Let’s start by providing a bit of context to the Steinhoff story, then we can get on to discussing the up-to-date strategy and the progression of the company.

The initial start of the business, under the name of Steinhoff, came from Bruno Steinhoff in the early 1960s. In essence, he commenced the business, which was really aimed at household goods. It was aimed at starting in what was then Eastern Germany, sourcing for the West, so Western Europe and Western Germany. He really built the business up from that time. From the fall of the Berlin Wall in the late 80s, it opened up all of the production facilities that he had started in Eastern Europe to make them even more easily accessible to Western Europe than they were before. So Bruno Steinhoff was the founder of the business overall.

In parallel to that was a group of guys who were all at university together in South Africa, who joined Accenture, so nothing to do with Steinhoff at this stage. This was people like Markus Jooste and people like Danie van der Merwe who is now the CEO. They were all together at Accenture. And they made early investments in forests, particularly in Eastern Europe and also in Russia, essentially, investing in land and taking tax breaks as a result of the investment in forestry. They came together with Bruno Steinhoff in the late 80s, early 90s. I guess due to the combination of their forestry and timber and his largely furniture-based production capability. It seemed logical to merge the businesses together and become one. In essence, the beginning of the vertical integration of forestry timber going into furniture. That was really the commencement of the business, if you like.

Their early strategy was to invest in production and distribution capacity, so really expanding the Steinhoff business as it was, and trying to link manufacturing and sourcing together to try to create this manufacturer/ warehousing/ distributor of household goods and timber related products, both in Europe and, later, in Africa. This was a logical extension as South Africa was where they were. That's really the history of the business.

It's worth saying, as well, that in market positioning, they were aimed at being a low-cost producer and distributor. They were really aiming at the low-cost mass middle market business in Western Europe, South Africa, and then latterly in Australasia. That was the commencement of their business: really looking to control raw materials, some third-party sourcing, their own manufacturing base and then selling it at that stage into retailers that they didn't own.

The next extension, again, from the basis of these raw materials and manufacturing capabilities, was to start to acquire retailers. And that's what they began to do in the early 2000s. They acquired businesses in the UK, in Australia, in France and in Germany primarily. Those businesses were available to purchase and they were relatively cheap. They had a property portfolio that was of interest to Steinhoff i.e. there was some value to the business that wasn't just related to its trading capability. They could be linked into the existing resources that Steinhoff had upstream and kind of make them vertically integrated, at least that is the outward positioning of the business. Whilst they were buying these retail opportunities, they also managed to acquire greater aspects of manufacturing capabilities, particularly in beds. In the UK, they bought companies like Relyon, the bed manufacturer, and Sprung Slumber in Australia. They then looked at particle board manufacturing, which was really the bedrock of the furniture business. They acquired a business called PG Bison. They bought Unitrans which is a logistics operation, particularly operating in Europe.

That's really the positive side of their growth. I think shortly after that, around 2005/2006, they opened a sourcing office in Shenzhen in China, which was really aimed at that time at the furniture side of the business. From that, they expanded to third-party sourcing operations of furniture in Asia, to put that alongside their own direct manufactured capability. I would say at that stage they were semi-vertically integrated, but very much aimed at furniture and household goods.

It's particularly interesting that in the last 10 years, they started to buy so many retailers. Obviously, hindsight is a wonderful thing. Were there any real synergies or scale effects when you're buying so many different retailers from a sourcing and procurement standpoint of the raw materials, given the infrastructure they had?

That’s a good question and outwardly the answer would look like ‘yes’, but the reality was ‘no’. What was an interesting approach that they had as a result of the acquisitions was, as I mentioned earlier, they were buying businesses that were available and those businesses were available for a reason, of course. They weren’t trading that well and they were relatively cheap. But what Steinhoff were not was a turnaround organization, they didn’t have the skills and the capability in order to take those businesses and really make them grow - I’m talking primarily the retail ones.

So the management just left them alone? Left them as a standard identity?

Yes and no. What they did, in terms of the control element, was put in finance directors or CFOs who were closely aligned with the South African business. These were either people who had worked within Steinhoff in South Africa or were very well known to the South African operation. So the CFOs and finance directors who went into all of those retail organizations then took control of the business alongside an indigenous CEO, somebody who knew the operation in the countries that they were trading in. They really ran it as, if you like, a two-handed operation. It’s not unusual for CFOs to be heavily involved in running a business, but it’s particularly true in the Steinhoff case that, certainly in my experience, the CFOs were almost as dominant as the CEOs. They largely ran the balance sheets of those companies. But what they did leave to the CEOs was the direction of the business. And this is the paradox of their supposed vertical integration strategy, in that no retail business was required to buy from the manufacturing operation. They were all stand-alone profit centers and as such, were able to trade and buy as easily from third parties as they could from within the organization. And because the manufacturing side of the operation was typically - there were some exceptions - a profit center as well, they were, of course, selling with a margin.

Yes, all stand-alone P&Ls controlled by the CFO. These were the parts of the business where they weren't that profitable and a lot of them weren't that profitable, they weren’t when they bought them, and they certainly weren't trading profitably. Many of them were cash generative, but that cash generation was largely siphoned off and was taken into a big pot in South Africa. So the CEOs of those organizations didn't really see the cash side of the business, they saw the trading P&L, clearly the essence is all costs and whatever. There were some cross-subsidies taking place. So if you take the UK as an example, the marketing costs of all of the UK operations were paid for centrally in South Africa. So marketing costs were taken off balance sheets in South Africa. As you can imagine, the furniture and bedding industry, particularly in the UK is very promotion-led with a straight-line correlation between marketing and sales.

If you're the CEO and you're working in Harveys or Bensons for Beds and such a core driver of your top line is marketing and promotions and yet you don't really see that spend or control that spend, from an organizational structure standpoint, how did people actually respond to that?

They bid for it, effectively. Typically, what would happen, if you were at a very senior management level, is people like Markus Jooste and Danie van der Merwe would arrive every three months, they would spend a day with the management of the business. In the case of the UK, we all used to go down to the office in Cheltenham. We would present to them things that had been going on in the three-month period. This was sales, customer feedback, customer information, et cetera. But you’d also, at that stage, be bidding for capital or things like marketing spend. Although the money came from South Africa, you largely put in the requirements that you had for marketing and you would put together an annualized marketing budget, and it was updated every quarter. In fairness to them, they were usually pretty free in agreeing, particularly around marketing. You would often run through the ad campaigns as part of the presentation that took place every three months and if you had a case for what you wanted to spend, they would agree. So they weren’t tight about marketing spend. They were much tighter with regards to capital expenditure associated with plant infrastructure, property leases, all of those kinds of things. In general, because they trusted implicitly the finance directors of all of those operations. The finance director was obviously at all of the meetings and presentations. If it got the nod from the finance director, it was deemed as being kosher by the South African management team then they would more or less go ahead with it.

Underneath all this was a business that was based in South Africa and listed on the Johannesburg Stock Exchange, and the currency movement in South Africa had obviously gone in the wrong direction overall. It’s difficult, almost impossible, to move money out of South Africa without a reason. So they essentially went on what would’ve been, if you’re being very purgative, a spending spree, with this acquisition of companies across Europe: spending money, getting the money out of South Africa.

It is, yes. All of those acquisitions like Poco in Germany in 2008, Conforama in France in 2011. They were all part of that. Move the money out of South Africa, getting into Euros rather than South African Rand.

Looking back, what lessons did you learn from an organizational structure point of view that can leave a business at risk? I think the structure of an organization can encourage some bad behavior from CFOs or senior executives. What major lessons did you learn from Steinhoff in that sense?

I think there were several. Let’s talk about what one didn’t see, rather than what one did. What one didn’t see was the traditional senior management focus on sales and profit growth. I mentioned earlier that when you take on a business, you look at that business, you establish what the pluses and minuses are, where is it that we need to change things, do things, spend money, save money, recruit people, et cetera. There wasn’t this very aggressive stance on improving the operational standing of the business. So the sort of stuff you see now in the UK, you know Mike Ashley takes over House of Fraser and immediately you see changes in management, investments in some areas, all of that turnaround activity. I’m not putting Ashley up as a paragon of it, but just as an example.

That isn’t what you saw within Steinhoff. What you largely saw was the business being managed in order to move money into areas where there were relatively low tax opportunities, low tax regimes and move money and profit out of areas where it was highly taxed, so, at worst, manipulation of tax around the business. But probably no different to what you would see at Starbucks, Amazon, Apple. Multinationals are quite good at this. And the investors certainly didn’t mind it.

Who actually saw the cash generation because I think you mentioned there were standalone P&Ls, but no one really saw or had control over the cash generation at an operating subsidiary level, therefore it gave those CFOs or financial directors at the centralized Steinhoff entity control of the cash?

Basically, all of the cash operations, financial management took place in South Africa. So, each of those countries themselves wouldn’t see the total balance sheet, if you like, the consolidated balance sheet of their full operation showing cash costs. You only had your operational balance sheet. Therefore, when we got back, just over a year ago, everything blew up. Overall, there were reported cash surpluses, €2.5 billion cash surplus, which was inexplicable at country level. So when I was doing the calls just over a year ago for yourself and some of the other companies, with the analysts, with the capital management companies, one of their questions was: “Where is all of this cash?” No one person could actually answer that. Whether it’s me or Stephen Campbell and there were other people having the same conversations, nobody could talk it through. The only people who really knew were in South Africa. Again, if you follow it through now, you probably know that the PwC were appointed in order to do the forensic accounting and they’re still doing it. It should have been answered by now, it’s been put back to April 2019. To give you some idea of the complexity and the web of operational, financial gearing that was taking place across the Steinhoff operation.

Doesn’t that structure encourage that though?

Very much so. Going back to behavior and people, overall, one would almost say, there was a conspiracy in order to run the business in that particular way. We used to refer to it inside the business ourselves. At worst, it looked like an elaborate Ponzi scheme, where money was being moved around overall that didn’t really exist in order to support businesses. And then, if you underlie all of that with what was a fairly opaque annual reporting of their information, with very few like for like comparisons to be able to be made, often with acquisitions that seem to be sort of third quarter of a financial year. I remember, in 2014/15, we actually moved the financial year by three months, which was absolutely horrendous.

Exactly. And you could say now that that’s a practical part of the conspiracy, you know, to confuse, obfuscate, make it tough for people to look at the numbers. In 2015, they moved onto the Frankfurt Stock Exchange, joint listing with the Johannesburg Stock Exchange. That again confused issues because it wasn’t exactly what was happening.

That fits the narrative of the red flags over the last few years, especially from my angle. From the investors point of view, like you said, moving the cash out of South Africa, is not necessarily a bad thing and is quite logical or rational for anyone who had cash or assets in South Africa at the time. But, in terms of how it was done, the move to the Frankfurt listing was a red flag. I’m just curious about the internal structures like the reporting and the actual humans at the top of the chain within Steinhoff. In terms of the internal structures that were red flags, or maybe lessons in organizational structure, did you guys have access to like-for-likes and more operational KPIs on an operating subsidiary level?

You would for your own business. So you would understand it completely for your own business, so in the UK, essentially, Harveys, Bensons, the manufacturing side of the business. So you'd have all of that, that was completely transparent. What you couldn't see was what the other businesses that help support what you were doing. We've touched on the sourcing side of the business overall. There was a sourcing operation in Shenzhen.

Exactly. You were required to buy through that. That, again, worked as a profit center.

What exactly was this entity? I've done a bit of work on this and there are different views and different perceptions of it. Maybe you could just walk us through how it worked and who it sourced for, was it only for the European assets or was it also for the South African?

There were two major elements to it. There was Steinhoff International Sourcing, which was the Chinese based business, which was really focused on furniture and household goods. Then there was PGS, which was more associated with the apparel sourcing operation. They were largely separate. So Harveys and Bensons were only dealing with Steinhoff International Sourcing.

Is this one based in Beijing or Shenzhen?

I'm not actually sure, I think as an entity it might have been in the Netherlands. But, operationally, it was in small offices dotted around China. This was really focused on apparel, on the Pepkor operation.

And they would charge a commission of 2% to 2.5% of the total unit cost of the materials that they were sourcing. And to my understanding it was mainly for the retailer Pepco, the Eastern European retailer. Who were Pepkor sourcing for and what was the split?

There has been further integration of those operations in the past. I was involved in the due diligence acquisition of Poundland. Poundland wasn't integrated at all into the international sourcing operation until the last year or so. Before that, Poundland was a separate entity and when they acquired it - much as they did with everything else - they left it more or less alone. But it has subsequently become more closely aligned with Pepkor, the apparel sourcing business. But, don't forget if you look at the product types, the product types in Poundland are drastically different. The Pepkor business is really discount clothing, whereas Poundland sells a myriad of goods, some branded, some non-branded.

There wasn't an easy early synergy in just putting those two operations together because fundamentally they were sourcing different products. The furniture side of it was different again. As you can imagine, there are no synergies between acquiring furniture in Asia and acquiring apparel.

The narrative that management tried to claim in their reporting was that the acquisitions, i.e. Poundland, Conforama, would then source through either Steinhoff International or PGS. But that wasn't the case with Poundland?

No, Poundland was completely separate. If you take Conforama as an example in France, they sell a wide range of products from Samsung TVs through to kettles, toasters and ceramics. The majority of Conforama sourcing was outside of both Steinhoff International and PGS.

Who was procuring through Steinhoff International Sourcing?

Anything that was furniture related overall and coming from Asia went to Steinhoff International Sourcing.

So Harveys and Bensons, Conforama, POCO, Kika/Leiner, which they then owned, and Freedom in Australia.

So most of Harveys and Bensons would be sourced through this entity?

In the case of Harveys, it would be around 60% to 65%. Harvey’s procurement was busy. UK manufacturing division provided about 10% of the business. The Eastern European operation that Steinhoff had was about 20% of the business. That was directly sourced from Steinpol as it’s called in the Poland and Hungary operations. There was also direct buying from Italy, from people like Natuzzi, the people making for the general market. The majority for Bensons was coming from the UK, from UK manufactured sources, partly from people like Relyon. It was a real mix; you couldn’t say any one of them was working in any one particular way. It was very disjointed.

There was no operational focus, so when they did buy these assets, there was no CEO going in and trying to aggregate the suppliers to get that scale, which was the narrative given to investors. It was left as it was, if you will.

Broadly speaking, yes. It was very much left to those countries to try and develop their business in the way that they saw fit. The positive side of that would be that there was no attempt to force people to source products from a certain area. In all the retailers I’ve worked in, the buyers want to do their own thing. They want to buy from the people with the best product development, with the best prices, et cetera. There wasn’t a requirement saying: “You’ve got to buy from in-house operations because that’s the decree of the business.” They liked it in that respect, but on the other side of it, of course, those Steinhoff vertical businesses were then competing to sell their product into the business, but also to competitors.

But the rationale for buying the business is flawed in that narrative.

Absolutely. You’re absolutely right that presentationally the focus looked really quite logical, but financially it was very difficult to make year-on-year comparisons, the acquisition process appeared to be looking at the value market overall, whether it was clothing or furniture or household goods. The supposed interim part was the logistics operations and sourcing operations, which were supposed to be synergistic. The reality was quite different. I did the due diligence process on the Argos bid. If you remember far back enough, when Home Retail Group came up for sale, Sainsbury’s and Steinhoff were the two interested parties. When you looked at their trading performance, Argos was declining in profits. They had too many stores. They required lots of investment, particularly in IT.

It was not a business that Steinhoff would have found very easy to run. Again, not very synergistic with all the other things going on with the business, but there was a lot of pressure to buy. I was one of about 6 or 7 people from the European team who were looking at the recommendation saying, “We should not buy this.” It was a huge disappointment. There was a lot of pressure from the center as to why that was the case. It then transpired that Sainsbury’s took it. Likewise, we were doing the same thing with Darty, the French electrical business. Again, Steinhoff bid for that. Again, that wasn’t synergistic.

It’s interesting, they’re on the treadmill to keep the narrative going and keep syphoning cash from South Africa.

Yeah, like you said, it’s a house of cards, one card falls and then…?

Indeed, and with all that cash they supposedly had. Having said for years that they would never go and trade in the United States, they went and bought Mattress Firm. If you go back through it – you don’t buy Argos, you don’t buy Darty: you limit your operations of available growth in Europe and then you go and buy Mattress Firm. It’s been an unmitigated disaster.

The price they paid for that and the amount of stores they had. From the outside looking in, it was another red flag.

The stuff I’ve read about the Mattress Firm side: Mattress Firm were virtually doing a Steinhoff themselves, which was maybe why they looked so attractive to them. There was a UK head who was looking after the European and Australian operations, a guy called Sean Summers, South African. He’s done a lot of work in South Africa. He freed himself up from the operations of the UK business in order to go and acquire Mattress Firm.

How were senior management incentivized? Was there any indication on the KPIs they were incentivized on in terms of the senior execs?

The simple answer is no. The good news - or bad news - for them was that most of it was a long-term incentive associated with shares. All of them have had their nest-eggs collapse. I still know some of the people in the Steinhoff operation and it’s the area of most bitterness for them that all of their shares are now worth 95% less than they were 18 months ago.

It was a very patronage lead business, particularly if you’re South African, and there are lots of South Africans around. You were almost part of the family. Provided you were going in the same perceived direction as the business, you were absolutely fine. For instance, there were huge things to do in Harveys and Bensons within that whole furniture, bedding and bedroom industry in the UK. There were people like Steve Campbell that I worked with and he was pushing hard to get the investment to turn the business around and they weren’t really that interested. It was sort of, “Thanks very much Steve, keep plugging away, we’ll give you the marketing spend and make the best of what you can with the money we’re giving you.” But they weren’t going to give you enough money to invest in the business to turn it round, which ultimately may well have been a good decision on their part.

People were throwing good money after bad. These businesses needed huge investments to make them work. So that’s what was going on in the background, how these businesses were run. In my experience, when I was there, I went into consultancy and ended up staying a lot longer. But it was quite a frustrating business to be part of because when you knew what the issues were and what needed to be done, you really wanted the ability to get on with it and do it. And that wasn’t really where the central part of Steinhoff was coming from.

Is there anything else around the sourcing that you’d like to add? Specifically, for Steinhoff, you’ve got these two entities with an interesting dynamic. As you said, the narrative was that the subsidiaries would source mainly through these two entities to gain scale and lower costs yet there was no mandate for them to restructure at the operating level. Did these entities actually give any benefit to the subsidiaries?

Yes, they did. In the sense that the way that a lot of sourcing offices work means that they aggregate all of the purchase orders. So where there was common product - and there wasn’t a great deal of common product across Europe, Conforama, POCO, Harveys - one central purchase order went to Shenzhen. They placed the one purchase order with suppliers and they were able to negotiate better prices based on volume. They managed it, in the sense of looking at critical path, ensuring production was taking place on time and to agreed quality standards, all of the quality management teams over there. They would organize the shipping and the timeliness of the shipping and the documentation that was required for international freight boarding. So all of that, they were pretty good at. I ran a sourcing office for Kingfisher ages ago so I know what the functions are and they were good-ish at it. They weren’t brilliant but they were good-ish.

Did it give you a difference in unit cost? If you’re Poundland and you’re sourcing from the Far East as well or other entities in Europe who have some kind of contact with the Far East was there any material difference in the unit cost?

For Poundland, almost certainly not. For a furniture or household goods business, a bit, some difference. But you would really do it for administrative reasons and having people closer to the point of production than you would purely for financial reasons.

So it’s more like an intermediary for translation, aggregation of orders and on the floor access to suppliers?

People on the ground. We know when things go wrong, when things are late, you would have people in Shenzhen who could, within a few hours, get into a factory. Whereas, if you’re trying to do that from Europe, it’s much more complicated: you’ve got time differences, 12-hour flights, you can’t get boots on the ground as easily as you can if you’ve got an entity in Asia who can do that for you. In some cases, there were some people who were in the factories 24/7. Particularly around quality issues, there were huge issues around quality and furniture. When I got there, the fault rates were around 25% to 26%. You’re shipping product and you get it to Mrs Miggins in Acacia Avenue in Hertfordshire and she says, “there’s a tear in the sofa” or whatever. It’s very costly to sort it out when you’ve shipped it all that way. So, we had a big focus. Part of my responsibility was getting the people who sign off international sourcing into the factories to get this fault rate down.

Could you give us a quick summary of your key takeaways or what someone should understand about organizational structure and lessons from the Steinhoff story.

I think the biggest single take-away from all of this would be that businesses that don’t look like they’ve got fundamental synergies, shouldn’t be accepted at face value. In my view, the investment community and the media, as well, should have been far more skeptical about the real direction that Steinhoff was going in.

I think it’s about greater analysis of the way in which they reported. I’ve forgotten their name now, the group of analysts who broke the story on Steinhoff. We weren’t actually sure where they came from.

That’s the one. I think one of them transpired to be a Brit actually. But they basically did this balance sheet analysis and said this doesn’t all add up and make sense. Hindsight is a fantastic way of assessing situations but if you did enough digging with the information that was available, one could have found that the group had significant issues overall. I suppose what one would also have seen was the characters and personalities.

Businesses which are run by single, bold, dominant characters, inevitably their personality is imposed on the business overall and therefore one should look at those businesses with more skepticism. Whether it’s Dunkerton at Superdry, Ashley, Ray Kelvin, Marcus Joost or Martin Sorell. They’re the ones that immediately come to mind. Any business which is dependent on one person and their personality represents a risk, particularly if those individuals then move on. Take Ashley out from their operation overall and you’d say, “What’s left?” Everybody just does his bidding. It looks like the same thing at WPP. It looks like Superdry is there. So that would be another take away for me: be skeptical.

Just on that point of businesses that don’t look like they have the synergies that they claim they do. How would you suggest we analyze that? Apart from asking for better reporting, would you describe it the way we have today in terms of looking at the sourcing strategies, the entities they acquire and how that evolves? Or are there any other questions that you would be posing?

The detail one. It’s pretty obvious looking at it in hindsight. The questions to ask of Steinhoff are: what are the real synergies here? You’ve got businesses in Australia, in Europe. You’ve got clothing businesses; you’ve got furniture businesses. What are the synergies of sourcing for those different businesses?

The businesses in the Southern hemisphere with completely different timings of sales and promotional timings to the ones in the Northern hemisphere. What’s clothing got to do with furniture? What’s furniture got to do with beds? Although they sound like they’re the same category, a bed is a fundamentally different manufacturing process to a table and chairs or a sofa. Mattresses are very different: they’re heavy, they’re typically produced closer to the point at which you’re going to sell them. All of that kind of stuff. Basically, how did this synergy really work?

I think another one of the fundamentals was on the logistics side. You say that you’re running logistics operations synergistically but what are they? Again, distributing a two-man delivery operation for a sofa is nothing like what you would do in distributing clothes to stores or Poundland.

Exactly, you don’t even use the same warehouse, and they weren’t, they were completely separate warehouses. So basically, the issue, in a sense, was where are these supposed synergies that this business has got, because on the face of it, the product categories are all very different.

Steinhoff: Bankruptcy Lessons

A critical analysis on vertical integration and lack of synergies within Steinhoff

Leadership lessons and potential red flags for investors to look out for when analyzing companies

Steinhoff: Bankruptcy Lessons

Former Supply Chain Director, Steinhoff

inpractise.com/articles/steinhoff-bankruptcy

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Graham Wilkie

Former Supply Chain Director, Steinhoff

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Steinhoff: Bankruptcy Lessons(December 28, 2019)

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