Driving Profitability and Growth in a Disrupted World

A new financial reality for retailers

Technology has drastically reduced entry barriers. As a result, retail market share has fragmented and margins have eroded while competition has dramatically intensified.

Faced with a new financial reality, many retailers are finding that investing in new strategic capabilities and operating model changes in order to grow sales and improve margins to satisfy shareholders.

For example, many retailers have invested aggressively in new digital capabilities. The investment has only added to their cost structure and disrupted their supply chains. As a result, they are watching as costs grow faster than revenue.

Between 2011 and 2012, retailers delivered average Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) growth of 4.9 percent largely through sales growth. Many retailers invested in pricing and reduced gross profit margins (-0.8 percent). However, between 2014 and 2015, the picture had reversed and retailers grew EBITDA by 4.3 percent through better price realization (0.3 percent gross margin growth), and (Selling, General, and Administrative expenses) SG&A reduction (4.0 percent)¹.

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Rethink the path to growth

In the midst of disruption, Retailers are beginning to take a fresh look at their operating models, how work gets done, and the cost structure of the business. The model for growth is no longer about opening new stores and increasing comps, it is about growing the business by giving customers access to the brand from anywhere.

In the past, when the economy was soft, retailers operated from the standard playbook: trim costs until customers started spending again and invest for growth when the business was booming again. But times have changed. In the disrupted environment, the economy continues to steadily grow but because of share fragmentation, retailers are not seeing the growth they should because it is spread across a broader set of competition.  Retailers are left wondering if they should tighten their belts but also recognize they cannot save their way to growth.

To thrive in uncertainty, retailers are having to fundamentally reconsider how they are using precious resources and simplify their business models while freeing up resources to invest in business growth.

These new times call for a new playbook:

• Rethink the operating model to reduce organizational complexity and improve operational effectiveness
• Recast the cost structure of the business to free up resources for reinvestment in the business
• Improve organizational agility and responsiveness to quickly adapt to a rapidly evolving customer

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Rethink the operating model

If you were founding a new retail business today, how would your operating practices differ from what may have been designed 20 years ago?

Retailers are quickly realizing that the new competitive landscape is made up of many companies who have had the opportunity to design their capabilities, organization structure, talent models, and supporting tools and technologies in the digital age.

Thriving in disruption, starts with understanding that future success is dependent on modernizing the operating model–streamlining core capabilities and freeing up resources to invest in new capabilities that will be your strategic differentiators.

This seems sensible as nearly 90 percent of retailers we surveyed in our annual research study with MIT Sloan Management Review believe that digital technologies have disrupted the industry. Still less than half (44 percent) believe that they are adequately preparing for the disruption caused by digital².

We see successful retailers focusing on three areas of change in the operating model:

Integrate the organization

Lines between organizations are blurring and old organization structures no longer make sense—many retailers are getting rid of channel and functional lines and orienting around the customer.

Simplify the core

Core functions that have for a long time been "off limits" to restructuring are being reexamined and redesigned to simplify operations while taking advantage of how technology has enabled them.

Invest for differentiation

Many retailers that thrive in disruption are constantly thinking about new capabilities needed to deliver on their customer value proposition.

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Recast the cost structure

Creating headroom for growth will require retailers to take a fresh look at spend, investing to support the new growth agenda while simplifying the core business model and diverting resources from areas that do not drive market differentiation.

Rethinking the cost structure to drive profitable growth is more critical than ever before and requires a balanced and integrated approach to be effective.

Fifty percent of companies surveyed that have gone through a margin improvement program found costs "bounced back" after the reduction and more than 30 percent of cost reduction efforts substantially weakened the company³.

Recasting the cost structure is not about looking where to cut costs; instead, retailers should consider a non-traditional perspective on major costs themes based on the strategy:

• Create "fuel for growth" by moving resources and investments to strategy-enabling capabilities, while simplifying activities and reducing costs in core capabilities
• Move from an allocation mindset to an integrated business perspective, and look for cross-functional cost reduction opportunities by taking an end-to-end capability approach
• Use robotics and automation to significantly reduce costs in core capabilities and basic services

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Embrace organizational agility

To start to thrive in uncertainty, retailers must improve speed of operations and decision making. In the past two years, stock returns of the top US retail innovators outpaced the market by 38 percent. These retailers, who grew up in the age of technology, are 31 percent less likely to get bogged down in hierarchy, and 17 percent more likely to make quick decisions⁴.

Agile retailers:

• Have lean organizational structures
• Aggressively delayer their organizations 
• Have small, multidisciplinary teams/cross-functional collaboration
• Foster innovation
• Have a willingness to try new things and apply lessons learned
• Focus on innovation, not limited to product innovation
• Are effective decision makers
• Leverage predictive analysis to quickly inform decisions
• Push decision making down in the organization structure
• Focus on value to the business
• Use real-time data tracking around every aspect of the business
• Align incentives to behaviors that drive value
• Leverage new staffing models
• Leverage on-demand staff ("sharing economy")
• Make own versus renting decisions

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Sources:
^1,3 Thriving in uncertainty Deloitte's fourth biennial cost survey: Cost improvement practices and trends in the Fortune 1000. Deloitte.com, April 2016.
² Aligning the organization for its digital future. MIT Sloan Review and Deloitte Digital, July 25, 2016.
⁴ "Retail talent disrupted" Deloitte.com, 2016.

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