstrated the benefits of using high-quality ingredients like keratin and Moroccan argan oil, masstige brands are succeeding because they feature such ingredients but are widely available and are lower cost. The $4 billion U.S. shampoo market has been growing at 2.6% annually since 2010, growth that can be attributed almost entirely to masstige (between $4 and $10) and premium (more than $10) products. Masstige shampoos specifically are growing at the highest combined annual growth rate—12.1%—of any price point in the category, as illustrated in Exhibit 1. EXHIBIT 1: U.S. Shampoo Market by Price Level ($ Millions, All Channels) 2010–2012 CAGR $4,000 $4,000 $4,200 2.5% 6.3% Premium (Ͼ$10) Masstige (Ͼ$4 and Ͻ$10) 12.1% Mid-Tier (Ͼ$2 and Ͻ$4) –0.8% 2.5% Value (Ͻ$2) 2010 28 2011 2012 And while unit growth since 2010 has been flat at less than 1%, the composition of the market has undergone a significant shift. Value (under $2) and mid-tier (between $2 and $4) shampoos have lost share to the premium and masstige categories, where sales have grown at a compound annual growth rate of 4% and 9%, respectively, during the same period. Among the greatest success stories in the masstige shampoo category is Organix, which promises premium ingredients and results, but whose standard-sized 13 oz. shampoos and conditioners top out at around $8 each in the United States. It’s especially well known for its Brazilian keratin therapy line, in particular the 30-day smoothing treatment, which sells for approximately $15. The salon-only Brazilian Blowout, meanwhile, can cost upwards of $400 and is eschewed by many because of the associated health risks of its key ingredient, formaldehyde. Another masstige shampoo line that promises salon-quality results without the use of harsh chemicals is CHI, owned by privately held Farouk Systems. Based in Houston and run by a team of hairdressers, Farouk Systems also produces a full line of salononly hair care products and tools. A PRODUCT IS MASSTIGE WHEN 1. t has some real or I perceived effectiveness. Its attributes echo those of its luxury counterparts, which have been given the seal of approval from prestigious sources 2. t’s priced right. I It’s affordable for mass shoppers but not so inexpensive that premium shoppers think it’s cheap 3. easy to find. It’s It’s available in mass channels that are conveniently located Juice Nowhere is consumers’ preference for natural products as well established as it is in food. The natural/organic foods segment grew from $13.5 billion in 2001 to $43.5 billion in 2011, a compound annual growth rate (CAGR) of 12.4%. 29
  16. 16. Masstige products bridge the mass and prestige markets by way of price point and perception. EXHIBIT 2: U.S. Refrigerated Juice Market by Dollar-Weighted Volume Change, 2012 21% Premium -6% Non-Premium Of particular strength in this category are premium beverages, which surged from $397 million to $553 million in the 2009–12 period, a CAGR of 11.7%. At the same time, beverages overall saw their CAGR contract by 1.5%, from $116 billion to $111 billion. 30 Traditional juice offerings, which are often loaded with sugar and little else, have started to fall out of favor in exchange for coldpressed and custom-blended options. Indeed, in 2011–12, unit volume in the non-premium refrigerated juice market dropped 6%, while premium unit volume grew 21%. (See Exhibit 2.) Looking to cash in on this trend is Starbucks, which in November of 2011 paid $30 million in cash to buy cold-pressed juice maker Evolution Fresh. In addition to making Evolution juices available in groceries like Whole Foods and in Starbucks’ own stores, the coffee giant opened the first Evolution Fresh store in Bellevue, Wash., in March of 2012, featuring 8 oz. handcrafted juices for $4.99, 16 oz. versions for $7.99 and smoothies priced at $6.99. There are now three retail locations in Washington state; a fourth opened in San Francisco in the fall of 2012. The price point puts Evolution squarely in the masstige fresh juice category vs. high-end BluePrint, which utilizes the same high-pressure pascalization process (HPP) as Evolution. BluePrint, which was acquired by Hain Celestial for an undisclosed amount in a deal that closed in December of 2012, is best known for its BluePrintCleanse line of juices, which starts at $65/day for six bottles—or almost $11 each. The contrast is even sharper in retail locations, where bottled Evolution juices start at $3.95; BluePrintJuices, meanwhile, range anywhere from $6.99 to $11.99. Other masstige acquisitions have included Bolthouse Farms, whose offerings include juices and smoothies as well as salad dressings and carrots. With sales estimated at around $700 million, it was purchased by Madison Dearborn Partners for $1.1 billion in 2005 and sold to Campbell Soup Company for $1.55 billion, or 9.5x EBITDA, in 2012. Bolthouse in late July inked a distribution deal with Core-Mark Holding Co. to make 10 of its juice flavors available to more than 30,000 convenience store retailers across the country. But many independent masstige brands remain, among them Suja Juice, whose organic cold-pressed juices are available in stores in 39 states and Washington, D.C. Pet foods Consumers’ growing push to buy natural/ organic not only extends to food, but to the food they feed their pets, whom many consider to be family members. It’s a push that intensified after more than a hundred brands of pet food were pulled from North American shelves in 2007 for containing melamine- tainted wheat gluten by way of China, which was linked to the deaths of an unknown number of cats and dogs. According to one recent survey, 63% of pet owners said they were very concerned about the safety of the pet products they buy, and 38% said they felt that natural/organic brand pet products are often better than standard national brand products. Combined sales of natural pet foods and natural pet care products are forecast to grow by 10% to 15% over the period from 2014 to 2017, to hit $9.4 billion. That concern has prompted a surge in pet foods that feature natural and, in some cases, organic ingredients, an increasing number of which are available in nationwide chains like Petco and PetSmart. While most of the brands with such ingredients are still priced high enough to be considered “super-premium,” the price range among them continues to widen, and a masstige tier is starting to take hold. Merrick, for example, 31
  17. 17. From notebooks to juices to shampoos, the success of the masstige category proves that some luxury comes at a price almost everyone can afford. which offers both a classic and a grain-free line, was one of the earliest entrants in the masstige pet food space; it launched its Whole Earth Farms line in 2009 with the express aim of providing holistic pet food at a value price. The opportunity presented by this masstige category is particularly unique in light of the loyalty that pet food engenders. For as any pet owner will tell you, changing foods is not a decision undertaken lightly. Other categories Of course, consumers aren’t motivated just by what’s good for them and those that they love, but by whom or what they desire to be. Just as aspirations have always driven people to buy luxury items, so they also do with masstige. With that in mind, the cachet of a Nike shoe is now available at far lower price points than ever before, its sales powered by the lifestyle image that the premium shoemaker’s logo carries with it. Moleskine, the Milanese maker of journals, diaries, notebooks and related writing accessories that invokes such great creative minds as Ernest Hemingway and Pablo Picasso in its marketing, is sold in the likes of Target 32 and Staples. The company’s unit volume grew 14% annually from 2009 to 2011, while the notebooks category as a whole dropped 1%. Moleskine’s spring 2012 IPO was more than 3.6 times oversubscribed and saw the company valued at $626 million. In Brief Quick looks at key strategic issues, hot deal opportunities and new ways to evaluate success And for those who are simply looking for a momentary indulgence, even if it’s decidedly not good for them and has no bearing on their aspirations at large, there’s the growing masstige category of chocolate. Notable brands include San Francisco–based Ghirardelli, whose products are carried in mass channels across the country. From notebooks to juices to shampoos, the success of the masstige category proves that some luxury comes at a price almost everyone can afford. v AUTHORS Michael Dart Senior Partner and Head of Private Equity and Strategy Practice michael.dart@kurtsalmon.com OUT LET S Drew Klein Manager, Private Equity and Strategy Practice drew.klein@kurtsalmon.com 33
  18. 18. Finding Authentic Deals in Ethnic Foods The appetite for ethnic foods in the United States is rising, seemingly exponentially, driven by two fundamental factors: the growing diversity of the population and the sophistication level of America’s palate. Such a shift in consumer taste can be a sweet spot for private equity investors, who are ideally positioned to help nurture small ethnic brands in the U.S. market. In the process, investors can turn them into compelling portfolio candidates for consumer products companies, which know from experience that authentic ethnic flavor propositions can’t be developed in-house; they need to be acquired. Desired characteristics Potential targets Private equity investors looking for ethnic food brands with maximum upside potential, which they can nurture until they’re large enough to attract the interest of a CPG firm, want them to have the following characteristics: PE firms are, on the whole, better positioned than strategics to establish an ethnic food brand, as they are structured to both provide hands-on guidance and shoulder the risk associated with developing a smaller company. 1. has a flavor profile that is recognized It as authentic 2. has a strong loyal following in an It identifiable region, be it overseas or in the United States Friedman Fleischer Lowe (FFL), for example, spent four years working with Hayward, Calif.–based Asian frozen foods maker Discovery Foods, best known for its Ling Ling line of appetizers, to establish a presence with key national grocery retailers. Together 3. I s ethnic influence is still early in the t menu adoption cycle, ideally somewhere between inception and adoption Even better is a brand that has the above characteristics but also leverages a broader food trend already underway, such as health (such as the move to gluten free), portability or convenience. 34 35
  19. 19. EXHIBIT 1: Ethnic-Influenced Menu Adoption Cycle they improved Discovery’s manufacturing operations, expanded its sales force and introduced new products, prompting Windsor Foods to buy Discovery from FFL in 2011. Mediterranean And in June, Montreal-based Claridge Inc. sold Circle Foods, maker of frozen and refrigerated handheld Mexican foods, uncooked tortillas, and Indian flatbreads, to Tyson Foods. Regional Mexican Regional Italian Thai Indian Spanish/ Tapas Peruvian North African Nordic Chinese Italian Mexican Cuban Caribbean Japanese Brazilian Steakhouse “We believe Tyson’s robust sales structure, as well as our frozen and refrigerated foods distribution system, will enable this business to accelerate its growth,” he said. 36 brand could benefit from being taken fully national and targeting the mainstream U.S. population with an easy-to-use and uniquely flavored marinade. Tajín. The Zapopan, Mexico–based seasonings and salsa maker, which is best known for its so-called “fruit seasoning” powder made of chili peppers, dehydrated lime juice and salt, has a three-year CAGR of 11%. Sales in the United States (it’s sold in Europe as well as in Central America) are estimated at nearly $5 million a year. It also claims to be the leading maker of “powdered salsa” in both the United States and Mexico. Sun Luck. This maker of many popular Asian sauces, including hoisin sauce, sweet and sour Among the ethnic food brands that could be acquired and turned into household names are: Vietnamese Korean INCEPTION “Claridge and the Circle Foods team have developed an outstanding portfolio of products and customers, with a fantastic plant and workforce, and will be an excellent fit within our branded consumer products group,” said Tyson President and CEO Donnie Smith. with an 8.5% CAGR of its own. However, the ADOPTION PROLIFERATION UBIQUITY sauce, and plum sauce, comprises about Gaucho Ranch. This popular brand of Argentinean chimichurri and dulce de leche (caramel) sauces does about $1 million in sales in major grocery stores in the East Coast area and in Texas including Publix, H-E-B and Kroger. It has a 10.8% CAGR and occupies the top share spot in a small but growing segment at roughly $15 million. It owns 73% of the sales of its parent company, Allied Old English, the most complete portfolio of Asian sauces, a feature that has helped propel it to a three-year CAGR of 8.4%. Its hoisin sauce in particular offers significant potential given wider distribution—it currently makes up just 8% of the brand’s total sales. 37
  20. 20. Immigration-based American diversity by the numbers The Millennial equation The number of people in the United States is surging due— Millennials, who have grown up in the most ethnically diverse and globally overwhelmingly—to immigration. According to the Pew networked environment in U.S. history, are as a result more likely than older Research Center, by 2050: generations to eat ethnic foods. » the national population will rise from 296 million in 2005 to 438 million » of that growth, 82% will be attributable to the arrival of immigrants and their subsequent offspring » non-Hispanic whites, who in 2005 made up 67% of the population, will fall to 47% » the percentage of Hispanics will rise from 14% to 29% » the percentage of Asians will climb from 5% to 9% Millennials are also more likely to cook ethnic meals. A spring 2013 survey conducted by Mintel Research found that 90% of 25- to 34-year-olds had prepared ethnic food at home in the past month compared with 68% of adults ages 65 and older. Moreover, of adults with children under 18 living with them, 91% said they’d cooked ethnic food vs. 78% of those without As the number of people of immigrant origin rises, so will kids at home. their purchasing power. According to the Selig Center’s Bolstered by more focused product development, the market research firm 2012 Multicultural Economy report, by 2017: predicts that such a virtuous cycle will drive growth of the ethnic foods » Hispanics’ buying power will climb from $1.2 trillion to $1.7 trillion market by » Asian-Americans’ buying power will rise from $718 billion to $1.0 trillion 20.3% from 2012–17. And both groups spend more on groceries than the average American household. The weekly grocery bill of Hispanic households, for example, who place an especially high value on cooking and eating with family at home, is $133 vs. a national average of $92.50, according to the most recent figures available from the Food Marketing Institute. AUTHOR Andrew Tully Director, Private Equity and Strategy Practice andrew.tully@kurtsalmon.com 38 39
  21. 21. DEAL IDEAS AT A GLANCE DEAL IDEAS Tribes of One OVERARCHING THESIS Consumer demand for customized products and services continues to rise. Concepts that capitalize on these trends can achieve sustained growth and strong margins due to high customer loyalty. OPPORTUNITY DRIVERS » Cultural trends (“me” not “me too”) reinforcing demand for customized and personalized products and services » Technological advances (digital transformation, production techniques) enabling efficient supply » Personalization is an important part of the purchasing decision set, and consumers are becoming more comfortable sharing information that enables this » Consumers are growing more interested in the co-creation of products and services (NIKEiD, My MMs, Coke’s Freestyle machines, MiO water additives) 72% 48% 35% % of consumers rating personalized benefits as most influential factor in value 40 % of consumers receptive to brands tracking personal data in return for more personalization % of online consumers interested in customizing product features or purchasing built-to-order products DESCRIPTION RATIONALE E-commerce business; platform enables consumers, professional artists and brands to create and offer custom products of all kinds 40% apparel, 35% gifts Sales of $135 million VC ownership Capitalize on favorable secular trends in product customization ong-term vision of moving beyond L T-shirts and gifts roviding mass-customization serP vices to every product imaginable trong traffic momentum vis-à-vis S competitors greements with Disney, Google, A DC Comics, American Apparel, etc. E-commerce business; platform enables customers worldwide to create, buy and sell customized/ personalized products Categories include clothing, accessories, art, posters, stationery Sales of $218 million in FY 2012 Forecasting FY 2013 sales of $248–$261 million Publicly traded ontent is unique and proprietary C roprietary print-on-demand P service otential growth through new P categories and international istorically has traded at a low H EV/EBITDA despite strong growth Fitness club concept that uses technology to offer its members customized exercise and nutrition plans Over 125 franchised locations nationwide Startup costs between $203,000 and $341,000 Growing $60 billion fitness industry Capitalize on favorable secular trends in customization Proprietary software enables low er-cost delivery of fitness services Franchise model reduces capital requirements GO TO WWW.KURTSALMON.COM/DEALIDEAS 41
  22. 22. DEAL IDEAS AT A GLANCE DEAL IDEAS OPPORTUNITY DRIVERS » 32% of U.S. population is “beyond the suburbs” and represents 36% of population growth » Only 20% of retail growth over past decade serves these markets » Not surprisingly, exurban and rural consumers are less satisfied with their shopping options » Total retail spend per store within 10-mile radius is 4X in exurban/rural otential to accelerate store P openings bility to localize merchandise A competitive advantage (especially given store size and market strategy) Apparel, accessories and footwear chain Offers men and women “big-city fashions” 55 stores in 8 Midwestern states 87% of stores are rural or exurban Sales of $35–$40 million, growing ~7% OVERARCHING THESIS Exurban and rural markets are underserved by retail despite substantially lower costs to operate. Retailers focused on these markets enjoy attractive economics and high potential for new-store growth. RATIONALE Sporting goods chain with ~870 stores, sales of $820 million Small box (~5,000 square feet), predominantly strip mall based 56% of stores in rural markets, 9% in exurban markets Primarily in the South Southwest, Mid-Atlantic and Midwest Publicly traded “Beyond the Suburbs” Retail DESCRIPTION otential to accelerate P store openings ncrease scale in purchasing, I distribution, management Footwear retailer offering athletic, dress, casual shoes, boots, sandals Value pricing for men, women and children 1,125 stores in 38 states 48% rural and exurban markets Sales of $700–$900 million Opportunity to extend into western United States Enhance private-label business markets as in urban/suburban markets » Lower space and labor costs in these markets reduce breakeven revenues by 20%–30% SHOE SHOW I N C O R P O R A T E D SHOE SHOW SHOE DEPT. All Retail Stores per Capita (000) (within 10 minutes) 39 55 14 City 42 Suburb 8 Exurb 5 Rural GO TO WWW.KURTSALMON.COM/DEALIDEAS 43
  23. 23. The Predictive of Digital Chatter Power Retailers and consumer products companies know all too well how important it is to engage with their consumers online and to monitor digital chatter in order to keep tabs on what consumers are saying about their brands. But for companies and the private equity firms looking to invest in them, aggregating and analyzing digital chatter—the millions of tweets, Facebook posts, blogs, reviews and comments made on everything from news stories to YouTube—offers more than just a snapshot of brand sentiment. As two recent high-profile retail stories make clear, digital chatter can be used to determine the effects of a material event, regardless of whether it was intentional or not, and in the process, uncover any potential risks to the brand. JC Penney For JC Penney, there was a spike in negative digital chatter after the retailer announced and then implemented its so-called everyday low price (EDLP) strategy. The spike, and the sustained negative sentiment that followed, foreshadowed a precipitous drop in revenue. To be sure, negative sentiment toward the retailer’s pricing had already been building 44 when newly installed CEO Ron Johnson announced in January of 2012 that JC Penney would eliminate coupons and sales in favor of the EDLP strategy. Johnson, who had most recently overseen the wildly successful Apple Stores, changed the pricing strategy— which also included even cheaper “monthlong” prices and so-called “best” prices—as part of a $1 billion transformation aimed at returning the department store to steady earnings growth. And some of the other initiatives Johnson unveiled alongside the EDLP strategy yielded a temporary boost in sentiment toward JC Penney. They included the addition of Ellen DeGeneres as part of its marketing campaign, a redesigned logo and a revamp of the store layout into a series of brands shops, with new labels that included Martha Stewart and Nanette Lepore. But any boost was short-lived and ultimately outweighed by the reaction to the EDLP strategy, as a snapshot of the digital chatter between June 2011 and 2013 makes clear. (See Exhibit 1.) During that time, the conversation about pricing strategy was overwhelmingly negative, accounting for 18% of overall digital chatter vs. just 5% of digital chatter that was positive. 45
  24. 24. Aggregating and analyzing digital chatter can bring to light the potential risk to a brand. EXHIBIT 1: JCP Social Media Sentiment* by Drivers 39% Pricing Strategy Marketing Campaigns Style 10% Total 6% 100% 5% 9% 55% 18% 9% 6% 14% General 15% Positive * Percentage of posts from June 2011 to June 2013; n=813,000 46 14% Negative Neutral 12,000 10% 5% 0% –5% –10% –15% –20% –25% –30% –35% Number of Negative Pricing Strategy Posts 10,000 8,000 6,000 4,000 2,000 May-13 Mar-13 Jan-13 Nov-12 Jul-12 May-12 Mar-12 Jan-12 Nov-11 Sep-11 Jul-11 May-11 Mar-11 Jan-11 Nov-10 Sep-12 JCP SSSG 0 Sep-10 When Mike Ullman returned as CEO in June of 2013 and started reintroducing elements of a more traditional high-low pricing strategy, JC Penney’s negative pricing chatter finally started to die down. EXHIBIT 2: JCP Negative Pricing Strategy Sentiment vs. SSSG Number of Negative Pricing Strategy Posts All told, JC Penney suffered sustained samestore sales declines of greater than 20% lasting more than a year, which translated into a 25% plunge in total revenue, or $4.3 billion, for the 12 months ended February 2. By paying attention to the chatter taking place online, JC Penney would have been acutely aware of consumers’ sustained displeasure at the prospect of having to give up sales and coupons and perhaps could have changed course more quickly. SSSG Not only did the digital chatter surface the degree to which consumers were unhappy with the pricing strategy, but it was a leading indicator for a subsequent drop in sales. As Exhibit 2 demonstrates, there was a notable negative correlation (R-squared of 64%) between negative pricing strategy sentiment and same-store sales growth. lululemon athletica On the other hand, the digital chatter that followed lululemon’s handling of its seethrough yoga pants product recall in March of 2013 makes clear the impact of taking quick, deft action that reinforces a brand’s core strategy. Initially, the product recall not only caused an uproar from consumers, as illustrated in Exhibit 3, but prompted many Wall Street observers to raise concerns that the company had larger strategic and operational issues, due in particular to its dependence on a single fabric supplier. The company’s handling of the situation consisted of offering a full refund to con- sumers who bought the affected pants and proactively pulling the remainder from stores shelves. lululemon subsequently reported samestore sales growth of 7% for the first quarter and an 8% rise for the subsequent threemonth period. Both were a reasonable degree of disparity from the company’s historic double-digit growth rates, given that the recall affected the luon, its most popular line of yoga pants. And as Exhibit 4 highlights, the overall sentiment toward lululemon has since largely returned to historic levels; consumers clearly approved of its handling of the recall. 47
  25. 25. EXHIBIT 3: lululemon Social Media Posts (000s of Posts) EXHIBIT 4: lululemon Social Media Sentiment (% of Posts) Negative Sentiment Neutral Sentiment Positive Sentiment 80% 93 70% lululemon Announces Recall of Pants March 2013 Positive Sentiment 60% 50% 40% 30% Negative Sentiment 20% 56 52 48 10% Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 43 34 23 36 24 19 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 48 Investors weren’t so forgiving. The company’s shares plunged after lululemon, citing recall-related delays in deliveries of its fall line, cut its full-year per-share earnings outlook to $1.94 to $1.97 from its initial adjusted outlook of $1.95 to $1.99. However, the digital chatter suggests that the consumer franchise remains strong. As the experience of both JC Penney and lululemon demonstrates, aggregating and analyzing digital chatter can bring to light the potential risk to a brand, be it the result of a purposeful strategy change, such as new pricing, or an unexpected event, such as a product recall. Digital chatter can also provide invaluable insight into what, if any, corrective action should be taken and can make clear whether or not that action is working. It’s data we cannot afford to ignore. v AUTHOR Dan Goldman Senior Manager, Private Equity and Strategy Practice daniel.goldman@kurtsalmon.com 49
  26. 26. Outlet stores will actually increase brand loyalty—and, ultimately, sales—well into the foreseeable future. OUT LET From afterthought to profit center S Outlet centers were created in the 1970s as a low-cost vehicle for retailers like Nordstrom to unload their old or defective stock, the product they had trouble moving in their full-price locations, where space was needed to sell the latest inventory. The investment was easy for retailers to justify: Rents at outlet locations have historically come in some 30% to 40% below those of full-price malls, and they require fewer staff. Capex buildout is lower as well, as simpler fixtures and displays mean cheaper construction costs. Making the Case for Outlets Outlet stores, for both consumers and retailers, are a win-win. For consumers, they offer a place to buy their favorite brands at a steep discount, oftentimes as much as 60%. For retailers, discounts come in the form of lower rents, fewer staff and smaller capital expenditures, resulting in EBITDA that exceeds their full-price locations by an average of 500 to 700 basis points. Return on invested capital, meanwhile, is often double that of traditional locations. 50 But some worry that for retailers, the success of outlet stores is turning into a liability. To be sure, real estate is getting harder to come by, which means rents are going up and margins are increasingly coming under pressure. But the bigger concern, that outlet stores are dilutive to retailers’ core brands, is not only overblown, but unfounded. On the contrary, when managed properly, outlet stores will actually increase brand loyalty—and, ultimately, sales—well into the foreseeable future. Then in the early 2000s, retail giants like Ralph Lauren and Gap Inc. starting making product expressly for their outlet stores. Inspired by the current and most recent year of fashion, but with less elaborate, more cost-effective materials that yielded gross margin parity, the Made for Outlet (MFO) channel was born. The MFO channel helped to boost outlets’ ROIC even further, since with product bets based on bestsellers, the likelihood of conversion was even higher than that for last year’s leftovers. It was especially popular during the recent recession, when consumers doubled down on their hunt for lower-cost apparel and retailers tightened their inventory, resulting in fewer overstock items from their full-priced stores. The result is that outlets now generate a disproportionate share of retailers’ North American operating profits. The outlet business of Gap Inc., for example, contributes some 20% to 25% of brand sales, but accounts for 35% to 40% of its profits in the region. And even with the economy on the road to recovery, consumers have been reluctant to give up the discounts they’ve gotten used to at outlets. Total estimated sales at the 185 outlet centers in the United States came in at $25.4 billion in 2012, according to Value Retail News, up $3 billion from the year before. Sales productivity and comps rose 9% in 2012 over 2011, second only to Internet sales for most specialty fashion retailers. Further growth Retailers, many of which are shuttering or at least downsizing some of their full-price stores, are at the same time opening more outlet stores. Coach, for example, recently announced plans to close 16 of its traditional stores but open 15 new outlet locations. But newer entrants like the fast-fashion success story 51
  27. 27. Retailers, many of which are shuttering or at least downsizing some of their full-price stores, are at the same time opening more outlet stores. Forever 21 are also expanding their outlet store footprints, as are luxury brands like Armani, Prada and Jimmy Choo. In fact, the number of outlets is on pace to exceed the full-price locations of high-end department stores. Such is already the case at Nordstrom and Saks; Saks’ Off 5th outlets, for example, currently account for more than 60% of the retailer’s brick-and-mortar locations, and it plans to open an additional seven outlets in 2014. In a bid to keep up with the demand for space, real estate companies have put an additional 43 outlet center projects on the books through 2015. But along with the additional square footage comes a rise in rents. Why outlets don’t mean brand dilution EXHIBIT 1: Outlet Store Growth Leading Fashion Outlets # of Outlet Stores CAGR Gap Outlet 206 5% Coach (incl. Canada) 172 13% Ralph Lauren 144 1% Banana Republic 131 20% While the pressure on margins is real and needs to be taken into consideration going forward, the discrepancy can be more than offset by the increase in customers and resulting higher sales that come from having outlet stores, as retailers from Nike to Michael Kors to Barney’s have learned firsthand. Nordstrom’s best-performing stores, for example, are those placed closest to its Rack outlet locations. That’s because for high-end retailers, outlets open the door to an entirely new set of customers who otherwise wouldn’t shop the full-price stores, whether due to their locations in urban centers, the expensive atmosphere or the prices themselves. With an outlet store presence, luxury brands suddenly become accessible. Conversely, the number of high-end shoppers who will eschew full-price locations in favor of outlets is negligible. EXHIBIT 2: Planned Outlet Store Growth 2013–15 Current Tanger Factory Outlet Centers, which along with Simon Property Group owns 109 of the 185 outlet centers in the United States, said that renewals resulted in a more than 23% increase in rent expense in 2012. And Simon estimates that since 2004, productivity has risen by more than 20%, but rent has gone up by nearly 50%. Guess 103 8% Ann Taylor Factory 99 2% Ann Taylor LOFT 74 52% Outlet rents are currently averaging around $38 per square foot, close to that of full-price malls. Store EBITDA margins for legacy players could be reduced by up to 500 basis points once their leases are renewed. J Crew Current + Planned (2013–2015) 52 98 185 228 70.9 8% Number of Centers American Eagle 70 28% 85.0 Square Feet (millions) 53
  28. 28. How to trigger neurological connectivity— and increase sales—through strategic pricing For mid-tier brands like Gap and J. Crew, such accessibility draws in lower-income shoppers for whom such brands were previously unaffordable. Existing customers, meanwhile, ultimately increase their number of shopping occasions due to the lower price points and wider selection that outlets provide, even while continuing to shop full-price locations. increasingly viewing the online channel as a way to capture a different, incremental customer. Outlets, in other words, will continue to grow and be a critical component in an integrated omnichannel strategy. v Making clear the difference between fullprice and outlet channels in the minds of consumers, therefore, is critical. While the brand should be consistently communicated regardless of channel, the outlet discounts have to be significant. The truly high-end, more aspirationally priced product—and the related store style elements and staff that support them—should be kept exclusively in the full-price locations. Customers’ in-store experiences, in other words, should meet their expectations. 54 Triggering the all-important dopamine surge When a customer whom Sid was helping would find a suit he liked and ask what it cost, Sid would shout to his brother at the back of the shop, and Harry would shout back, “$42!” Sid, explaining to the customer that he was hard of hearing, would ask again, prompting Harry to repeat: “$42!” Sid would then turn to the customer and tell him that the suit’s price was, not $42, but $24. Believing he’d just been offered a steep discount on an otherwise expensive suit, the customer would more often than not jump at the chance to buy it. Neurological connectivity, which occurs when a retailer or brand makes its particular value offering so compelling that it results in a dopamine surge in the consumer’s brain, is one of the great differentiators in retail, as Robin Lewis and I explain in our book, The New Rules of Retail. That’s because once triggered, the consumer will subsequently seek out such a positive subconscious reaction again and again. Robert Cialdini in his book Influence: The Psychology of Persuasion holds the Drubeck brothers’ story up as an example of the belief on the part of consumers that expensive equals good. And any consumer will tell you that a more than 40% discount off an expensive item equals not just good, but great, value. E-commerce Expanding into the online space, outlets can further accelerate growth. For example, Saks’ Off 5th launched e-commerce at the end of September. So whereas retailers previously resisted creating an online presence for their outlets for fear of price competition, they are Have you ever heard of the brothers Sid and Harry Drubeck, two tailors in the 1930s? AUTHOR Michael Dart Senior Partner and Head of Private Equity and Strategy Practice michael.dart@kurtsalmon.com One way of achieving neurological connectivity is through pricing. Retailers often determine pricing using a formula based solely on input costs: Costs + standard markup rate = price. But such an approach fails to take advantage of the power of a creative pricing strategy. We would take that one step further and posit that it’s also an example of how strategic pricing triggers neurological connectivity, a powerful tool for getting consumers to buy your product—and, in the process, turn them into loyal customers. 55
  29. 29. Women Who Typically Shop for Clothes on Sale And as the creative pricing strategy of the Drubeck brothers illustrates, consumers not only believe that expensive equals good, but that when deciding whether the product is valuable in the first place, it’s all relative. Indeed, as Dan Ariely explains in Predictably Irrational, we make decisions based on comparisons. Ariely, who showed three oneyear subscription offers for The Economist to a group of 100 students from MIT’s Sloan School of Management, found that they made the following choices: 2012 59% 68% Men Who Typically Shop for Clothes on Sale 2000 2012 55% 66% 1. Internet-only for $59 – 16 students 2. Print-only for $125 – 0 students 3. Print and Internet for $125 – 84 students But when he removed the print-only option —the option not a single student had chosen in the first place—the number of students who opted for Internet-only rose to 68 from 16, while the number of students who chose the print-and-Internet option fell to 32 from 84. The thrill of the hunt But it takes more than a relatively low price to trigger neurological connectivity in a consumer’s brain; the consumer must also feel like they’ve had to exert some effort to get the deal in the first place. The dopamine surge, then, becomes not just a pleasurable 56 result, but a reward. Even better is when there’s an element of surprise—when the consumer knows her efforts will yield something good, but she doesn’t know exactly what that something good will be. Some examples of how retailers trigger neurological connectivity by getting customers to search for deals include: JC Penney. Customers had not only grown used to but loved finding lower prices through JC Penney’s frequent sales and coupons, which is why the retailer’s move to an Everyday Low Price strategy (EDLP) in 2012 may go down as one of its biggest missteps. The EDLP strategy eliminated what customers felt was their reward. (For more on JC Penney’s failed EDLP strategy, see our piece on digital chatter.) Source: Cotton Inc.’s Lifestyle Monitor 2000 Gilt Groupe, Fab, Rue La La, etc. Flash-sale sites have found enormous success tapping into the power of neurological connectivity by offering deep discounts on an ever-changing lineup of products at regular intervals for a limited amount of time. Savers. The for-profit thrift store partners with local charities that bring thousands of new items to its locations every day and has an aggressive, but simple, markdown cadence. For customers, that means every time they visit, they have the opportunity to purchase a unique item at a discount that grows deeper the longer the item sits on the shelf. Triggering neurological connectivity through pricing requires doing the following: 1. Creating a frame of reference that estab- way that consumers are making individual price comparisons and buying decisions, the cost of a product must not be the sole driver of its ultimate price. 4. Making consumers work for it. The satisfaction consumers feel when they have found a deal—whether through clipping coupons, being the first in line at a preplanned flash sale or hunting for one-offs in a thrift store— cannot be overstated. Consumers always have and always will look for great deals. But when the shopping experience offers more than just a low price and instead triggers an actual chemical reaction in their brain that produces a feeling of pleasure, even reward, they will go from being shoppers to loyal customers. v lishes your product’s value in the consumer’s mind, then discount off that. Remember, however, that consumers have an innate sense of value, a deep understanding of what things are really worth, which is why retailers must instill integrity in their pricing strategies by assigning an original full-value price that is credible. 2. Using “good, better, best” pricing to drive people to your higher-margin, “best value” products. Much like Ariely’s students demonstrated when choosing subscriptions to The Economist, the comparisons offered by the retailer or brand will shape the relative value assigned by the consumer. 3. Throwing standard, across-the-board markups out the window and price each product on an individual basis. In the same AUTHOR Michael Dart Senior Partner and Head of Private Equity and Strategy Practice Co-author of The New Rules of Retail michael.dart@kurtsalmon.com 57
  30. 30. How to Assess a Retailer’s Expansion Potential from Afar One of the key factors when deciding whether or not to invest in a retailer is its potential to add stores, which is typically the main engine of revenue growth. If the company opens up sales by store as part of due diligence, a detailed multivariate regression model can be used to come up with a solid estimate of expansion potential. But if not, it’s also possible to do an outside-in assessment that will yield a solid approximation, which can be used to validate management’s (or analysts’) forecasts or to independently develop a forecast from scratch. Armed with such an objective perspective, private equity firms and hedge funds can better predict a retailer’s future store growth and revenue and, ultimately, make a better-informed investment decision. Ann Taylor and LOFT Women’s apparel retailer Ann Taylor caters primarily to professional women searching for work-appropriate clothing and accessories. In 1996, in response to the by then well-established trend of less formal attire in the workplace, the company launched LOFT, which offers more casual clothing and attracts a younger clientele. Management currently believes that it can open 100 LOFT 58 stores in addition to its current 516 while it continues to downsize the number of original Ann Taylor locations. To assess management’s forecast, we did the following: 1. We identified the mix of different psychographic segments within 15 minutes of each current LOFT location to find out where LOFT over-indexes. (See page 61.) 59
  31. 31. 2. For each segment that is overrepresented 2 to come up with the total potential number of new location sites. (See Exhibit 2.) in LOFT markets, we determined the thresholdlevel concentration required for a “successful” 4. We then eliminated any sites within specified drive times of the new locations. The typical starting point is the existing median drive time between locations but, again, given changing retail patterns, a more conservative approach increases the drive time. We determined that LOFT locations, as with comparable mall-based apparel retailers that we’ve analyzed in the past, can successfully be opened within 10 minutes of each other. store. The median level is usually a good starting point, but given the shift to e-commerce and declining traffic in almost every retail format, a more conservative approach for future projections is the 75% percentile. (See Exhibit 1.) 3. We took a database of all existing retail locations (around 42,000) and screened them against the criteria established in step THE FOUR DEMOGRAPHIC GROUPS WHERE LOFT OVER-INDEXES Young City Solos—Younger and middle-aged singles living active and energetic lifestyles in metropolitan areas Significant Singles—Middle-aged singles and some couples earning mid-scale incomes supporting active city lifestyles Flourishing Families—Affluent, middle-aged families and couples earning prosperous incomes and living very comfortable, active lifestyles Singles and Starters—Young singles starting out, and some starter families, in diverse urban communities EXHIBIT 1: LOFT Psychographic Segments EXHIBIT 2: Population in Key LOFT Psychographic Segments (LOFT Distribution vs. National Distribution, within 15-Minute Drive-Time Radius) (Index to National Average % of Population, within 15-Minute Drive-Time Radius) 200 Power Elite Power Elite, Young City Solos, Flourishing Families and Significant Singles are the most over-indexed groups These groups collectively encompass 33% of LOFT’s core population vs. 21% in the national average 150 Young City Solos 56.0 Flourishing Families 52.9 Significant Singles 51.2 42.9 40.5 34.6 100 28.5 90th Percentile 23.5 50 14.5 13.6 0 Power Elite 60 Young City Solos Flourishing Significant Families Singles Booming with Confidence Suburban Aspirational Style Fusion Singles and Starters Cultural Middle-Class Thriving Connections Melting Boomers Pot Median 10th Percentile 5.2 0.1 LOFT 2.6 0.0 National Distribution 7.1 0.0 LOFT 0.0 National Distribution 12.6 7.6 0.5 LOFT 0.0 National Distribution 7.5 1.9 LOFT 0.0 National Distribution 61
  32. 32. 62 E-Commerce Sales Growth (2-year CAGR, 2009–2011) E-Commerce Penetration (2011) ett as we did to LOFT, we determined that Hibbett could open 298 stores, 122 fewer stores than the 420 management had projected. In order to achieve the forecast of 420, the company would have to pack more stores 39% ate the company’s store growth potential. An arm’s-length starting point 2% 11% 16% 15% 7% 14% 8% 6% 0% 12% 12% 10% 0% Jos. A. Bank would be necessary in order to further evalu- 18% New York Co. impacted by the growth in e-commerce, 11% 13% 2% 6% 4% 5% bebe 19% brick-and-mortar expansion is increasingly American Eagle management has in mind, especially as Guess? business itself. Identifying which strategy Forever 21 43% store format or modify the economics of the Gap into a smaller radius, change its existing Aéropostale Hibbett Sports tends to open in small markets that most national and other large chains do not and features a smaller footprint (roughly 5,000 square feet vs. 55,000 for competitors’ chains, on average). It offers a mix of merchandise specifically tailored to the local market, such as that of sports teams favored by its surrounding populations: primarily ethnically mixed, middle-aged couples with modest incomes and little to no college education. And just 30% of Hibbett Sports’ stores have another location within 20 minutes—consistent with the 106% Charlotte Russe Hibbett Sports, a full-line sporting goods retailer, operates mostly in the Southeast, Southwest and Midwest, primarily in smallto mid-sized markets. Currently, it has 879 stores in 29 states, a number management believes it can grow to more than 1,300, with approximately 420 new stores. Applying the same method of analysis to Hibb- EXHIBIT 3: E-Commerce Overview Abercrombie Fitch Hibbett Sports in each of its small markets. Ann Inc. In the end, we determined that there are in fact approximately 175 potential locations for future LOFT stores in the United States alone. company’s strategy of having just one store The Men’s Wearhouse 5. The final step was to do a reality check by looking at competitor locations, as well as the demographics and income in the trade areas, to make sure that the psychographic segments were truly representative of more basic measures. Few factors are as important to a retailer’s growth as its ability to open new stores, even as e-commerce continues to rise in importance. Indeed, our formula can easily accommodate the addition of e-commerce sales and sales projections (see Exhibit 3), including those expected to cannibalize brick-and-mortar sales down the road. And further analysis can and should be conducted once inside information, such as the sales and AUTHOR Drew Klein Manager, Private Equity and Strategy Practice drew.klein@kurtsalmon.com profitability of each location, is obtained. v 63
  33. 33. Authors MARK ANGLIN Mark Anglin is a partner in Kurt Salmon’s Private Equity and Strategy Practice. He has more than 15 years of experience advising leading global brands on their growth strategies and helping private equity firms evaluate transactions in Asia, Europe and North America. Mark can be reached at mark.anglin@kurtsalmon.com. Greg Ellis is a director in the firm’s Private Equity and Strategy Practice. In his more than 14 years of consulting, Greg has worked with many leading retailers, consumer products companies and private equity firms. He can be reached at greg.ellis@kurtsalmon.com. BRUCE COHEN PETER HSIA Bruce Cohen is a senior partner in Kurt Salmon’s Private Equity and Strategy Practice and a North American practice director. With more than 20 years of consulting experience in the retail and consumer products industry, Bruce has worked with executives and boards focused on mergers and acquisitions, due diligence, and developing and implementing strategies to drive profitable growth. He is regularly quoted on retail and consumer topics in the Wall Street Journal, Bloomberg and The New York Times, among others. He can be reached at bruce.cohen@kurtsalmon.com. Peter Hsia is a partner in the firm’s Private Equity and Strategy Practice. In his 25 years of consulting, Peter has worked with many of the leading consumer packaged goods companies, retailers and private equity firms. Prior to Kurt Salmon, Peter was a consultant with McKinsey Company. He can be reached at peter.hsia@kurtsalmon.com. MICHAEL DART ANDREW TULLY Michael Dart is a senior partner and leads the firm’s Private Equity and Strategy Practice. In his more than 20 years of consulting, Michael has worked with many leading retailers, consumer products companies and private equity firms. He is also the co-author of the industry-acclaimed The New Rules of Retail. He is frequently quoted in the Wall Street Journal, Financial Times, global and national media, and trade journals. Consulting magazine recognized Michael as one of its Top 25 Consultants of 2010. He can be reached at michael.dart@kurtsalmon.com. 64 GREG ELLIS Andrew Tully is a director in Kurt Salmon’s Private Equity Practice. He has 20 years of experience in the consumer products industry, both as a strategy consultant and in director-level management positions. He joined Kurt Salmon as part of the firm’s merger with Swander Pace Co., and before that was a senior consultant with the consumer products practice of Coopers Lybrand. He can be reached at andrew.tully@kurtsalmon.com. 65
  34. 34. Authors DAN GOLDMAN Dan Goldman has expertise in private equity due diligence and sell-side support, growth and turnaround strategy development, brand and category management, marketing, and new product development, as well as marketing mix and trade promotion optimization. In addition to his experience at Kurt Salmon, Dan’s broad background includes brand marketing experience with Procter Gamble as well as prior consulting experience with Cannondale Associates (now Kantar Retail) and Hudson River Group. He can be reached at daniel.goldman@kurtsalmon.com. DREW KLEIN Drew Klein has conducted dozens of strategy and due diligence projects in the retail and consumer products space, many in apparel and footwear. Prior to Kurt Salmon, he worked at UBS Investment Bank in the retail group, where he specialized in apparel and the sporting goods and health club industries. He can be reached at drew.klein@kurtsalmon.com. 66
  35. 35. kurtsalmon.com