eCommerce and Retail – Digital Mindset and misallocation of capital

Date: 18/06/2020   l   Category: Retail

 

A Profit and Loss statement is a lag measure. It tells us how good a CEO was in allocating capital (during the preceding 12 months) that influenced items of the P&L.

 

Traditionally in any accounting period cash generated by a business is

 

  1. Operating earnings + (b) non-cash charges

 

In an age where eCommerce is influencing decline in sales another item of cash allocation needs close scrutiny.

 

Reinvestment in the business to maintain its long-term competitive position and its unit volume.

 

  1. Operating earnings + (b) non-cash charges – (c) required reinvestment in the business.

 

The digital world turns this decision upside down.

 

In a digital world (c) is greater than (b) so more investment in stores to sustain a business debilitates the business.

 

Let us say a business is today generating $3 of sales for each $1 invested in store assets.

 

And suppose a CEO decides to allocate an additional $1 to opening more stores, his decision is based on a belief that $1 will give him at least $3 of sales.

 

If this happens it is OK.

 

However, every dollar invested in stores without a commensurate investment in ‘digital marketing’ - to acquire customers and create demand - is yielding sales far less than $3.

 

Rather a better choice would be to:

 

  1. Shut stores with low productivity (increase $ sales per $ invested in business).
  2. Invest in inventory
  3. Sell through an eCommerce marketplace at a lower margin (rotate inventory for cash). 
  4. Not Invest in new stores

 

 

Hence, I say that digital change requires change in CEO mindset. 

 

Business is to be managed with a Return on capital mindset (i.e. the balance sheet) and not the trading mindset (margins and P&L).