From Home Furnishing Business
Cover Story: Business as Unusual STRATEGY Has the Business Model for the Traditional Furniture Retailer Changed Permanently?
For most furniture retailers, the hope is that the business model has changed. With net income increasing 2.68 points in 2020 compared to 2019 and more than doubling in the final quarter of the year, it is a good objective. The initial reaction of an increased demand for furniture was what one would expect, but only for the furniture industry as a whole. As seen in Graphic A, traditional furniture retailers did not benefit from the initial growth. While the total industry increased 8.1%, furniture stores declined 2.4%.
Without a doubt, when consumers escaped the shelter-in-place orders and the furniture industry escaped the “nonessential” classification, business boomed, with written sales surging and backlogs increasing. While experiencing the typical backlog buildup in the first months of 2020, retailers’ shipments increased as written sales decreased, and by the end of March and during April written sales plummeted. Beginning in May, traditional retailers began to cope with the shutdown environment alongside manufacturers coping with the pandemic impact on the supply channels.
According to Smith Leonard’s Furniture Insights, shipments declined 6% in 2020 with backlogs up 168% from year-end 2019. Obviously, furniture demand went somewhere during this time and the answer was other distribution channels. We estimate that e-commerce gained 3% to 5% market share followed by the home improvement channels (Home Depot/Lowes) and value retailers (Big Lots/ Target). Will traditional retailers regain this share?
That is a topic for future articles. So, if the substantial net income was not driven by volume, what was the contributor? In summary, the industry’s performance was driven by increased gross margin and reduction in expenses. But most important was the sheer determination of this entrepreneurial sector of the furniture industry. Owners returned to the daily details of the business. Discovering what was important took center stage while driving business in this unusual environment. The financial performance for the 2020 pandemic year is shown in Figure 1.
It was necessary to present the results by quarter to reflect the tumultuous year — a year that began normally and appeared to be on the road to a good year, only to fall into a chasm in the second quarter. The upturn was just as dramatic as the decline, as consumers rushed to satisfy pent-up demand and traditional retailers adjusted by incorporating sales by appointments generated from website leads. Retailers used their reserves along with government stimulus to maintain staff until the critical decision to allow the return of business in May and June. Soon, inventory was depleted and the next challenge facing the industry was a lack of product and transportation cost. While these significant shifts were challenging, the results to the bottom line has been rewarding, as seen from the key performance indicators shown in Figure 2.
Controlling prices while absorbing rising price/transportation costs became a daily challenge of repricing the floor. Gross profit increased by 0.8% for the year and almost 2% by the fourth quarter. We believe, and most would agree, that the strategy to increase gross profit was the result of attempting to stay ahead of the very necessary price increases from vendors and the unbelievable container prices, moving from $3,500 per container to north of $10,000 per container.
However, the price increases instilled confidence that the competition was not looking to discount as a strategy. Compared to other consumer products, the consumer price index in 2020 increased only slightly (from 113.2 to 114.5), while all products and housing continued to soar, as seen in Graphic D.
A major question moving into 2021 is, “Will these price increases and the resulting margin increases hold?” In comparison to other consumer products, furniture can endure a price increase. The gross profit increase contributed only 30% to the increase in 2020 net income. Depicted in Graphic E, one obvious contributor was the reduction in sales expense.
Sales expense reduction was reduced by more than a point (1.70%) by the end of the year. However, during the volatile third quarter, sales expense dropped two points from the disastrous second quarter. Sales expense began to trend up in the fourth quarter, primarily driven by handling expense. Advertising decreased 1.63% in 2020 from 2019, but was down substantially in Q3/Q4 by almost two points. While traffic fell considerably with the onslaught of the pandemic, it returned to normal levels by the second and third quarter without significant advertising. Traditional retailers began experimenting with digital advertising, as consumers have embraced the internet to begin their shopping process. Unfortunately, this change resulted in a loss of market share to the e-commerce channel, which did not have to comply with non-essential retail directives.
Handling expense (warehouse/ delivery/service) declined slightly (from 7.09% to 6.88%), primarily driven by the lack of product for handling. However, the lack of personnel at the current salary levels may dictate an increase in this cost element moving forward.
Selling expense for retail sales associates declined in the latter part of the year, partially driven by the loss of staff from commissions left unpaid because of backlogs. This delay in commission is forcing retailers to consider paying on written sales instead of the more common delivered sales. We would anticipate that this cost element will increase in the coming year.
The next area of cost is general and administrative. Stable for the year after experiencing a significant increase in the first part of 2020, this cost area fell in Q3 with rent concessions and staff reductions, but Q4 brought a leveling off. We expect general and administrative to return to historic levels. The table/graphic illustrates the breakdown. The other impact of these cost ratios is the fluctuation in volumes by quarter reflecting a volume variance in that the majority of these cost elements are fixed. No government subsidies (PPP loans) were included in these expense elements, but were shown as other income until forgiven.
Credit expense has remained the same during the pandemic year, as seen in the table/ graphic, and, interestingly, the stimulus funds did not impact the credit-driven consumer. As important as expense elements are the above the line revenue elements. Other than merchandise sales, as seen in the table/graphic, protection sales and delivery income remained constant from 2019 to 2020. The results were historical net income levels, as seen in Graphic K.
The major concern is if this level of performance be maintained. As backlogs are diminished, will the demand continue? Without a doubt, the consumer has become more focused on the home. However, as the nation puts the pandemic in the rearview mirror, other discretionary expenditures will take center stage. Additionally, forced expenditure reductions, such as dining out and kids’ sports, will reclaim its share of the family budget. Expenditures for advertising will increase to reclaim consumer interest fueled by promotions resulting in the decline of gross margin.
With all these expected trends, there is a hidden issue of market share loss to other distribution channels. While most retailers’ sales increased significantly in the third and fourth quarter of 2020, they lost three to five points of market share. Answer this question: Could your store have sustained a sales decline of 3% to 5% before the pandemic? That is the hidden crack in our future.
Know When to Hold Them, Know When to Fold Them
For the last three quarters business has been great, increasing 13.9% in Q4 over the same quarter in 2019. While the pace declined in subsequent quarters, it was still a very profitable time for traditional furniture retailers.
However, prior to the pandemic, many single-market retailers were concerned about the future of the independent furniture retailer based upon the expansion of the large regional chains and the erosion of market share to the retailers such as Wayfair.
While the aftermath of the pandemic shutdown did create a tsunami of purchasing, concern was still present, with the Bureau of Labor Statistics projecting a loss of 16% of furniture stores in the next five years — a pace exceeded only by clothing stores and electronic stores. Many asked the question: Is it time to fold them?
One retailer that made that decision was Wilcox Furniture, a fixture in the Corpus Christi, Texas, market for 68 years. The company, led by George Moore for the past 30 years, decided, along with other stockholders, it was time to take advantage of the consumer demand and liquidate. With the assistance of Wahlquist Management, the liquidation sale began and two months of sales was generated in eight days.
The icing on the cake was when the sale of the real estate (four stores) was accomplished with a targeted email and buyers were secured. What was good for the stockholders was also good for the employees, in that the purchaser was another established retailer, Beale Furniture, out of Houston. The transition will occur by Memorial Day.
While George Moore will miss the furniture industry, it was the right time for everyone. The independent furniture retail channel will continue in Corpus Christi — a positive for the citizens.