Sq. feet growth equal to profit growth for retailers? - Views on News from Equitymaster

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  • Jun 8, 2011 - Sq. feet growth equal to profit growth for retailers?

Sq. feet growth equal to profit growth for retailers?

Jun 8, 2011

Retailers these days are back to the expansion mode. They are booking mall spaces and have laid down plans for opening more stores across retail formats. However, most large retailing companies are focusing on hypermarkets. Technically speaking, hypermarkets are large departmental stores that offer general merchandise, food, clothing and electronic appliances also. These are larger than supermarkets and measure 30,000- 1, 00,000 sq ft. Hyper in hypermarket refers to size- in terms of store area as also the number of product options available. As a result of their large size, they provide visibility to a number of product categories at once. They are economically more viable for retailers because of economies of scale in operations.

It may be recalled that the last expansionary phase was not particularly a pleasant one for retailers. There were some that had to liquidate assets to pay off debts. Economic slowdown forced a few of them to shut shops. So let us see whether investment in larger sized hypermarkets is indeed a viable one?

Retailers growing preference for hypermarkets

Retailing players like Aditya Birla Group (More), Pantaloon Retail, Star Bazaar (owned by Trent) all plan to expand their hypermarket operations. A major advantage of hypermarkets is that these provide more visibility to the products. So if a person goes to buy toiletry item at a hypermarket, there is a higher chance of impulse buying of other items as well. This may eventually increase the revenue for the retailer. A hypermarket normally requires a huge area for operation and so retailers prefer ground floor while setting up a store. This enables them to attract increased footfalls from people visiting the malls. Hypermarkets mainly sell essential products of daily use like food, personal care items, and household necessities. Thus, these are less impacted in times of economic slowdown. Also, hypermarkets typically have lower cost per square foot. For retailers, revenue per square foot is an important determinant that retailers consider while setting up a new store. Lower cost per square foot means more revenue per square foot. Thus, the retailers are preferring this format over others.

Challenges

Growth in retailing is more predominant in tier 2 and tier 3 towns these days. In cities like Surat, Aurangabad and Patna it is hard to find such large areas as required for hypermarkets. It is not easy to source manpower also in these areas. There is a need for people with customer service orientation. Also, proximity will always be an issue with the customer. Indians still prefer to shop near their homes at a distance which is probably 10-15 minutes away from where they live. The hypermarkets have to be ideally located so that they can attend to the requirements of the people in the nearby area. Also, sometimes the population in the catchment is quite diverse in nature. Retailing companies will have to customize promotions to specific catchment needs. Hypermarkets try to differentiate by selling goods on discount basis . However, whether this strategy works or not will not be clear immediately. The retailers might have to take a hit on profit margins if they want to sell goods at discounted prices.

Important financial parameters

When a retail company is in a growing phase, we need to look at certain important parameters to decide if it is reflecting in the earnings growth of the company or not. The graph below represents the growth in stores and the corresponding growth in sales for a leading pan-India retailer. It is evident from this that a retailer may add new stores but the corresponding increase in sales may not be in line with the increase in square feet area. Thus, revenue per square foot is an ideal way to judge the efficiency of the company. Other important metrics to look at are sales per store along with same store sales growth. Sales might be increasing because of addition of stores or because of rise in sales of existing stores. We need to see whether a new addition is resulting in a considerable rise in sales or not. Also, a company needs to invest more capital when it expands. Thus, return on invested capital also is an important ratio to consider.

Growth for retailing companies can certainly filter into margins over the longer term. But investors must keep a close watch on profitability if the company has been in an expansion phase for quite some time. The companies that are able to grow but at the same time contain their costs through efficient supply chain and store management are the ones that will ultimately survive and prosper.

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