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Boohoo's sustainability questioned as PwC quits as auditor

The fast fashion retailer saw a surge in virtual footfall due to the nationwide lockdown, but can it climb back from PwC resigning as its auditor and a recent working practice scandal?

28th Oct 2020
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Boohoo is (or was) a fast fashion darling; founded in 2006, the UK-based online fashion retailer has accumalated revenues of £1.2bn and has a market cap of £3.5bn. Following a recent factory scandal, PwC resigned from its Boohoo auditor role, highlighting the growing sustainability issues of the fast fashion industry.

If you’re London-based, you will have come across Boohoo's adverts all over the underground. If not, and you don’t have teenagers, you will likely never have heard of them! Boohoo’s target audience are those in their mid-teens to early twenties, but you won’t see Boohoo on the high-street; they follow an online-only model, meaning that the nationwide lockdown and subsequent fall in high-street and shopping mall footfall has led to minimal disruption.

Fast-fashion is a controversial segment in retail; it fulfils the millennial target market demands of ‘I want it now’ and does so at an accessible price point, but to the apparent detriment of sustainability and other ethical practices, which are increasingly under scrutiny by today’s conscious shopper (and investor). It’s these that have more recently caused a stir among investors and stakeholders, leading to drops in share price.

Boohoo plc share price

Boohoo plc share price

Background

  • Boohoo was founded in 2006 by businessman Mahmud Kamani and designer Carol Kane.
  • The company went international in 2012, launching in Australia and the US (21% of revenues come from the US).
  • In 2014, the company floated on the stock market and was valued at £560m.
  • In June 2020, the company took advantage of ailing brands Oasis and Warehouse and bought them for £5m.
  • In July 2020, The Sunday Times reported that workers at a factory in Leicester making clothes for Boohoo's Nasty Gal brand were paid £3.50 an hour (less than half the minimum wage).
  • In the same month, it was alleged that workers were being forced to come into work while sick with Covid-19.
  • In the space of two weeks in July, the share price fell by more than 45%.
  • In October 2020, a BBC investigation found money laundering evidence at one of Boohoo’s suppliers.
  • On 20 October PwC resigned as Boohoo auditor.
  • After gradually climbing since the employee scandal, the share price dropped again by 20%.

Online-only business model and fast-growth

Asides from the the current ‘scandal’, Boohoo is a story of success - they demonstrate the power of nailing the target market, marketing strategy, the online-only business model, and unit economics. Clearly there is the issue of how those unit economics have been achieved (low production costs and labour), but the business has had huge growth since its inception. It’s even bought up the online businesses of well-known high-street brands Karen Millen and Coast.

Much like the story of Gymshark’s growth, Boohoo’s revenue curve is impressive.

Boohoo’s revenue curve

The business model has a strong focus on key seasonal trends at low prices and high turnover of stock.

One of the main advantages Boohoo has over competitors is that more than half their stock is made in Britain; where traditional high-street retailers will manufacture overseas with long lead times, Boohoo can stay on top of the current trends and clone outfits worn by celebrities to get onto their site within two weeks. They also deploy an MVP approach and order small quantities of new lines to test how they land with consumers before ramping up production on the most popular items.

They are able to keep prices low by owning their own labels and being more in control of their supply chain. Also, like Gymshark, Boohoo has embraced influencer marketing with celebrities such as Paris Hilton driving their social following (their Instagram alone has 6m followers), allowing them to decrease their customer acquisition costs.

It’s a fascinating business model - integrating strongly with your supply-chain, ordering small quantities and ramping up production on favourites.

Governance: Supply chain & working practices in factories

However, fast-fashion brings its challenges - trend shelf-life, unit economics/margin and ethics being the most common. In order to remain cheap, you need very slick processes, such as quality technology, cheap customer acquisition costs, and a cost-effective, efficient supply-chain. The lower the product price, the more you have to play with.

This summer a scandal hit the press involving a number of factories in Leicester that Boohoo use in its supply chain. Boohoo was accused of sourcing garments from manufacturers who pay less than the minimum wage. Equally, Labour Behind the Label accused Boohoo of sourcing garments from factories that did not protect staff from Covid-19 as well as general poor working conditions at their UK suppliers.

Boohoo appointed a lawyer to look into the allegations and distanced itself from the factories. The review found that while the company did not profit from the abuses, it certainly knew about them and had not acted quickly enough. In fact, it went on to report that Boohoo’s supply chain oversight had been “inadequate for many years” and its internal processes were “well below the standard which would be expected of a company of its size and status”.

“Whilst it put in place a programme intended to remedy this, it did not move quickly enough,” the review stated.

One of its top ten shareholders in the group, Standard Life Aberdeen (SLA), announced that it sold most of its stake in the company after the reports of the practices.

All organisations, especially public business, have a responsibility not just for what is in their direct control but also for their entire supply chain. How well do you know what’s going on in your supply-chain?

Money laundering

In October, a BBC investigation found a network of clothing manufacturers in Leicester involved in money laundering and VAT fraud - some of these firms were suppliers of Boohoo. Of course, Boohoo told the BBC it would never knowingly conduct business with anyone acting outside of the law and has now terminated its relationship with one of the firms highlighted by the investigation.

The report focuses on Leicester-based company director Rostum Nagra who, through a complex supply chain network involving shell companies with addresses in Leicester, arranged for false invoices to be produced, artificially inflating the purchase prices of stock and claiming VAT on these. Effectively, Nagra was running two sets of books - one for the taxman with false invoices, and a dark cash book with codified jottings. HMRC completed 25 separate investigations in the city’s textile trade and recovered more than £2m of tax.

Again, it demonstrates how import it is to understand who you are dealing with and your entire down-stream supply-chain.

If you want to hear more about the endemic fraud in Leicester’s garment factories, you can listen to File on 4: All Sewn Up.

Auditor resignation

However, just as the share price was recovering from the first scandal and the Standard Life Aberdeen share sale, the company announced their auditor for the past six years, PwC, would be resigning. The resignation came shortly after the money laundering investigation hit the press, presumably due to concerns for its reputation by association of a business that has questionable ethical decisions and the proximity of the money laundering scandal.

Just as Sports Direct had challenges in appointing a new auditor, it transpired that the other Big 4 also weren’t interested in taking up the position either and declined to tender. As a result of the news, the share price collapsed by 20%.

Conclusion

Despite two major scandals in the past few months, Boohoo is likely to navigate through them and the share price has already climbed back up somewhat; the directors have been buying up shares which has helped the share price to recover whilst boosting their own stakes in the company.

While their target audience is possibly oblivious to the scandals, other stakeholders aren’t and both investors and auditors have reacted to the news.

Ethical brands are becoming much more valued by investors and other stakeholders. Just as organic food has become much more visible in supermarkets, sustainable manufacturing will also become much more visible.

While we all may want market competition to drive cheaper products, we need to consider what it’s at the expense of; if you’re paying so little, what’s going in the background to get to that price point? If it seems too good to be true, it probably is.

Replies (4)

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By flightdeck
29th Oct 2020 10:55

Interesting. The problem is that crime does pay in the UK

https://www.accountancydaily.co/seven-year-additional-restriction-boss-o...

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By chrisholmes
29th Oct 2020 11:55

If the fashion industry cant audit its supply chain in a location an hour by train from London, theres a cat in hells chance it can do it properly if the factory is in the far east.

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By clairebear
29th Oct 2020 15:25

Sadly, the customers who want cheap, fast fashion are unlikely to care less if people are being exploited for their "bargain". As long as they can look like an influencer on a Saturday night, it's all good.

But, the question is more surrounding the auditors. If they become too toxic a brand to get a notable (i.e. big 4) auditor and they have to go for smaller firms, then will this start to affect their attractiveness to the stock market? That is a different question altogether.

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By mikebeadle
30th Oct 2020 00:38

Thanks, a really high quality article on a difficult business. The QC’s report didn’t pull any punches if you read Chapter 6

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