Part of the whole strategy of the private equity owners of Debenhams was to drive cash flow they renegotiated the payment days. The payment days in Debenhams at the high were 120 days but I think they're falling now. Clearly that's going to cost suppliers to finance and they will then start to jack up their costs. You get into this vicious circle whereby your cost base is going up and you're starting to find that you're then putting pressure on your selling prices and you stop becoming competitive. That's part of the Debenhams problem.

They start increasing selling prices and therefore they need to promote more to drive sell-through and you get into this really vicious circle of ever-increasing cost price, ever-increasing selling price, more promotion activity, more pressure on margin. That is quite typical. To them because they're very own-label focused business unlike House of Fraser, it's particularly exaggerated and the real problem for them. Yes, I think that that is one very good example of where there's been a focus on trying to drive down or look at cost. Your margin is forever on deterioration.

This all stemmed from the time of Debenham’s under PE ownership?

Yes, it's coming from the PE time, and what you then found post private equity because there is relatively little money to invest there is still this desire to drive cash flow and to maybe try and do something better because you then got a need to become more sophisticated in things like Internet and omnichannel shopping. You're still in this world trying to drive cash flow plus all your like for like sales are built on the foundation of promotion activity. Unless you do something very different with product, the only lever you have got is promotion on price.

In that period then since the PE ownership as the days payables went from 30 to 120 days. Did we see a shift in the sourcing based at the far east and did this not approve landed cost?

Yes, you did, you've seen a movement from, let's call it a supply base, China, Europe include the likes of Bangladesh, then you really are then competing with Primark and all the value players but it's absolutely a change in the sourcing

On apparel, if you move from China to Bangladesh, you're going to get between 2 to 300 basis points improved into margin at a minimum.

Is that the landed margin? For example, if the raw materials for a product are £10 in China and I moved to Bangladesh 2-3% lower?

Something yes, as a minimum, if it arguably can be greater. The background at that time base you are working in a world of ever decreasing selling prices, the emergence at that time of Primark would have put pressure on selling prices anyway. You got downward pressure on selling prices mitigating some of the down pressure on cost price. You can't bank all of that margin improvement because you're trying to remain competitive and of course, you are discounting more and more. Yes, in theory on a like for like basis, you are going to see some significant margin improvements.

What is the typical landing cost of a product you're familiar with and then we can run through the margin from there?

You’ve got all sorts of other different costs involved from promotional cost through your shipping, how you're handling the product. You've got other impacts along. Take a pair of jeans, a pair of denim jeans and you're selling those for let's say £30. You've probably got an FOB price from China of around say, £8. I won't try and convert it into US dollars. You've got about an £8, in Bangladesh, you're probably paying about £5.50, you then have got other costs associated in terms of duty. It's very hard to over the telephone actually give you all the breakdown of costs but you'll have to understand your duty costs, your shipping costs, you've got a significant cost price reduction, but then there's a cost of doing business out of Bangladesh and Debenhams they opened an office in Bangladesh to be able to do that. If you're going to deal direct with these factories, you'll need someone on the ground actually doing business. That needs to be incorporated into the margin calculation.

Let's just say the £30 pair of jeans, from Bangladesh you'll probably get the products on the ground in the UK at probably £10, probably a bit higher.

Maybe much higher to fair, the margins are high 60s low 70s on a landed basis. It's a significant margin but as I'm pained to say there are a lot of other great additional hidden costs. Of course, the problem you've got is you're starting to work into commodity product and it's basic, you're not working with a huge amount of additional add-ons in product detail and the fabric is quite basic and you're taking things out of a product. That's one of the challenges that retailers use as your driving down cost, you are going to either Bangladesh or Cambodia or other very value orientated sources. Your product is being compromised all the time and that's part of the problem, then you're competing with value players and there's no difference in the products and that's actually the wrong way to go because.in the end Debenhams or House of Fraser or Marks & Spencer’s will never compete with Primark in terms of volumes. When you start to source from those places it’s the volume play rather than a quality play.

So as the business was owned by PE and run for cash, days payables extended to 120 days, a change in the supply base, the product assortment actually shifted to a more basic and lower priced products. Is that across all categories?

Yes, absolutely. Yes, it is, something like home products when you are working on those kinds of payment terms, you're even more restricted. I'll give you the example of Vietnam which is one of the better places to source home products from, if you're working on those payment terms you can't because they work on LCs so letter of credit. When you're working on FOBs 120 days, those sources are closed off to you completely. You're very restricted on the places that you can actually source product from. I don't know whether you heard of landed agents like Li & Fung, they’re one of the biggest sourcing companies and one of their real issues with dealing with Debenhams was many of the most innovative and creative sources were closed off because your 120 days is just so penal that you can’t source.

Over time you had a decline in added value on product, and a department store that's what they're about, they're about adding something different to the product, they're not commodity-driven businesses. Whilst Bangladesh has a role to play, there's far too much focus on that because in the end, we gave you an initial improvement on cost, but in the end what you're finding is actually you were compromising on product.

What is the split in large vs smaller suppliers for Debenhams?

No, they're larger, they're typically larger businesses.

Very few now, very, very few. There are a number of those suppliers who continue to supply on a basis of trust and relationship and they don't have insurance. I have been contacted myself by several of my old suppliers asking my opinion about Debenhams and its viability and whether they should continue supplying because their whole issue is, can we deliver for Christmas and will we get paid three months after Christmas? If you think about it, all the trading statements are going to be coming out mid-January, but they don't get paid until March and there is a real risk. I factually know that there are several suppliers that had to say no, we're not supplying you any more or they're supplying on a hand to mouth basis by paying us we will supply you. They're on a highly geared business, like Debenhams, when you start getting into those scenarios.

The haven’t go the cash to fund the business.

That is what happened in the House of Fraser the lack of credit insurance tipped the company into bankruptcy.

House of Fraser happened about nine months ago, that's when it started becoming very restricted. Debenhams is about six months later in that process as they're being downgraded.

Is there any material difference in supply base?

They're quite different, House of Fraser and Debenhams. House of Fraser is predominantly a branding business and its volumes are a lot less. It was less developed in its supply base than Debenhams. Debenhams is very developed. They will be using supplies that are familiar with, M&S and Next in that world rather than House of Fraser. Their own buy business was much, much smaller and the volumes are much smaller. It's quite different.

So because House of Fraser is more of a branded business where these brands are more likely to have credit insurance than typical suppliers, these brands are quicker to cut supply to retailers in adverse scenarios?

Yes. If you look at the House of Fraser example, so some of those brands House of Fraser was a large account for them and many lost significant amounts of money that was still in House of Fraser as they clearly were continuing supplying them without credit insurance.

Can these suppliers trust the likes of Debenhams given the House of Fraser bankruptcy?

No. You've got concession partners who supply both, those that have been burnt with House of Fraser are far more second spot with Debenhams than they were. It's the concession model where you've got a major cross-over between two businesses and there's a significant issue where those concessions are now being far more circumspect.

It's 20 to 25% of the assortment is actually concession, it's a significant part of this business that even if a small proportion or a few large concessions leave, it could put the company in serious, serious trouble.

I think if we look more from the concession side then it will drive this downfall.

Possibly, the one consolation for Debenhams is, that's not where they make their cash margin, their cash margin is in own label and beauty. The thing I was going to say I'm not familiar with is what happening to the beauty house because that's an interesting one but they're ones that have been far more cautious on payment days with those retailers. The beauty thing is quite interesting but if there's one area that could bring Debenham’s down, it's beauty, because it's so reliant on it.

Are there any other key factors that led to the decline in Debenhams that we haven’t discussed?

Inevitably it's its inability to react to the wider trends in retail. Everyone knows how important the internet and omnichannel shopping is. For example, Next have taking the big book and they've adapted what they've done in the directory to now a huge Internet business. They've invested over a long period of time and they have the infrastructure to supply Internet demand logistically, which is expensive, and you need the infrastructure to be able to do it. The problem with department stores and House of Fraser and Debenhams specifically and M&S as well is their inability to be reactive to that massive trend of omnichannel shopping because they've got their big space retailers, they got big amounts of retail spaces they need to leverage. They have to invest in that space, they don't have the money to be able to develop a fleet of foot and reactive multi-channel business.

Don't take my word for it, Will, just go and have a look at the websites of these retailers and it will tell you everything about their inability to invest, because it takes a large amount of cash. John Lewis is fascinating because they've invested as they should but they are really struggling to make that payback because they've got the noose around their neck of large space and interestingly cost to them which is a whole different conversation. If John Lewis with their business model are struggling then that just shows how difficult it is for the rest of that sector.

John Lewis just spent £500 million over the last few years on supply chain and yet, they still lost money last year. Why is their operating performance different?

They had a long-term vision about where their business is headed and they stuck to it. They have the infrastructure to start with so the directory gave them all of the logistical advantage because logistics is one of the biggest issues around being a true multi-channel retailer because you've got to deliver what the customer wants, when they want, how they want. The additional problem with John Lewis had, that Next haven’t had is John Lewis never knowingly undersold. So they've invested 500 million, whatever they've invested, but their margins have been hit because they're the most promotional retailer in the UK because they're matching everyone. If you look at this week it's fascinating because it's happening again.
If you look at search on any brand it goes to John Lewis is always there because their price match, but their margin is wafer thin, they haven't got the headroom to invest that capex and make it payback because the margins like most someone like Next with their own unique offers they can do so.

That's to say they've got the advantage because they've been doing this, they've been having the Directory for 20 years plus, they've developed the infrastructure to be able to do it and John Lewis in some way has started to get off that price and that price matching drug, they're very seriously in trouble because they just constantly match anyone in the high street or anyone online. They've invested which is something, at least they do have a business model that will work in the future, but House of Fraser and Debenhams just have got no chance, I don't know whether you looked in any detail of what Rachel said for Debenhams when they made the announcement and they wrote off £100 million of IT costs which is, I don't know, that is truly scary and that is a managerial incompetence.

I’m not sure what they've been doing with that.

I know exactly what, they bought licenses for software, essentially that is Oracle licenses that they've had to write off and Adam will be as familiar, not more familiar than me in terms of what they're doing. That is incompetence of the highest order.

This software is just supply chain management systems?

No, mostly they're buying merchandising systems and IT licenses so infrastructure. Things like tills how they process sales, these words could cater for a complete oracle-based solution because the IT infrastructure is very old. They've not been able to do it successfully; they've had to recognize and write it off. That cost has been sat there in the books for about a year and a half and Rachel is new the CFO has come in and then said, "Yes, I see that's the cost and I'm going to recognize it." I think actually what she did in all aspects of the £500 million case, I think she did the right thing. That's been sat there for quite a long time as a cost of the business that wasn't recognized by her previous sector.

So how do you look at the future of the department store business model?

Debenhams, House of Fraser, they're all large spaced retailers and they're all recognized in fact they got too much space in different ways and John Lewis have completely stopped their store program, they have got stores now that if they could they would dispose of. They all recognize they've got too much space, that's the first thing.

How much overcapacity do you think there is in the UK?

The excess space is in secondary or tertiary markets. They're markets where you will not have the foothold to be able to justify having that space. In the end department stores will be advanced into bigger markets, bigger conurbations, whether they're not fought for if you can't justify it otherwise. That's why it seems to be how House of Fraser are now to announce their closures. We'll see what Debenhams does with their 50. 50, by the way, is nowhere near enough, they have 170 I would suggest that no more than 80 stores is the right number for Debenhams.

At the maximum, absolutely the maximum because you spend £50 to £60 a square foot just refurbishing and they can't afford it, they absolutely can't afford it. There's a lot of extra space, that needs to be addressed and then how do you leverage the space that you have in the markets that you're doing business with to drive customers into their stores. The best example I've found is Selfridges is a classic case study of how you create experiential retailing, I know it's a cliché but it's absolutely true. That's the role of a department store is for people to come into experience, to services and make shopping easy. If you want to buy something, well you can come and have a look, we'll deliver it the way you want, where you want when you want.

We'll not be the cheapest but we'll be the best value-added retailer. You'll spend half the day there, you'll go and eat, you'll go and watch demonstrations, and the whole thing around it being an experience is the only chance department stores have to survive. The fact that there is one retailer who is already doing that, and I think Harvey Nichols is also doing relatively good jobs on doing that. Harvey Nichols' Knightsbridge store is trading particularly well after they changed that.

Is it unique to a higher end of the market?

Yes, to a degree higher end. What they are doing is if you look at Harvey Nichols first floor, they’ve reduced their stock density by 60%. They’ve created inspirational displays. Customers are responding. Their conversion rates have gone through the roof.

That is how department stores work. You can’t put a lot of stock on the shelves, high stock entities and just hope people will shop. That’s not the way it works. You create inspiration displays. You drive your conversion rates and you also use your space in a more creative way, response, demonstrations.

How should we segment the store space at Debenhams post-closures?

I will segment it by market type because I think that’s how you can understand. There are many stores where in private equity they’ve opened that where part of the whole sales storage and you would close sales.

I think you’ve got major markets. You’ve got shopping centers. You’ve then got a normal high street market and then you’ve got out-of-town. Within that context, you’ve got valuable markets and less valuable markets.

What is the split between those four roughly?

I would say the smaller high street, that’s a significant number for Debenhams. They’ve got about a 170. I would say 60 to 70 fall into that camp.

Yes, they are. They are small. We have the likes of Stratford upon Avon or Redditch. Really? The big markets there’s probably 20 major markets and 50 big markets that they will want to be in. That’s why I say, from my point of view, there’s probably up to 100 that will be incorrect.

There probably are 70 valuable markets that in 10, 15 years’ time you would definitely want to be in. Then the question mark is, "Of those 100, how many will work? How many you would want to stay in?” Well, I live in Brighton. Brighton isn’t a major market but it’s a valuable market and you probably would want to stay there, whereas Bluewater or Lakeside or Meadowhall, they are valuable big markets and they will remain at Westfield.

What is the difference in the format between older stores and new openings such as Watford for Debenhams?

Yes, a decade ago, a good example will be Westfield which is probably about a decade and maybe their mall, it’s a square box, a very traditional layout, beauty on the ground floor. Men's are in the basement ladies are on the first floor and the second floor. Very, very typical. When they opened, there was one food offer and that was it. Stevenage, which opened a year ago, two floors store, four food offers. It’s not a wide box. It’s more aspirational. It’s got a much high degree of digital content. Creativity and more inspirational. They’re giving less space to stock, more space to show me how to wear it. Not more space to pick and collect. No stockroom today, whereas 10 years ago there would have been a stock room.

Yes, so it's next day delivery into those so you don’t need a warehouse. You can use your space much more effectively or you have less space.

In terms of the revenue of the new stores would you expect say 5% to come from food?

Well, in Stevenage for Debenhams is 30%. Well, not revenue, sales.

Yes, gross transaction value. Stevenage has 30% which is extreme. I think Debenhams desire is 10% to sales. They have currently about five. A lot of stores it’s 1% or 2%, which is very, very small.

Where is the Watford store food revenue percentage?

They’ve already got two food offers. They were unable to get the same numbers they did in Steven. That is the problem is that in the Harlequin center you're already very well catered for second base.

So they only have their food offering out-of-town and--

Or where it’s a less developed market because the whole F&B (Food and beverage) thing works when you’ve got brands or partners that actually want to open with you.

Just on that point. Let’s say we’ve got 70 stores that are in good or big markets, it's highly likely that these stores are in the densest area in terms of population and retail footage, therefore there’s going to be a high food and beverage offering already. My question is, how representative is Stevenage or Watford or Debenhams stores?

Stevenage is not something you can replicate easily. They are trying to do it in Oxford Street. The last I heard they had some heads of terms with Franco Manco and had about three, four offices in Oxford Street. They were expanding in Oxford Street. That’s a real one-off. You’re absolutely right. It is very difficult to develop F&B offers where it’s already well developed.

Of course, it’s an expensive thing to do. Stevenage is a brand-new store. You could develop the shop fit to account for it but if you’re going to go into adjacent stores, it’s incredibly an expensive thing to then put in a restaurant. It’s expensive from the host point of view, It’s also expensive from the retailer, from the brand’s point of view.

Does the brand share that fit-out expense?

Well, it depends on where you’ll start. The House of Debenhams or the House of Fraser will then make space ready. The brand will then expand. It’s incredibly expensive. Of course, you’re going to spend on a sit out you’d want some surety of tenure. You want to know that you’re going to be there for 10 years and you’re going to drive--

How long are the restaurants signing for?

They are signing for a minimum of five. It really does depend, again, on location retailer-- Usually, who the brand is. You can imagine someone like Nando’s who signed into Stevenage they were on very favorable terms because Nando’s were in a strong position to able to do that. Five years is the minimum, typically seven you can sign up to 10.

Let’s just say for argument's sake the gross transaction value of 10% is food. In the best-case scenario, which seems, even in my opinion, a bit too far-fetched.

Yes, it is. I know. I would agree with you. I would agree.

How do you look at the assortment changes on the fashion and home inside? They claim to be integrating more digitally and therefore they basically inform purchasing and buying. How difficult is this?

Incredibly difficult. The apparel is the most challenging part trend in the market. It's the one that's got the highest value because the margins are the highest. It's a big market so it's valuable but it's incredibly challenging. The problem is that over the last five years, the year that has the most progression and development of being beauty which is you're working on a net margin something like 33% to 34%. Whereas on apparel, you're working on about 65% were apparel is where the market is particularly competitive.

And the food margins for Debenhams must be low single digits?

Yes, at the best arguably. I mean, this is a debatable one. Arguably, you barely make any money at all.

Does it drive cross selling to other categories in-store?

No, not really. Not particularly no. Very, very little. If you take on the owned food offer a non-branded, it's an older less valuable customer who only goes in to buy their fish and chips or like coffee and goes out again. They do not cross shop but again, something like Stevenage I think you will find there's a high degree of cross-shop but I think, mostly, no. I think that's overestimated. I don't think there is a strong cross-shop certainly on the old business, there's very little crossover between those who actually went to the restaurant and those who shopped, very little.
I think it's a good story Will, I think it sounds very plausible that you drive your F&B business, drive footfall, and cross sell. It's a great story. The reality is somewhat different. If in Stevenage you've got a play on turn-over because it's 30% that's all well and good but when you're talking 5, 6, 7%, really it doesn't change the dial.

How do you see the assortment and offering in other categories excluding food changing in new department stores going forward?

Well, they've stated the fact that home and furniture isn't a focus for them so their furniture business is declining. It's small and getting smaller. It's the category whereby they're more compromised on space. I don't think home or furniture or gift for that matter is going to be a big area for Debenhams. I don't think it's a focus for them unless they change their view on that but it’s small.

Just from the fashion point of things, we touched on the focus on costs vs sales earlier. Can you change this strategy going forward?

Yes, you can. The great difficulty is you have to have a complete reversal and your own product and that's what they're trying to do. Steven who is the new MD for clothing and home. His brief is to innovate on products. I think it's incredibly difficult. Well, I think really difficult to be able to do that. If I was a betting man, I would say, "No, you wouldn't succeed because you've got too many other distractions. You've got too many other things going on in that business to be able to." If you had a benign competitive landscape and you were on stable footing, then yes you probably could but you got so many other things going on in that business and in the market that I think it’s an incredibly difficult thing to pull off.

How are they materially going to change product from here?

Yes, you can change. You can innovate, you can invest in a product but that all comes with a cost. It will come as a cost to the margin and you can see this week with Black Friday and the activity going on at the moment. Whereas someone like Debenhams says they want to be less promotional and where they're not at the moment because they can't afford to be.

So to round up what does the future of Debenhams look like to you going forward?

Smaller, much smaller and one where you got more third-party businesses using space in a more particular way. If it's going to be there, it's the one that's going to be far more multichannel focused for experiences but with a very strong internet business to fulfill demand. Enabling you to use the store space in a more innovative way because that's what Selfridges, are doing. They're reducing their stock densities they're fulfilling demand online and they're using their store space to create inspirational display and excitement.

Debenhams Bankruptcy

How the private equity sponsor strategy imapcted Debenham's competitive positioning

Debenhams Bankruptcy

Former Trading Director at Debenhams

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Steve Lightfoot

Former Trading Director at Debenhams

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Debenhams Bankruptcy(December 17, 2019)

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