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Primark tightens belt as High Street suffers

As the coronavirus strips retailers bare, Alastair Barlow looks at Primark as a case study of how the struggling High Street can navigate the storm – especially one without an online presence.

13th May 2020
Founder & Chief Dreamer flinder
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Primark in Brighton
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Physical retail has absolutely and definitively taken a complete beating in the last month.

John Lewis has furloughed thousands of staff (some 2,000 have moved to Waitrose to cope with increased demand there), fashion retailer Cath Kidston said it has closed its stores for good, Oasis and Warehouse have also permanently closed with a loss of 1,800 jobs (guess who bought the brands – none other than Hilco, the turnaround specialists involved in the HMV rise…and err…fall).

But while many other retailers have shifted their focus to e-commerce to maintain some stream of revenues and cash inflows, one high-street giant, in particular, has not had that luxury.

If you didn’t know, fast-fashion store Primark does not actually operate a transactional website. What? Yes, that’s right – one of the biggest names on the high-street does not have an e-commerce store you can buy from. Sure, you can browse online, you can see how much products cost, and you can find your nearest store, but you can’t actually click and ship.

So, while the entire country is in lockdown and most businesses are desperately trying to pivot to some form of online or remote service, Primark has both its doors and business firmly closed, resulting in lost sales of £650m per month.

What does this mean for Primark and its stakeholders? And what you can you learn from it?

A brief history

  • The first store opened in June 1969 in Dublin.
  • They sell a diverse range of fast-fashion products across baby, children's, womenswear, menswear, homeware, accessories, footwear, beauty products and confectionery.
  • They operate over 370 stores across 12 countries.
  • Their largest store opened in Birmingham April 2019.
  • In 2005, they bought Littlewoods retail stores for £409m (retaining 40 of the 119 stores and selling the rest).
  • In 2006, the first Primark store outside Ireland and the United Kingdom opened in Madrid, Spain.
  • In 2008, Primark opened in the Netherlands, followed by Portugal, Germany and Belgium in 2009.
  • In March 2020:
    • 68,000 (UK: 37,000) staff started to receive furlough payments from governments across Europe
    • Implemented temporary pay reductions of 10% - 30% across head office, senior executives and leadership team
    • 375 (UK: 189) stores have been closed
    • Since closing the last store on 22 March, they’ve sold nothing.

A missed digital opportunity?

I’ve written about business models previously, and specifically the click vs brick models of HMV and Marks and Spencer. So, the big question here is, why do they not operate a transactional website? Surely, it’s a missed opportunity – both the opportunity cost of no online sales and missing out on all that rich customer data?

Well, not to get too technical, but if you’re not familiar with ecommerce metrics, two of the most important ones to focus on are:

  • customer acquisition cost (CAC) and
  • customer lifetime value (LTV).

In fact, they become even more relevant when you compare the two of them together to create LTV to CAC ratio (LTV:CAC). Those that are more familiar with SaaS or other subscription businesses will be familiar with this metric too (along with churn and negative churn). In ecommerce, it’s typical that your LTV is calculated from your gross margin, whereas in a SaaS business it’s typically the top-line subscription fee.

You should aim for a positive LTV:CAC ratio which implies you are ultimately making more from your customer than you are paying to acquire them. There is an optimum ratio to have – too low and you will be losing money on every customer, too high and you’re not investing in growing your customer base as aggressively as you could.

However, you need to consider the length of the period you are assessing as the lifetime. For example, if your repeat order stretches out to three years you may be burning too much cash to sustain that cycle. The cost of acquiring the customer is vital when assessing unit economics and overall viability for running an online store.

The snag here is that Primark has extremely low average price points. However, let’s assume Primark doesn’t need to spend a penny on acquiring their customers digitally. After all, they have a huge number of customers wading through their stores so chances are they would have a huge organic following. There is still the cost of delivery to factor in. Scrolling through their online showroom, they have many products that are priced at only a few pounds. Delivery would cost more than the product.

However, let’s assume they charge delivery on top of their product price. There is still the cost of returns, and a returns rate could be anywhere between 30 – 40%. But it’s not just the cost of the return delivery but also the associated costs of processing, cleaning, folding and repackaging along with a percentage of waste too.

So, all these factors would turn a very relatively small margin into quite a sizeable loss margin per unit.

And that is one of the primary reasons Primark doesn’t operate a transactional website which means, right now, they are firmly closed for business and losing £650m sales per month.

Navigating the storm

So, when you have 68,000 employees and over 350 stores but zero revenue, how do you go about managing that and minimising your cost base and most importantly, your cash burn?

Well, probably not too dissimilar to most businesses across the world. They looked at their largest overheads; people and location costs.

  • Staff – furlough and pay cuts

68,000 people are receiving furlough payments from governments across Europe, without which they would have been forced to make most redundant. Additionally, they have introduced a 20% reduction in pay for senior executives, a temporary 10% cut for the remainder of colleagues across head office, and the leadership team is due to take a temporary 30% salary cut and no bonuses are to be issued for this year.

  • Rent and rates

The retailer has written to landlords informing them it will be holding the quarterly rent payments on its 110 leaseholds stores. The letter asked landlords for their support on lease agreements going forward to mitigate the financial impact of coronavirus on the business. Additionally, in the UK they have the welcome relief from business rates for 2020/2021.

Across the group, they took immediate action to stop nonessential capital and discretionary operating expenditure. As a result of all these cost mitigation measures, they currently estimate being able to recover some 50% of Primark’s total operating costs but still leaking a monthly cash outflow of some £100m, while the stores remain closed.

There is also the downstream impact on their supply-chain too. With sales ceasing immediately and an inbound supply chain continuing for several weeks they had stock in transit to the tune of £600m which they agreed to pay for. To prevent further cash outflows and further inventory building up, they’ve cancelled all future orders until further notice.

Of course, stock is seasonal, especially in a fast-fashion store, so they’ve also had to write down their stock by £284m. There is likely to be one big sale coming out of lockdown.

And the one that will hit shareholders hardest (other than the fall in share price) is that the Board of their parent has decided not to declare an interim dividend.

What other measures would you put in place?

The fail-safe of a diversified portfolio

While no one could have predicted the cataclysmic shift in society due to Covid-19, it has long been a good business practice to diversify. So much so, that in general society we’ve developed the common idiom “don’t put all your eggs in one basket”. Now clearly, not every business can be a global conglomerate spanning sectors or geographies but it’s a stark lesson in business and a good reminder to look for multiple ‘baskets’ to diversify and de-risk.

Primark is actually owned by Associated British Foods plc, which is the world’s second-largest producer of sugar and baker’s yeast and a major producer of other ingredients. It has a market cap of nearly £14bn (as of 5 May 2020) and consolidated revenues for 2019 were £15bn. It operates in grocery, sugar, agriculture, ingredients and, of course, retail markets. Some of the more famous brands are Ovaltine, Ryvita, and Twinings.

Primark

Associated British Foods plc (of which Primark is a subsidiary) share price:

Retail (Primark) accounts for approximately 50% of ABF plc £15.4bn group revenues.

While the overall ABF plc share price has taken a tumble, the cliff-drop of Primark activity has been balanced out with the increase activity of their other markets, which has actually shown an increase in demand over the past month.

“Our food businesses, and in particular our food factories and depots and drivers, have equally been put under intense pressure since this pandemic began, but in very different ways. ABF businesses produce more food in the UK than any other organisation and we are significant producers of food in other countries too…Indeed, during the weeks of panic buying, they had to produce more than ever before.” George Weston – chief executive, ABF plc.

A little known fact, owners of Primark, Associated British Foods plc is owned by Wittington Investments, which also owns Fortnum & Mason, the upmarket department store. They really do have a diverse portfolio with both ends of the consumer budget.

A new business model?

It’s not just the lack of a transactional website that will hamper Primark sales this year. Once we’re eased out of lockdown, it’s difficult to predict how consumers will react when stores reopen – they could very well be hesitant about too many people in a confined space.

Chief Executive of ABF plc, Weston said: “When we are allowed to reopen we must make our Primark stores safe for our staff and our customers, even if that means ensuring there are fewer people shopping at any one time and so accepting lower sales at least until the remaining risk is minimal."

So, even during this reintegration phase, Primark is bracing for a much lower level of activity than they ordinarily would cram into their stores.

On the flip side, shoppers may well be more conscious of excess spending for the foreseeable future, which would be a boost for value retailers like Primark.

So, should Primark chiefs be taking this time to reconsider their business model?

It continues to be a challenge for Primark to make its “high-volume, low intake margin, low selling price” model to work on a transactional website for the reasons previously mentioned. However, concerns about physical contact and a potential second wave of social distancing measures in colder months may make them reconsider their business model.

They obviously value the upsell experience they have instore much more than the power of the digital algorithm on an electronic basket, “Customers enjoy looking online at the latest offers, and then come to stores on the high street to buy. The in-store design and experience is part of Primark’s attraction to customers,” said Weston.

Conclusion

Investors have a balanced portfolio for a reason; they don’t “put all their eggs all in one basket”, and that, right now, is a huge saving grace for Primark. While Primark has no transactional website that could minimise some of the lost store revenue, ABF plc has an FMCG division that has been relatively unaffected from the pandemic thanks to soaring demand in grocery.

On the very few occasions I have been in a Primark store, I find it cluttered, frustrating and messy. Personally, I would far rather shop online than experience that…but then, again, I’m probably not their target customer.

Surely there is a way for Primark to develop a digital model to complement their normally busy physical retail store. Creating more resilient and flexible business models to weather retail’s new challenges will be a top priority for all retailers – not just Primark, and we will certainly see others invest more in this.

What you would do if you were the CFO advising the CEO at Primark?

Replies (7)

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By njpandya
14th May 2020 09:25

I am discussing this repeatedly with my friend, colleagues and business circles. Not for once I feel sorry for these clowns call Primary who on Earth do not trade online. Whoever their strategic think tank is must be sacked for an absolute zero vision. Future is digital and online based and it will work seamlessly, given the insane rent and rates for commercial premises. Not heard single word and read anywhere that council staff and bosses in particular have taken salary cut, these tribal costs are all interlinked and this is the first vibrant call for rise of AI and first line of defence for pandemics and wars is e-commerce.

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Replying to njpandya:
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By rememberscarborough
14th May 2020 10:31

Just like the credit crunch very few if any will have seen this pandemic coming.

Primark's business model is not conducive to online retail but it works very nicely for its targeted customers and they usually do very well out of it. However, in the long term the "High Street" will disappear completely as will the Primark brand but you can bet your bottom dollar that their owners are planning for this and will be looking at the next option that will supersede online retail whatever that is because it will come.

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Replying to rememberscarborough:
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By njpandya
14th May 2020 12:01

Agree on disappearing of high street to large extent but not on Primark. After snatching more than 30% market from M&S though cheap it's still far good business but caught in poor planning. In fact reverse will be more true for Primark and it will rise like never before due to significant less costs of rates, rents and other costs which come along with retail occupancy, IMHO!

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By Nina_Guinness
14th May 2020 09:39

That was a long but very interesting article - I had to skim the middle section for lack of time but glad I stuck with it as I was most interested in the ownership structure and diversification. Fascinating thanks.
More articles on who the corporate survivors and victims will be would be very interesting to read.
As to what Primark should do - not much- I think online clothes shopping must be well down as people aren’t going anywhere and tightening belts - so Primark being the cheap end of the market might thrive on the other side of this just as well as those with large online presences.

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Replying to Nina_Guinness:
Alastair Barlow
By Alastair Barlow
14th May 2020 13:21

Thanks Nina. Actually, I've seen and spoken to a number of other retailers in different categories that are actually thriving with online sales at the moment. All smaller than Primark (most are) but these smaller operations are still fulfilling orders. I've seen there is a split between online at the moment - some have paused operations so there is less choice and less competition for shoppers. But more medium and longer term, we may very well see more bargain shopping. Thanks for persevering, it is a long article, so glad you enjoyed it. Thanks.

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David Ross
By davidross
14th May 2020 09:45

I saw the share prices drop 50% and punted £5000 on ABF and £10,000 on Ryanair. So far I have a loss on paper but these are the two business I know and use that I have always seen as 'capitalist in tooth and claw'. I expect to double my money over time.

Ryanair has a massive cash pile and still are refusing me a refund on cancelled flights. As an investor I cheer the management, and a customer I rage against it!

Thanks for the analysis of the online sales business - very informative

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Replying to davidross:
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By njpandya
14th May 2020 12:05

Yes, and Churchill quote apply more than ever "Keep buffering on". Sales are down but not as if people don't have monies, government pumping monies aren't fool because they know in long run this bet will be paid off handsomely, won't be easy but not dire as people and pessimists armchair economists forecast. I agree more with Lord King approach and forecast.

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