By John Cronin, Tiger Group, firstname.lastname@example.org
Appraisal firms are often asked by lenders if condensing a retail chain’s store base early on, or even prior to, the beginning of a liquidation sale will enhance the overall net recovery value (NOLV) of the inventory. Early closures present unique expense savings opportunities to liquidators since bankruptcy court protections can allow for the exiting of locations prior to actual lease termination dates. On paper, shuttering poorer performing sites and moving their assets to better performing locations seems like a no-brainer. The sale saves operating costs while positioning the goods in areas where they should sell best. In practice, however, closing stores early in a liquidation is not always the best way to maximize value.
MYTH: Every liquidation model has some amount of collapsing built into it.
REALITY: Given the type of inventory to be sold, early exits from stores are not always possible or even practical. For example, fragile or bulky items can be too risky and/or cost prohibitive to move. Items damaged in transit rendering them unsalable, incur the double-whammy of lost revenue and sunk freight costs. Likewise, if the items are part of a set and need to be sold as such, shipping them together adds additional layers of complexity to transfers that may make such moves unrealistic in the compressed timeframe of a liquidation sale.
REALITY: Chains operating multiple banners and/or varying store concepts such as full-price and outlet locations also pose problems for transferring inventory. POS systems may not recognize goods from a different banner or concept. While full-price goods can usually be moved to outlet locations, the opposite is rarely seen. Further, customers of a particular store type may not respond favorably to unfamiliar merchandise.
REALITY: Consideration also has to be given to the physical locations themselves before closing stores and consolidating goods. Many retail spaces are tightly plan-o-grammed with little to no backroom storage. Attempting to stuff these sites with an influx of transfers might only cause problems and necessitate renting additional storage space — thus, defeating the purpose of the transfer in the first place. Furthermore, many store types are not equipped for large-scale inventory movements. Not all retail spaces, especially mall-based sites, are equipped with docking bays, packaging/palletizing equipment and other features needed to accommodate shipments of this magnitude.
MYTH: Closing the weakest stores ensures expense savings.
REALITY: Again, this sounds like a given, but if by transferring large amounts of goods the stock levels at other locations become too deep to effectively sell through, the sale term may need to be extended, quickly eating away at any potential expense savings.
REALITY: Additional labor costs are also often overlooked when contemplating consolidation. Liquidation payroll budgets are lean as-is, but they may need to be increased on both ends of the transaction if transfers are planned. Staff cannot be on the sales floor and processing transfers at the same time, fueling a need for additional bodies on the timesheet or extended payroll after-hours.
MYTH: Pushing as much product as possible to the best stores maximizes the top line.
REALITY: The sale term may not support effective inventory transfers. For example, short sales can feature rapidly advancing discount cadences. By the time transferrable goods are identified, consolidated and shipped, the return on these items may not offset the freight costs. Furthermore, while en route to their destinations, discounts on the merchandise may have risen, further eroding the eventual return.
REALITY: Savvy customers can recognize when the inventory is overstocked in a particular location and may choose to wait out the discounts, making their purchases deeper into the sale term when the prices are lower — translating to diminished returns for the liquidator and the estate.
REALITY: Store sales capacities and achievable comparable sales increases in a liquidation can be adversely affected by overstocking. In many instances, the best performing locations are situated in small markets. Depending on the product, these locales can become saturated, meaning virtually no amount of discounting will entice customers to continue to make purchases of the same items. Transfers-in may simply sit unsold, with margins eroding over time.
The cautionary statements presented here are not intended to dismiss the concept of store consolidation in retail liquidation sales. Certainly, liquidators explore the possibility of consolidations in each and every deal. However, the myriad factors that can affect successful transfers of merchandise need to be evaluated closely, often on a case-by-case basis.
As a result, it is difficult for high-level appraisal models to fully vet the costs and benefits of collapsing the store base and inventory during a liquidation sale. If the circumstances appear to favor a liquidation analysis that assumes store consolidations, lenders may want to choose an appraisal firm backed with real-world liquidation experience that fully understands the risks and rewards involved in this approach.
John Cronin is director of planning and analysis at Tiger Group. He can be contacted at email@example.com.
This blog originally ran on ABL Advisor on December 3, 2013.