Challenges in Retail: Navigating Rising Debts with Storefront Strategies

By Dominick Keefe, Vice President, Hilco Global

When walking into any retail shopping area today, you may come across recently opened brick-and-mortar stores from brands that you’ve only ever encountered online.

E-commerce, initially celebrated for its operational efficiency and lower retail customer acquisition costs (CAC) due to the absence of physical storefronts, has encountered challenges. In retail, the online sector's maturity has led to a competitive digital market, significantly elevating CACs and diminishing its cost-efficiency advantage. This shift has prompted some retailers to integrate physical stores into their strategies, balancing the strengths of both digital and traditional retail in a more synergistic approach.

The interest rate dynamic over the past two years has caused major challenges to nearly every retailer, especially those with debt-laden balance sheets. In today's high-interest rate environment, the traditional model of funding growth with substantial borrowing is becoming less viable. During the peak of the COVID-19 pandemic, the Secured Overnight Financing Rate (SOFR) hovered around 0%, driven by the Federal Reserve's monetary easing to support economic activity. As of December 2023, SOFR has escalated to as high as 5.3%, substantially increasing the total cost of capital for nearly all retail borrowers.

During the era preceding the recent rate hikes, retailers were inclined and even encouraged to leverage debt, taking advantage of favourable financial conditions to fuel growth and expansion. The strategy of aggressive borrowing for rapid expansion hinges on leveraging the dynamic between retailer debt, revenue growth, and equity value. Essentially, a company takes on substantial debt to fuel growth and expand its customer base. As the company grows and its revenues increase, it typically becomes more valuable, often assessed at a multiple of its revenue. This increased valuation benefits equity holders: as the company repays its debt over time, the proportion of value attributable to equity rises. In other words, even if the company is sold later for a value similar to its initial worth, the reduction in debt means that a larger portion of the sale proceeds goes to the equity holders, significantly boosting their returns. This dynamic makes the approach of using debt for growth and later paying it down an attractive strategy for increasing the value of equity, especially when money is cheap and easily accessible.

However, this approach is now much less tenable due to the dramatic increase in interest rates. Many retailers, burdened with substantial debt, are struggling, particularly as most of these debts are tied to floating interest rates. This scenario has led to a negative cash-to-current liabilities ratio for many in the sector. Lenders, in response to the heightened financial risk, are imposing stricter covenants to secure their investments. The shift in the financial environment has thus forced the rethinking of these once-commonplace retail growth strategies, shifting the focus towards approaches that emphasize immediate cash flow generation.

In this challenging financial climate, retailers with still-viable balance sheets need to take decisive action. Retailers need to shift focus toward achieving profitability and generating the necessary cash flow to service their debts. This goes beyond mere cost-cutting; it involves a thorough reassessment and optimization of their market positioning, differentiation, and value proposition. Retailers must effectively communicate these aspects to their customers, ensuring that customers perceive significant value in their purchases, even at higher margins for the retailer.

While e-commerce offers the potential for expanded customer reach, online retailers have faced the challenging task of reconciling this promise with the substantial costs associated with digital operations and fulfillment, making it difficult to achieve robust profits. Furthermore, e-commerce retailers tend to face increasing CACs over time as each incremental customer generally requires more spending to capture. This contrasts with traditional brick-and-mortar retailing, which generally requires higher upfront capital expenditures for physical space and facilities but benefits from declining acquisition costs due to foot traffic and word-of-mouth exposure. To this end, unless the lifetime value of e-commerce customers grows in alignment with the rising costs of acquiring them online, the very foundation of the e-commerce business model is at risk of being undermined.

Retailers are placing a greater emphasis on their physical store presence.

‍The brick-and-mortar playbook: are key retail store challenges not going away soon? 

At first glance, the substantially higher gross margins of physical stores, around 36.6% in 2023 versus 27.8% online, present brick-and-mortar expansion as a potential fix for struggling e-commerce retailers. However, consumers increasingly expect the convenience and selection of online shopping, so an effective omnichannel strategy has become critical for most major retailers.

Physical retail benefits from declining CACs over time and opportunities to drive impulse purchasing through experiential environments. E-commerce provides the advantages of expanded product selection unconstrained by physical footprint limitations, personalized recommendations fuelled by shopper data analytics, and flexible purchasing via mobile/web channels. Retailers must strategically balance their digital and in-store operations to capitalize on the strengths of both models. Those who figure out how to do this, and mitigate rising acquisition costs online while maximizing margins, stand the best chance of long-term success.

However, even with an optimal strategy, ongoing staffing shortages still pose a major obstacle to brick-and-mortar retail prosperity. Open store associate positions outpace interested candidates, a trend forecasted to linger into 2024 and beyond. Simply hiring more people is not viable, given the depths of the labour shortage. Instead, the solution lies in equipping existing staff with the best possible tools and chances to thrive. Lean and nimble workforces equipped with essential tools can deliver outsized impact through effective collaboration. A few empowered employees can be pivotal in driving operational excellence, significantly elevating the store experience and its value to customers.

E-commerce platforms provide the distinct advantage of precise brand messaging, enabling a digitally curated customer experience that seamlessly aligns with a brand's identity. In contrast, achieving such consistent branding in a physical store setting is markedly more complex. It requires meticulous coordination and clear communication among all employees to ensure that the brand is uniformly represented across various departments and displays, thus ensuring a consistent and cohesive customer experience. As the pendulum swings back towards prioritizing an optimal in-store experience, the competition to attract in-store shoppers intensifies, necessitating an enhanced and innovative store experience. It might seem straightforward, but ensuring the customer has a positive in-store experience is table stakes; it leads to improved conversions, boosts same-store sales growth, enhances gross margins, and, consequently, improves profitability.

How do retailers succeed with brick-and-mortar stores in today’s market?

Step 1: Focus on frontline employees.

Make your teams true brand ambassadors. Effective interaction with your customers is the start and end point to successfully driving high-margin revenue from brick-and-mortar stores.  

Step 2: Go back to fundamentals.

Ensure in-store staff is empowered to do the right things at the right time and in the right way to promote your brand and deliver a quality experience to your customers. Focus on what I call the six retail fundamentals that will improve customer experience, move merchandise, and drive high-margin revenue.

Step 3: It’s all about conversion.

Focus on driving consumers back to your stores by delivering an excellent customer experience aligned with your unique brand. Provide your staff with smart, easy-to-use technology that enables them to be more efficient and effective – therefore giving them more time to engage and service your customers.  Develop a playbook from which your frontline staff can deploy your back-to-fundamentals vision and integrate that playbook into your technology.

At Hilco Global (ReStore’s parent company), we have been running retail stores for over 30 years. We’ve developed many best practices on how to maximise merchandising efforts, drive employee efficiency and deliver consistent brand experiences. To help deploy our in-store playbook, we developed a smart technology-based service called ReStore for Retail that is leading the way to a new and improved shopping experience. ReStore for Retail provides retailers with the opportunity to channel the vision of their corporate teams into every store to create a consistent and reliable brand image and experience for their customers.

In the ever-evolving retail landscape, brick-and-mortar, while not without its challenges, stands as a crucial, perhaps most effective, cornerstone of any retail strategy.

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