Not a month goes by that another retail concept announces an assault on the traditional furniture supply model. The recent announcement is that Amazon is planning four major distribution centers to serve its anticipated expansion into furniture in order to increase its retail presence. This move on top of the major discount retailers of Target and Big Lots indicate their future stores will have a focus on home furnishings.
This constant evolution of the furniture supply model is not new. In 1886 the upstarts, Richard Sears and Alvah Roebuck, created a mail order company to compete with the general stores in the hinterlands whose model was limited selection and significantly higher prices. While less of a presence today, it has lasted for 131 years.
Innovative concepts have always been part of the landscape. For example in Lebanon, Pennsylvania Richard Levitz introduced a concept that evolved into a national chain that pioneered the “furniture warehouse” concept. This concept expanded for nearly 100 years before liquidation because the consumers wanted to see furniture displayed in “vignettes” in order for them to envision how the furniture would look in their homes.
While there are tantalizing announcements, such as furniture on demand produced from 3-D printers, there are two considerations required when exploring changes to the furniture distribution model. The first is the cost to conceive and deliver to the consumer a product that meets their demands. The second is the ever-changing demands of the consumer – and this is the most important. The fickle consumers are fast to embrace a new concept that they believe will address their perceived shortfall in the current model, only to abandon when the new model doesn’t address another need.
Top quartile retailers are continuously analyzing their financial performance in order to discover ways to increase the bottom line. However, as can be seen from the following article, these improvements are incremental. Major profit improvement can only occur with changes in the total business model. The accompanying table presents the major cost components comparing the traditional model to those that are currently challenges to the status quo.
Furniture Brands International, using the manufacturing vertical concept, was poised to capitalize on its consumer brands by opening, with retail partners, focused stores under distribution agreements. Financial difficulties halted that strategy. However, Ashley Home Store, founded in 1997, had prospered with this concept. It now has over 450 locations in North America with over $3 billion in sales.
This model has the potential for changing the traditional industry model. Financially, it reduces the expense of selling/marketing to retailers since the dealers are captive to the manufacturers. Interestingly, the manufacturing direct concept challenges the perception that the consumer will not wait for delivery. The dealer maintains little inventory at its warehouse. It is only a cross dock transferring to delivery trucks for the consumer. The major challenge is the percentage of consumers who will wait the 20-30 days for delivery when competition is offering same-day delivery.
The manufacturing vertical model relies on the local dealer to execute a local advertising plan supported by a national advertising campaign. This approach, in total, is a more efficient expenditure executed at a higher level of professionalism.
The store footprint of around 30,000 square feet reduces the occupancy cost of display. At this point the lack of selection is not a negative to the younger consumer who prefers a more curated presentation that supports their busy lifestyle.
The challenge is that this model must conform to the perceived retail experience of the consumer, an experience that is constantly changing based upon research from Impact Consulting Services, parent company of Home Furnishings Business. These are the major factors.
While the potential exists to reduce costs which can translate into higher profits or lower prices, the increased risk of relying on a single manufacturer to consistently satisfy the consumer’s perceived needs.
The emerging etailers, using ecommerce as the way to distribute furniture, are challenging the retail sector of the traditional furniture model. Eliminating the brick and mortar of the traditional furniture retailers and utilizing their web presence to entice the consumer to purchase is still a challenge. The need for the consumer to experience the product before making a major purchase is important to most consumers. However, they have still captured 15-17% of total furniture sold.
The need to provide white glove delivery has been a significant expenditure when compared to local delivery by the brick and mortar retailer. To overcome this factor etailers, such as Wayfair, are establishing their own warehousing/delivery infrastructure. While more cost competitive, can it provide the service levels expected by the consumer?
The discount chains are just developing their furniture strategy. Their major opportunity for cost reduction is in the sales process. Relying on consumer-to-self sell will be an interesting experience. While acceptable for bar stools and less expensive product categories, will it translate to more expensive products? It has worked in apparel for all except the premium price points. The integration of the furniture product category into the already-established warehousing/distribution system is the next opportunity for cost reduction.
While new concepts are always exciting, what about the existing traditional model? We have discussed several over the last decade, but have failed to execute. For example:
Suppliers’ prices include delivery, not just the containers, but also small lots.
Delivery directly to the consumer, competing with the etailers.
Suppliers assuming responsibility for communicating to the consumer the uniqueness of their products and relying on retailers to communicate price/value and service.
I could go on, but why don’t we “whiteboard it.” Let’s make existing models
Traditional furniture stores, feeling the relentless pressure from online retailers as well as local competition from vertical manufacturers, warehouse price clubs, and discount superstores, are scrambling to maintain market share. As the furniture industry in total experienced slow growth last year, traditional furniture stores subscribing to an online performance application developed by Impact Consulting Services, parent company of Home Furnishings Business, took baby steps to improve their profitability, eking out minor improvements wherever possible. These are retailers actively involved in managing their businesses. Net income for this group increased only slightly from 3.7 percent in 2015 to 4.0 percent in 2016. Meanwhile, the total furniture and bedding industry slowed growing 3.0 percent 2015 to 2016. (Figure A)
This is the fourth report on Performance Metrics for Furniture Retailing providing a comprehensive look at financial performance in the home furnishings industry via comprehensive data collected throughout the year by Impact Consulting Services, parent company of Home Furnishings Business. This data is collected through Impact’s FurnitureCore application, Best Practices, which provides an ongoing monthly measure of a retailer’s performance. This subscription-based online application allows retailers to compare themselves to other home furnishings retailers and devise a plan to better manage store operations. No individual retailer’s numbers are shared, only composite percentage results. (See methodology for additional criteria used in the retail metrics report.)
The focus of this article’s financial comparisons is two-fold. Results are provided for all participants and reflect the performance of the entire sample compared to last year. In addition, the top quartile results are presented in four retailer size segments for performance comparisons based on revenues – under $5 million, $5 million to $25 million, $25 million to $100 million, and $100 million and over. The top quartile includes the top 25 percent in performance. It should be noted that retailers participating in FurnitureCore’s Best Practices application are retailers focused on improving their company’s performance and does not reflect the industry in total.
The sales ranges not only reflect size of retailer, but in turn the differing operational characteristics the company size brings to profitability. The under $5 million retailers are the surviving Mom and Pops who have developed niches and strategies for staying in business. Retailers with sales $5 million to $25 million have often emerged from Mom and Pop stores and are usually very owner-focused in operations. The larger $25 to $100 million retailers may also reflect similar ownership, but have also developed more tiered management operations adding professional managers, for example in warehousing/delivery functions. The largest sales group, the over $100 million retailers have accounting practices that are often driven by tax strategies.
The overall financial performance of all participants is shown in Table 1. Each portion is further compared to the top quartile in each size segment with more in depth analysis.
Overview of Key Performance Indicators
After a hefty improvement in financial performance in 2015 among the traditional retailers that comprise the statistics in this report, retailers showed only a slight improvement in net income in 2016, up from 6.4 percent to 6.8 percent total. Lacking a clear strategy going forward to combat the pressures from the e-tailers and alternative distribution channels, all areas of the P&L held steady with the only slight improvement being a 0.4 percent improvement in cost of goods sold.
Table 2 gives an overview of key indicators – gross profit, sales expense, general & administrative expense, net operating Income, and credit expense. Last year produced very little improvement in any of these areas. However, the importance of controlling all facets of the business is reflected in the higher performance level of the top quartile retailers compared to all participants. And while these top retailers did slightly better at controlling cost of goods sold, significant to their success was their reduction in sales expense and general and administrative expense compared to the group. Sales expense is comprised mostly of sales force compensation, advertising, and warehouse/delivery expense. The biggest chunks of G&A are occupancy costs (rent/lease) and administrative costs, primarily administrative and managerial salaries.
Each segment of financial performance is presented in more detail below.
Above the Line Income
Total revenue encompasses merchandise sales as well as returns, sales of fabric/leather protection, and delivery income (Figure B). The needle moved very little last year compared to 2015 in all of these areas.
Returns: Merchandise returns (Figure B) represent about 1.3 percent of total revenue for the group, about the same as last year. (Note: Historical 2015 data has been revised from previous reports.) Smaller retailers tend to handle many of their returns outside of the tracking system with voided tickets and even exchanges. Meanwhile larger firms are more likely to document these transactions negatively reflecting on their performance.
Merchandise Protection: Merchandise protection (Figure B) is often an important profitability component for traditional retailers, with the exception of upper to premium dealers, who often consider it a negative. This income usually represents around 3 percent of total revenue, regardless of retailer size, and was essentially flat in sales growth over last year.
Delivery Income: Free delivery (Figure B) has become the expectation of consumers in all retail outlets, and this is especially true for smaller retailers. The best performing companies have still been able to offset this expense as delivery income as a percent of revenue continues to slowly decline. Larger retailers are able to offset this expense at nearly double the rate of smaller companies.
Cost of Goods Sold
An improvement in cost of goods sold for the retailer is accomplished by either “buying better” or simply not having to discount its merchandise so heavily. The total group did neither last year seeing less than 0.5 percent improvement – 51.5 percent COGS in 2016 compared to 51.9 percent the previous year. Larger companies over $100 million outperformed their smaller counterparts; however, no size segment saw much change from the previous year. (Figure C)
With little improvement in COGS, gross profit also saw only minor growth as well. For all participants, gross profit grew only slightly from 48.1 percent of revenue in 2015 to 48.5 percent in 2016. Top quartile performers among all sales ranges reached gross profits of 51 percent, except for the size range $25M to $100M who as a group struggled to keep up with the entire group at 48.2 percent GP. (Figure D)
The furniture industry’s gross margin is the envy of many retail sectors. Some vertical furniture retailers enjoy higher margins due to their direct sourcing models while electronics and appliance margins can run in the teens. With such healthy margins, why does the furniture industry make so little profit? Tracking how much of it the industry spends on selling the product and running the business brings these low profits into focus.
A significant 23 percent to 24 percent of revenue is spent on selling expenses (Figure E), and this figure has remained constant last year over the previous 2015. This is the cost of attracting the consumer to the store (advertising), converting that consumer to a purchaser by trained personnel (sales) and successfully delivering that product to the consumer’s home (warehouse/delivery).
Advertising Expense: The cost of promoting product has also remained constant at about 6 percent of revenue (Figure E). Except for very small firms under $5 million in sales, the top quartile companies in profitability held their advertising costs to about 4.3 to 4.5 percent. Advertising channels may differ by size of retailer where larger retailers will use more broadcast/air channels while smaller retailers rely heavily on print media, but the cost results are similar. Very small Mom and Pop retailers are increasingly required to spend more on advertising to attract customers with the top quartile of these small dealers spending around 7 percent of revenue. It is imperative that advertising’s effectiveness be measured on a weekly basis and the only measure is number of visits – or ups – to the store or the website. (Figure E).
Sales Expense: The largest component of selling expenses is the cost of the sales associates, along with the cost of managing and motivating them. Included in sales expense (Figure E) is the sales associates’ commission, as well as sales management, bonuses/contests and similar activities. Overall, sales expense runs about 9.2 percent of revenue. Last year these costs were consistent across the sales ranges for the Top 25 percent of each group.
Warehouse/Delivery/Service: The “after the sale” cost of warehouse/delivery/service is also a significant cost to the retailer. Last year these expenses totaled 6.9 percent of revenue similar to the previous year (Figure E). Often a retailer’s upfront performance is negated by the backend if the retailer is unable to manage it correctly. Many midsize traditional retailers are now outsourcing this function in an effort to bring this cost down.
Store Sales Expense: A small but important selling cost, store sales expense, averages 1.8 percent of sales for the total group. For the most part, top quartile companies do a better job controlling these expenses. Larger companies over $25 million do the best job, spending under 1 percent of revenue on store sales expenses (Figure E). Retail technologies exist to eliminate the sales counter which can cost one percent or more, but can negatively impact the consumer’s excitement for the furniture purchase.
General and Administrative Expense
While not directly touching the selling process, the final piece to profitability is the control of general and administrative expenses. General and administrative expenses are, for the most part, fixed expenses and must be controlled relative to the potential volume. Primary components include occupancy costs – the place to conduct business and the costs to keep it open, the cost of the management team that develops and executes a strategy, and finally the technology and information systems that are essential in controlling the process. These expenses can be as much as the selling expense in some cases and generally vary significantly by the size of the retailer. (Figure F).
Information Systems: Technology costs are staying well under 1 percent for the total group as well as the best performing retailers (Figure F). Even smaller retailers are embracing the implementation and ongoing maintenance of systems necessary to run a business smoothly understanding these systems are critical to profitability. The larger retailers investing more in information systems have achieved an advantage in processing the customer order after the sale, often by transferring the process to sales associates.
Occupancy: Costs for keeping the doors open ran 7.7 percent of revenue for the total group last year, only slightly higher than last year. The best performing companies enjoy occupancy costs around 5 to 6 percent (Figure F). And while very large retailers over $100 million often have the upper hand with the ability to secure the best locations, real estate rents are escalating in prime areas with the top quartile of these high volume companies averaging 9.1 percent in occupancy. Consumers are increasingly placing a priority on location wanting to shop closer to home or visit retailers along their normal shopping routes.
Administrative Expense: The largest chunk of administrative expense is management salaries along with bonuses, professional fees, and insurance. Overall administrative fees can total 8 percent to 10 percent of revenue on average for all retailers. Top quartile small Mom and Pop stores run higher at over 10 percent. Larger retailers over $25 are keeping their salaries down to 7 to 8 percent (Figure F). The high cost of hiring managerial positions is often a difficult decision but can often produce big results with the proper personnel.
Credit Income and Expense
Retailers acting as credit houses are disappearing and what was once a key area of profitability is now a crucial place to control costs. Net credit expense totals 2 percent to 4 percent of revenue for the top quartile regardless of size and 3 percent for all participants (Figure G). From our perspective, credit is a selling expense that has emerged as a perceived necessity to generate consumer traffic. But in our experience, less than 30 percent of consumers opt for offered credit promotions.
Net Income (Percent of Revenue)
After deducting an average of 0.3% of revenue resulting from other income and expenses, including insurance and taxes, net income crept up to 4.0 percent in 2016 for the total group, up from 3.7 percent in 2015. For the top quartile in each size range, small improvements in all areas of cost of goods sold, sales expense and general and administrative expense added up to much higher net income for these top performers. Depending on company size, net income reached 8 percent to 12.4 percent among the top 25 percent. (Figure H)
The slow growth in the furniture industry this year is reflected in the flat financial performance of traditional furniture retailers. And lacking any new strategic direction to combat the onslaught from online retailers and other local distribution channels, management in these active and performance-focused companies realize they have their work cut out for them. Keep in mind our numbers are only guidelines to stimulate thought and discussion of how to profitably run a retail operation. We caution any specific retail figures, to be comparable, must be compiled to conform to these classifications.
We believe an ongoing focus on a company’s statistics is the path to high performance. It is not achieved in a month, but is part of a continuing process. Such a process is greatly enhanced with membership in a retail performance group that allows for open and frank discussion with peers of the barriers to achieve certain objectives.
While the overall industry statistics indicate slow but steady growth, many retailers are achieving exceptional results. We challenge you to be one of those. Home Furnishings Business is committed to providing input to your process.