MAKING THE MOST OF THE MIDMARKET
Byline: Vicki M. Young
NEW YORK — Entrepreneurial apparel vendors and retailers can remain viable in a world dominated by megafirms intending and equipped to grab even greater share of market, provided they have the courage to broaden their business perspective and even narrow their businesses.
Survival isn’t easy for small and medium-size firms in a land dominated by giants, but financial experts serving the apparel industry told WWD that it could be done. Bigger is not always better, and many smaller firms living by their wits can do some things immediately to better their chances of thriving in the new century, starting with taking a good, hard look in their own backyards or, more appropriately, back offices.
The mistakes that small firms often make, and many of the simple measures they can take to prevent them, dominated the discussion at this month’s WWD Financial Forum here. Participants were:
Jonathan A. Lucas, senior vice president, regional manager, The CIT Group/Commercial Services, a factor.
Philip F. Bleser, senior vice president, Chase Manhattan Bank.
Walter Loeb, retail analyst, Loeb Associates Inc.
Adam D. Winters, vice president, business development, Merchant Factors Corp.
Emanuel Weintraub, management consultant, Emanuel Weintraub Associates Inc.
Erwin Isman, managing director, Marketing Management Group.
Of course, size is a virtue in mature, consolidating markets, but a smaller company’s agility and ability to clearly differentiate its position and core competencies are often overlooked. “There’s a lot of sameness out in retail, and the competitive advantage that the small firms have is they can bring newness to the table,” Bleser noted.
However, Bleser and his fellow forum participants pointed out there’s no sales cutoff that determines the classification of companies as large or small. While the financial professionals typically deal with companies that do at least $2 million or $3 million in sales, all agreed that the concept behind what a company does is more important than its sales volume.
Bleser noted, “If you have a company doing $1 million in sales and growing rapidly, it would belong on product platforms that would require an ability to scale.”
“Or you could have a company doing $1 million in sales that has been in business for 20 years. Chances are it’s not going to grow a lot,” observed Winters.
According to Isman, “A family business that has one dimension and is doing $10 million or $15 million can be a small business. A growing company doing $2 million with a broader perspective may potentially be a larger business and should be treated that way. “It has to do with the niche in the marketplace, and it has to do with the organizational structure. Seventy percent of the small companies in our industry are family-based businesses. Those businesses, even if they do $30 million or $40 million, may have a very small business concept.”
Loeb says he’s not particularly enamored of such mundane details as defining the size of a company. “I never define the size of a company. I’m more interested in its scope: What is the company doing, where is it going, what is its focus and where is it aligning itself.”
According to Weintraub, even a firm doing $40 million can be a small business. “Those firms are a one-man business. He’s got a bunch of guys he calls vice presidents. They’re not vice presidents, they’re just guys. The owner doesn’t belong to a golf club. His life is his business. He’s very creative and he’s doing things so instinctively because he grew up with that business. As long as he can keep reinventing himself and live by his wits, he can do exceptionally well. There are many small firms that are hugely profitable. But once that creativity gives out, he’s done.”
The small manufacturers, Weintraub noted, are facing the issue of less and less access. “Megafirms can talk to any retailer in America and get almost instant availability. If my client is doing $38 million with a great product — but not a brand name — and he wants to meet with one of the top retail executives, he’s got to bang on the door all day long. This is a very serious problem. If you are a no-name brand, and you are not a destination brand, then the stores can say, ‘Hey, wait a minute, I’m giving you the shelf space and we’re going squeeze you right to the ground.”‘
To be sure, the giants in the industry with greater access to a wide range of resources don’t have that problem. But firms don’t get into the megaclub until they do at least $1 billion in sales, Weintraub pointed out.
Winters observed, “I’m sure we all have clients that are doing $10 million or $15 million a year in annual revenue that are very profitable. The principals are hardworking and doing extremely well, and then we have other clients that are doing in excess of $100 million that are struggling. They are losing money and have tremendous problems. Is bigger always better?”
He doesn’t think so.
“There are certain brands doing under $50 million and their doors are being knocked down. They’re turning down business because they want to be in selective stores. They don’t want to sell on every street corner. These are companies who are very in tune with their customers,” Winters noted.
And the pressures of Wall Street suggest that maybe smaller is better for some firms. According to Weintraub, “The core issue for any firm — particularly a retailer — is market share, and the large firms are driven by Wall Street. Wall Street says we want 10 percent growth and lots of earnings in an industry that’s having 3 or 4 percent growth. Where are they getting their core growth?”
For Weintraub, the smaller firms get hit when retailers consolidate, limiting the doors to which they have access. Large vendors in the megaclub also start prowling around looking for small branded firms they can acquire to expand their market share.
If the small firm, as Weintraub pointed out, is a breed onto itself, then what can it do to increase its chances of survival? What are the more common mistakes small companies make and how can they be prevented?
Knowing the Numbers
“The uniqueness about the industry we serve,” Lucas noted, “is that most of my clients have no idea what their gross margin is. You tell me how you run a business not knowing what your gross profit line is. Because [maybe the problem is that it’s] the retailers who determine what the gross profit is, not the manufacturer.”
Manufacturers that don’t have a brand, Lucas suggested, aren’t critical to a retailer’s success and have a harder time controlling their own destiny. “It’s very difficult. My clients go through this, and I see it every January and February, the millions — and I mean millions — of dollars that come back hitting my clients. It hurts my clients and it’s coming from the retailers. Guaranteed markdowns, chargebacks, volume discounts — it’s all kinds of stuff. You tell me how a company that’s running a $20 million or $30 million business, whether it’s family-owned or not, how you plan when you don’t even know what your gross margins are.”
Weintraub added, “Not only do they not know their gross margins, but you go into some of these firms — and many have wonderful reputations — and you say, ‘You have all this shrinkage and margin, do you ever do a gross profit-margin reconciliation?’ You could ask them how they do their costing, their pricing. Many [of the firms] don’t know, so what does that say?”
Loeb was quick to defend the manufacturers, pointing out, “Most of these companies aren’t really formal companies. We’re dealing with salesmen. They’re sales companies, with salesmen trying to sell as much as they can.”
But entrepreneurs, Isman noted, while they understand the concept of gross margin and gross margin control, just aren’t schooled in negotiating with retailers about what is going to happen to them in January and July, when the retailers’ six-month cycles conclude. “They are not incapable of learning these skills. But by and large, gross margin control, overhead control, niche marketing and relationships with retailers and arrangements up front can mitigate your problems in the end. You usually can control your business to a significant amount of degree so that it doesn’t just get wiped out in January.”
Open to Suggestion
Bleser observed, “The best advice we can give to small business owners is that they surround themselves with professionals who understand the industry and bring something to the table. The bankers should bring more to the table than their money. They should bring business knowledge and business expertise. The same for accountants and lawyers.”
The same goes for inside executives and employees. Entrepreneurs only help themselves, according to Isman, by bringing in people who have skills that are complementary, not identical, to their own. “If the guy is a sales guy, don’t hire three sales guys,” advised Isman. “Get a good financial expert and an operations expert on your support staff.”
Many times, however, the advice falls on deaf ears.
According to Winters, “You can bring a horse to water, but you can’t make it drink. At meetings, you could tell these manufacturers, ‘Listen, we’re here; we can consult with you, and we’re as happy to be as involved with your business as you would like us to be.’ But these are sales or creative people, and their focus is producing and getting the goods out. Some of the other important business aspects take a backseat until they have a problem. Who do they run to? They run to their advisers. They say, ‘I have a problem.’ But if they’re proactive as opposed to reactive, then I think we would have a better situation.”
For Lucas, the key ability an entrepreneur needs is good listening skills. “Without good listening skills, you’re done. Every problem that I come across, I’ve got a principal that has very, very poor listening skills.”
Winters added, “It’s one thing to listen, but the entrepreneur also has to have an open mind and be open to suggestions. I’m sure we all have clients whom you can call into a meeting to tell them you want to bring to their attention certain trends you’ve noticed. They may listen, but they may not do anything to help their situation.”
Some manufacturers, observed Isman, are already taking the hint. “There used to be such a tremendous resistance. When someone is making money, they think they know everything. When somebody gets into trouble, then they need help. Lately I’m finding more people coming in before the proverbial stuff hits the fan and trying to improve and get their operations on a better scale.”
That’s good news for Weintraub.
“The small firms are product and sales-driven. But what their customers, the retailers, are saying is this: ‘The problem with dealing with small firms is that the ones that do $10 million, $20 million or even $60 million, this firm won our quality award four years ago and this year we have all these problems.’ So now the retailers are trying to persuade buyers that they can’t afford to deal with those kinds of firms.”
“One of our theses today,” Weintraub added, “is that your distribution center is as important as your showroom, because that’s where your chargebacks come from. It’s how you make money. These firms can’t even segregate their merchandise-driven chargebacks from their self-induced chargebacks. And how do you begin to attack the problem if you’re not even geared that way?
“It’s a profit center, but if you don’t have the facts on your self-induced chargebacks, you can’t even argue it,” he said.
He doesn’t expect merchandise chargebacks — the final negotiation of the sale — will ever go away because manufacturers are promising retailers a certain return, one way or another. Chargebacks have become a source of major support for retailers, helping to boost their gross margins. As far as manufacturers are concerned, Weintraub observed, “You don’t need to go to Harvard to know that you don’t willingly give up a piece of your profit to your customer after you’ve set the price.”
Bleser advised, “If I were a manufacturer or supplier, what I would be trying to do is cap the number on the merchandise chargeback.” He explained that trying to get retailers to agree to a cap helps the smaller firms because they have no control over when retailers get promotional on the sales floor.
The small firms also can get a better handle on their gross margins by fine-tuning their operations. One avenue for bottom-line improvement is for companies to closely monitor their self-induced chargebacks.
To Weintraub, this is a symptom of a far greater problem. “The self-induced chargebacks — shipping wrong, shipping late, shipping 11 in one box and 13 in another — the retailer’s got its 24 pieces, but your client’s getting two chargebacks. Small businesses are often operationally insensitive, and they have to get better. The high-profile brands are working day and night to be operationally better, better, better,” he explained.
Winters pointed out that a problem for many smaller firms is their lack of sophistication in negotiating with retailers. “Let’s just say I’m a manufacturer of dresses, and I’m selling to one of the large retail chain stores. I ship $100,000 worth of dresses. The stuff doesn’t sell. The retail chain says I’m going to pay you $50,000. I’m a very unsophisticated dress manufacturer. What do I do? I say, ‘Okay, pay me my $50,000.’ If you lack the sophistication, you’re going to have problems.”
Weintraub agreed, adding that there were other operational issues small firms could tackle to get their margins up. “Your less sophisticated clients say there’s a shipping window, the 15th and the 25th. We got it in on the 24th. But if they had it in on the 15th, it would have had nine more days on the selling floor to possibly sell at full price.”
If a company doesn’t know what its gross margin is, chances are it also hasn’t put together a business plan. The lack of business plan is a shortcoming common among companies living by their wits, according to the forum participants.
Winters observed, “Most companies don’t know how much they need or when. How many times have you seen a company come and say, ‘I’m interested in your lending arrangements.’ I ask them, ‘How much do you need?’ and they don’t even have a clue. The most valuable thing when going to meet with a lender is to have projections. Have a plan, have a road map. They’ll say to me, ‘I want to do $20 million.’ When I ask them how much money do they need, their response is, ‘I don’t know; just [enough] to support $20 million.”‘
Loeb said he won’t talk seriously with a company unless and until it has a plan in place. “Just to have a business plan is the essential underpinning to any business and to any financing. I don’t talk to them unless they have a plan, because I don’t know what their objectives are, where they’re going or how much they’re going to expand.”
Bleser advised, “If it’s a small business, and it has a financing plan, it may be sufficient to put a balance sheet and a profits-and-loss statement together. I’d want monthly projections. I want to see 12 months, a month-by-month balance sheet, because then you can watch the seasonal flows.”
For Isman, one of the most important reasons to do a plan is so the entrepreneur can “think out where he is going.” He explained, “Somebody else can put in the numbers for him. In our business, we have a saying: If you don’t know where you’re going, anywhere will get you there. And that’s often what we see in a creative or sales guy. But if you pin him down and you make him think his volume through, where his costs are, when he needs his money, when he collects his money, when he pays his bills, then he starts thinking about his problems.”
According to the experts, small business owners have a wealth of information available at their fingertips — they just don’t use it to their advantage.
“Sales inventory, shipment information — there’s a ton of information,” Weintraub said. He pointed out that the good firms know how to use it and how to mine that information. “The good firms deal with exception reporting. Instead of getting a stack of 60 pages telling you of every transaction, it’s a three-pager that tells you you’re off budget.”
One problem, observed Lucas, is that management often is unable to understand the information that its getting. “They don’t know what to get or how to analyze it.”
According to Isman, “A professional can come in and design it along the lines of [what] we look at daily, weekly and monthly. You don’t look at every single thing that goes on in the business because you can’t deal with it. What are the important things? I make sure there’s a daily status report on the principal’s desk. Every day there’s at least sales, bookings, accounts receivable, accounts payable, cash balance, all the minimum basic information.”
Another line item where firms need to focus their attack has to do with expenditures.
“These companies are chasing sales. What we’re finding is that our $50 million and $60 million clients, if they attack their selling, general and administrative expenses, they can suck $1 million out of costs. For example, these days, it’s not about paying your salesmen by commission, but salary. So now you have two people getting the same amount of money, but one is producing twice as much and the other is producing half as much,” observed Weintraub.
Lucas noted, “A lot of the situations I’m working on now are with the $100 million company that really should be $40 million or $50 million. Three or four cases come to mind where these companies have no business doing $100 million. I’m trying to encourage them to get their businesses down to $50 million or $60 million.”
The attitude of many firms is, “We’ve always done this business,” observed Isman. “Clients can lower their volume by discontinuing unsuccessful business units. They think they have this factory, they’re in that market or have been selling a certain product for an account for a long time. But when you do an analysis, they shouldn’t be doing that business. Do you modify the business, change the price, change the market or discontinue it completely and sell off the assets?”
Getting firms to become lean and mean, according to Lucas, isn’t easy. “These firms, they have to learn, you can’t love your product. You gotta love your customer. Whether a retailer or manufacturer, you can’t fall in love with your inventory.”
Bleser agreed, “It’s the consumer that drives the business.” He pointed out that firms need to keep as many of their costs as variable as possible. “A commission, for example, is a variable expense, while salary is not.”
“It’s easy for a company,” Winters said, “to go from $50 million to $100 million dollars in annual revenue. You sell product below your costs and your sales will go right up because you’re giving them quite a bargain. I think what our clients have to do is evaluate each one of their retailing partnerships and see which ones are profitable. Most of them [probably] are not.”
He added, “The buzz word ‘retail partnership’ is [perhaps] the biggest misnomer in the industry. It’s the only partnership where if the stuff sells, the retailer is going to pay you what it owes you. If it doesn’t sell, the manufacturer’s going to take the brunt.”