When it comes to leveraging costs in retailing, bigger is almost always better. Having sales of $1 billion helps, but the competitive advantages really kicks in at $3 billion. But there are exceptions to the size rule, such as executive compensation.
One of the greatest competitive disadvantages facing the middle-market retailer is an inability to use size to lower relative expenses. In economics, it’s known as leveraging economies of scale. The larger a company grows, the more it can cut costs because it gains efficiencies in a host of ways. Transportation costs, for example, come down dramatically as the volume of shipments goes up. Having more employees leads to job specialization, which allows for greater worker productivity. And buying most anything in bulk—from printer paper to bottled water for the office—saves money.
Looking at economies of scale in the retail apparel business, a WWD survey of three-year average selling, general and administrative expenses illustrates that the biggest retailers enjoyed an enormous cost advantage over the smallest. Indeed, companies with more than $20 billion in annual sales had an average SG&A ratio almost 800 basis points lower than retailers with less than $500 million in annual revenue.
Moreover, the cost benefits increased dramatically at the $1 billion sales mark, and especially once a retailer surpassed $3 billion in annual volume. Companies with sales of $500 million to $1 billion had an average SG&A advantage of 240 basis points over their smallest competitors, while companies in the $1 billion to $3 billion range posted an average SG&A 280 basis points lower. Pass that $3 billion point, and retailers’ average SG&A stood at just 23.8 percent of sales.
In an industry where SG&A expense of 30 percent is considered good, that is extraordinary. The $3 billion-plus retailers not only beat the rule-of-thumb figure by a whopping 620 basis points, but also came in far below the overall industry average and median of 27.8 and 26.6, respectively.
Emanuel Weintraub, president and chief executive officer of the firm that bears his name, said Wall Street is obsessed over comparable-store sales when they should be looking at operating costs. “Nobody wants to talk about the nitty gritty, yet there are successes when a company focuses on it,” he said. “Why is Wal-Mart successful? Because they understand that If you're going to be a value provider you have to cut out anything that's not absolutely pertaining to that product.”For the retailer doing less than $1 billion in business, the picture is pretty bleak. But happily for them there are intriguing and instructive exceptions to the rule. Of the 10 companies with the lowest SG&A, four had three-year average sales of less than $1 billion. Stage Stores, a department store, emerged from bankruptcy only three years ago and presumably has learned to live on a financial diet of rice and beans.
But the remaining three — Aeropostale, Buckle and Deb Shops — are all mall-based specialty retailers, which is telling. The specialty concept is scalable. There are also comparatively less store design costs. The other benefit of being mall based mall is more predictable operating costs. There’s also no snowy sidewalk to shovel.
Another important lesson mid-market retailers can learn from the exceptions to the size rule is the effect of executive compensation on SG&A. For the economy as a whole, labor accounts for about a third of total consolidated costs, so it’s no surprise that companies look to pare their wages and workforces when they need to cut expenses. But sometimes it’s the best-paid employees — the executive management team — that can cause SG&A to balloon.
Look at Neiman Marcus Group and Barneys New York, for example. Neiman’s had much larger sales than Barneys, so it follows that it would have a smaller expense ratio. The problem is that Barneys’ ratio is so outsized, it can’t be explained entirely by having a comparatively small business. In fact, at 40.3 percent, Barneys SG&A is the second-highest of the companies tracked by WWD. The difference is the way Neiman’s and Barneys compensate their top executives. Based on a three-year average as a percentage of sales, Barneys paid its top executives more than seven times as much cash in salary and bonuses as Neiman’s did.
Differences in compensation also partly explain the cost difference between May Co. and Federated, which have commensurate sales levels. Yet, May’s laudably meager SG&A of 20.4 percent was more than 1,000 basis points lower than Federated’s, and its managements’ pay was lower, too. Over the last three years, May’s total average executive compensation as a percent of sales was half that of its major competitor at 0.04 versus 0.08.Mid-market retailers should take heart in the data. They can keep costs down even when operating on a much smaller sales level. Although the rule of economies of scale will tend to reduce expenses and boost profits organically, it is by no means a gold medal in retailing. At best, it offers a shot at the bronze.
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