Wednesday, August 08, 2007

Lessons Learnt from the Closure of BiG Superstore

I read with interest (and a certain degree of amazement) the closure and bankruptcy of BiG superstore in Harbourfront Centre, which had just started its operations back in 2003. The managing director, Mr. Robert Young, had bought over the beleaguered Safe Superstore back in 2003 when it was in receivership and attempted to re-brand and re-vitalize the mega-store concept. The business was running smoothly till 6 months ago when problems cropped up. Even after pumping in another S$10 million, the company found itself hounded by creditors and being unable to pay up for merchandise which it had ordered from its suppliers. This posting is to analyze what went wrong with the business (according to the ST article) and what we can learn from it with regards to investing in companies listed on the SGX:-

1) Change in business strategy – BiG changed its business strategy early in 2007, going from a high volume low margin business to one with slightly higher margins on the back of reduced volume. This had the double-whammy negative effect: customers were perturbed by the higher prices and thus bought less; and payments to suppliers had to be higher as a result of the higher-value goods. Because of these effects, turnover plummeted from S$48 million for FY 2006 to S$12 million in the first 6 months of FY 2007 (S$24 million if annualized, representing a 50% drop !). Lesson Learnt: Changes in business strategy and pricing should be evaluated very carefully before being allowed to proceed. In this case, BiG was a retail business and thus catered to customers who were extremely price-sensitive. Demand was also very elastic as the goods were generic and could be found in most other department stores and mega-marts. Thus, a small change in price could have a drastic effect on sales volume, thus hurting revenues and profitability.

2) Competition – BiG had not anticipated stiffer competition as a result of their change in business strategy. Looking at it from the angle of the five forces, this business had low barriers to entry and so new entrants would find it easy to just set up a store and start selling products similar to those offered by BiG. Suppliers also had more power as they could decide which retailer to sell to, and prices and conditions could be dictated more stringently by the supplier, leaving the retailer at a disadvantage. The popularity of neighbouring VivoCity since its opening probably also contributed to BiG’s eventually downfall as it was drawing much of the crowd away from HarbourFront Centre. Lesson Learnt: Do not under-estimate the power of competition. Ensure that expenses and overheads are always kept consistently low and ensure a decent net profit margin in case a price war breaks out. If the price war gets too intense, consider (as a drastic move) scaling down operations by sub-leasing or “giving up” some space to reduce rental expenses - I have noticed some stores doing this in urban malls.

3) Cash-Flow Management – Cash flow started to become a real headache when sales did not hit desired targets, as BiG (being a retail store) naturally operates mainly on a COD (Cash on delivery) basis. As cash inflows slowly dried up, the store faced problems honouring larger payments to suppliers for higher-value goods. In turn, these suppliers then stopped delivering goods when they did not receive the requisite payment. This led to a vicious cycle as the lack of new goods meant that more customers could not buy, leading to even poorer sales. All it took was one creditor to petition for a winding-up order, and the rest, as they say, is history. Lesson Learnt: A business should always keep an eye on cash flow issues, as these are even more important than earning a profit (accounting profits are separate from cash flows). The cash conversion cycle, which measures the time cash is collected minus the time taken to make payments, should be as short as possible to ensure a steady and healthy cash inflow for the business. Many construction companies went bust in the late 90’s as a result of cash flow problems, not profitability problems. In a retail COD business, cash would normally not be a problem unless the cash outflow requirement was a lot higher than the cash inflows which were being received (which was the case for BiG).

4) Sale of Credit Instalment Scheme – To cut it short and sweet, this is linked to the previous point on cash flows as this scheme allowed customers to buy on credit, payment interest monthly which contributed to the cash flows of the store. By selling this away, the store was depriving itself of a steady inflow of cash and literally dehydrating themselves financially ! Lesson Learnt: Businesses should ensure a steady and consistent stream of cash inflows to fund purchases of stocks or fixed assets. Once cash flow dries up, the consequences can be disastrous as problems start piling up one by one, as can be seen in BiG’s case.

As can be seen, the points above illustrate just how easy it is for a company to go from boom to bust. All it takes is several big mistakes to cancel out the effects of years of good management and sound financial strategies. It is a pity that BiG had to shut down so suddenly as it shows that Management had not adequately considered the ramifications of their strategy change until it was way too late. Only when receivers and liquidators come knocking on their door will they know that their policies had gone tragically wrong. Thus, it is always important to do financial forecasts and assume the worst in order to get a more realistic feel of the situation. Business conditions can be cruel and only the fittest survive, according to Darwin’s Theory of Natural Selection.

My next post will be about Ezra's latest contract for Lewek Champion for the US$888 sub-sea installation project, as well as a brief update on Global Voice and why I am cautiously optimistic about its 1H 2007 results.


fishman said...

Great analysis mw!

I agree with all the points you mentioned.

It's really amazing how fast and suddent everything just went burst! Practically less than a year!

So my question is how do we investors "spot" such potential trouble beforehand and pull ourselves out before the bloodbath occurs?

musicwhiz said...

Hi fishman,

Yes, it's sometimes quite amazing how fast a business can go bust, considering how long it takes to build one up ! It's similar to reputation (as Warren Buffett often says): you take a lifetime to build up a good reputation but only 5 minutes to lose it all.

We can see the same thing happening to the stock market as well. Prices climb slowly as a business creates value for shareholders, but once things take a turn for the worse, prices can drop precipitously and without reason. The important thing to note is that Management is VERY important for a business. A mediocre Management running a good business can still make it work; but corrupt management (without integrity) can being an excellent business to its knees !

As active investors, we should continually evaluate the business conditions surrounding the business to see if it may be subject to adverse forces. Also, continually assess if Management is delivering on their promises (e.g. margin growth, more contracts etc). This will give an indication of whether they are competent. Of course, even with all this analysis, there is still a risk the business may decline and deteriorate. Examples are once-strong companies such as Trek, Creative and DMX who reported much lower profits this quarter.

Anonymous said...

lolipop from CNA:

I enjoy your blog posts, and didnt expect to find some business analysis as well. Thanks!

Will be really looking fwd to ur comment on GV, since I am vested as well. =)

musicwhiz said...

Hi lolipop,

Thanks for dropping by too :)

Hopefully my comments on GV will be useful to yourself, though I must admit there are parts of their business model which I don't fully understand....