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In need of a retail turnaround? How to know and what to do

More than 50 retailers in Europe, the Middle East, and Africa have been in distress since the global financial crisis, and many are in distress today. Some are in denial about their situation; others are busy fixing the wrong problems.

March 2014 | byPeter Breuer, Thierry Elmalem, and Chris Wigley

Over the past few years, sales growth at the top publicly listed European retailers has been a mere one or two percentage points above inflation; average EBIT1 margins have dropped to around 0.5 to 1.5 percent of sales. The short- to medium-term forecast doesn’t suggest any respite from these gloomy numbers. Changing consumer lifestyles and preferences, the Internet, and continued economic uncertainty are putting pressure on—and, in some cases, causing financial distress among—many traditional retailers.

There are broadly two types of distressed situations a retailer can face. One is a cash or liquidity crisis, requiring immediate cash-management and debt-restructuring measures. The other, which is trickier to detect, consists of a set of issues that may not threaten immediate bankruptcy but pose fundamental challenges to the sustainability of the business model. In this article, we discuss how to recognize—and emerge victoriously from—the second type, an undertaking we refer to as a “distressed turnaround.”

How do you spot a distressed retailer?

What’s a good reality check for retailers? How can a retailer tell whether it’s in a distressed situation? We recommend both an analytical and a strategic approach.

In analytical terms, we suggest these criteria: a publicly traded retailer is in distress if its total returns to shareholders (TRS) has been negative for two consecutive years and is 50 percent or more below its industry peers’ TRS.2 By this definition, more than 50 retailers in Europe, the Middle East, and Africa have been in distress since the global financial crisis. These retailers range from department stores to restaurant chains to consumer-electronics players, and from smaller national companies to large multinationals.

Strategically, retail leaders should keep a close watch on their performance in the six dimensions of retail excellence: customer focus, merchandising, operations, infrastructure, people, and, most important, customer proposition (Exhibit 1). Material underperformance in any of these dimensions can be deeply problematic, but if a retailer doesn’t have a compelling customer proposition—a reason for customers to choose that retailer over competitors—it simply won’t survive.

Exhibit 1

Retailers should monitor their performance in the six dimensions of retail excellence.

How do you turn the company around?

The experiences of distressed retailers that have successfully turned their business around, either during or since the global financial crisis, have shown that a five-stage approach to retail turnarounds can lead to sustained success (Exhibit 2).

Exhibit 2

A successful retail turnaround typically undergoes five stages.

Stage 1: Wake up

The first stage of the turnaround sounds easy and obvious: acknowledge that your company is in distress. But for executives accustomed to success, this stage can be difficult and humbling. Denial is the norm. When we surveyed more than 1,500 executives who have been in turnaround situations, over half of them said they had either underestimated the severity of the problem or refused to accept that there was a problem at all.3 One retail CEO, whose company’s TRS was well below competitors’ and had declined by more than 90 percent in a single year, refused to use the word “turnaround” in discussing the business. “We are not in a turnaround situation,” he insisted.

Our analysis suggests that in most industries 10 to 15 percent of large companies are in distress at any given time. Take a hard look at your company’s TRS performance; test whether your customer proposition is resonating with consumers. If your company is indeed in distress, it’s best to come to terms with it now, while there’s still time to act.

Stage 2: Believe nothing, prove everything

Retail leaders must then seek to understand the causes of distress—and do so in a fact-based way. Company myths can be pervasive and difficult to dispel; many companies move reflexively to action based on long-held beliefs and assumptions, not taking the time to figure out if they’re attacking the right problem. Among our survey respondents, only 22 percent said they conducted a diagnostic at the start of their turnaround program. As one senior executive told us, “We jumped to what we thought the solution was, only to find out later that we had wasted our time and effort.”

A rigorous diagnostic increases the program’s chances of success: in our survey, 60 percent of companies that undertook a diagnostic achieved a successful turnaround. The success rate was only 34 percent among companies that didn’t do a diagnostic.

The diagnostic should bring to light what’s not working, but it should also highlight what’s working well. Often, companies become too absorbed pinpointing the problems and overlook inherent strengths in their businesses that can help them overcome their difficulties. Our research shows that a turnaround in which the company diagnoses both its strengths and weaknesses is more than twice as likely to succeed as a turnaround in which the diagnostic identifies only the company’s weaknesses.

We recommend that retailers take a “clean sheet” approach, which can be laborious but often yields powerful and surprising insights. One retailer, in undertaking a clean-sheet exercise, discovered that no one on the top team knew the total number of the company’s back-office locations or the size of its workforce across all subsidiaries. Because of disparate data systems, gathering this information was a surprisingly tedious task. But doing the legwork paid off: after the clean-sheeting exercise, the company found that five of its back offices and several support functions had considerable opportunities to improve efficiency. Within six months, the retailer was able to generate material cash savings through lease exits and consolidation of back-office teams.

Stage 3: Act early and aggressively

Once the causes of distress are clear, a retailer must move quickly and boldly. In particular, the CEO must put in place an action-oriented executive team and set ambitious cost targets. Both will be critical to survival.

Without major changes in the top team, it’s hard for a company to make a radical departure from past decisions and direction. One CEO who has led multiple turnarounds has even gone so far as to formulate the following guideline: “My rule of thumb for the top team is that a third will remain, a third will be promoted from within the company, and a third will come from outside. Otherwise, nothing changes.”

Once in place, the top team must then rapidly find ways to cut costs. For retailers, the biggest cost levers are typically head-office costs, supplier funding and cost of goods sold (COGS), and property and store costs.

Head-office costs. Head-office costs can be a drag on retailers’ profit-and-loss statements. A retail CEO should streamline headquarters if one or more of the following is true:

  • The company has too many committees and boards that have been built up over the years (as a result of past priority projects or acquisitions) and never culled. One incoming turnaround CEO described encountering “a board for every topic.” Company leaders should be taking action, not sitting in meetings.
  • The headquarters organization is top-heavy. Simply splitting the head office into salary tiers can highlight this issue: there shouldn’t be more executives at the highest level than in the next couple of levels.
  • Executives have too small a span of control. The right span varies for every role, but in general (except perhaps for specialist roles), if each manager supervises fewer than seven or eight team members, the organization would benefit from delayering.

Supplier funding. Supplier negotiations, with the aim of lowering COGS, are a critical lever for most retailers. In distress situations, we have found that assertive and creative approaches to suppliers can create value very quickly.

One retailer was experiencing dramatic sales declines due to “showrooming”: customers would browse in the stores but use their mobile devices to buy from Amazon—often while they were still in the store, taking advantage of the free Wi-Fi. The company’s analysis of industry-sales data strongly suggested that its in-store displays and promotions correlated with online sales: when a product was displayed prominently in its stores, overall online sales (including Amazon’s sales) of that product rose; when stores stopped promoting the product, online sales went down. The retailer negotiated with its suppliers to get a “fair share” of the value by calculating the online-sales boost from in-store displays. Over the following six months, the retailer renegotiated with all of its suppliers and agreed on a level of ongoing funding support that offset the retailer’s promotional costs.

Property costs. As sales migrate online, a legacy store network can act as the proverbial noose around a retailer’s neck. To get a realistic picture of its store network’s future value, a retailer should adjust for industry trends (such as the shift to online) when calculating store profitability.

A European leisure retailer, for example, launched a store-transformation program that initially encompassed only the 5 percent of its stores that were unprofitable. But when the company extrapolated current trends into the future—specifically, the migration of sales from physical stores to online—it projected a 30 percent decline in sales volume across all stores within three years. And after taking into account the allocation of central costs (such as the IT to support store systems), the retailer realized that more than half of its stores could become unprofitable in three years.

The company thus radically redefined the scope of its store-transformation program. It evaluated the entire network from a “zero base”—meaning each store needed to justify its existence. The company divided its stores into four groups based on profitability and ease of lease exit, then developed a different strategy for each group (Exhibit 3).

Exhibit 3

Stores should be categorized by profitability and ease of exit.

Stage 4: Fire on all cylinders

Too often, retail executives in turnaround situations think only about cost cutting. While cost cutting is necessary when the company is in survival mode, it won’t always address the root causes that led to a turnaround situation in the first place.

In our executive survey on turnarounds, respondents said that cost issues were the cause of distress in one-third of turnarounds; two-thirds of the time the cause was a challenge to the business model, such as discounters entering the market or customers moving online. Yet when respondents listed the actions their company took during the turnaround, almost two-thirds of the actions were focused on costs and didn’t address challenges related to the business model. Without thoughtful business-model actions—format renewal or reinvention, shifts in the trading strategy (in assortment, pricing, or communications, for example), or even a major change to the business model—the company faces a heightened risk of returning to a distressed situation.

One accessories manufacturer traditionally sold most of its products to distributors, which would then sell to multibrand retailers. The company also owned and operated a handful of concept stores as brand flagships. It had steered clear of e-commerce to avoid competing with its distributors and retail partners. However, an analysis of channel profitability and customer trends showed that the future sources of profitable growth were the online channel and owned concept stores. The company thus turned its channel strategy on its head. Execution of the new strategy was a critical element of a turnaround that has led to a fourfold rise in share price and TRS uplift of 190 percent in less than two years.

Stage 5: Make it stick

A successful retail turnaround often involves changes across hundreds of stores, brought to fruition by many thousands of frontline staff, which translates into a significant performance-management challenge. According to our research, the average C-level executive spends approximately 15 hours per month in performance reviews, compared with approximately 40 hours per month for a turnaround one.

One approach that works well in turnarounds is to establish a “chief restructuring officer” (CRO) role for a limited period, typically 9 to 18 months. The CRO, usually an external hire with extensive experience in distressed turnarounds, leads the turnaround office—a “control tower” for all turnaround initiatives—and is responsible for spurring a radical rethink of the company’s operating model, pushing managers to reexamine how things are done, and challenging their assumptions about what is possible. The most effective CROs engage all stakeholders early and continuously, and they motivate colleagues by telling the positive change story over and over again. As a change leader, the CRO should operate as an extension of the CEO, with the authority and credibility in the organization to make decisions (with the approval of the CEO). The CRO doesn’t replace line leaders, but rather supports the CEO in driving the transformation so that the day-to-day tasks of running the business are not neglected.

This level of central control may seem like overkill, but our experience shows that without it, different parts of the business can easily report delivery of “turnaround benefits” while the profit-and-loss statement stubbornly stays the same. Our research shows that turnarounds with strong governance are seven times more likely to succeed than those without it.

Times are indeed tough for retailers. But being in a distressed situation isn’t cause for despair. If retail leaders face the facts early, identify and address the root causes of their financial distress, take costs out quickly, and ensure disciplined execution, they can deliver—and rapidly move beyond—a turnaround.

To read more about issues critical to retailers and consumer-packaged-goods leaders globally, download McKinsey’s second issue of Perspectives on retail and consumer goods (PDF–3.7 MB).

About the authors

Peter Breuer is a director in McKinsey’s Cologne office; Thierry Elmalem and Chris Wigley are principals in the London office.

The authors would like to thank Graham Biggart and Agnes Krygier for their contributions to this article.

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The material on this page draws on the research and experience of McKinsey consultants and other sources. To learn more about our expertise, please visit the Retail Practice.