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Private equity could ramp up ROI by emphasizing brands, customers


By Todd Maute, [email protected]

Back in March, Bloomberg ran a story headlined, “Private Equity’s $36 Billion Retail Bet Not Going So Well.” In a nutshell, this piece catalogued how investment firms like Bain Capital had poured large amounts of money into brick-and-mortar chains in the run-up to the recession, only to be met with lackluster results.

“The private-equity model — load up an acquisition with debt, cut costs and take it public — hasn’t gone according to the usual script with most of Bain’s retail acquisitions … Of the eight largest retail private-equity buyouts during [the pre-recession] period, only Dollar General Corp., a chain of discount stores acquired by KKR & Co., has gone public,” the story noted.

And to be sure, specialty retail category killers like Toys “R” Us, Sports Authority, Petco, and Guitar Center do indeed face some killer competition from Amazon and other Internet retailers. The collapse of disposable income that occurred in the wake of the financial meltdown only made things worse for brick-and-mortar stores, because harried shoppers quickly realized they could save both gas money and time by shopping online instead of driving out to the mall or the local retail strip.

And yet there happens to be more to this story.

Examine some of the more successful investments in retail by private equity firms and you will find they often share something in common — namely, a sharp focus on the customer and the brand.

This is actually a departure from the norm, because private-equity’s usual model for investing in retail tends to be mostly a backend affair. These savvy firms certainly employ some of the best in the business when it comes to ramping up efficiencies and reaping the benefits of scale. But while customers might feel the beneficial effects of these backend changes in their pocketbooks, they do not feel them in their hearts. After all, these changes are all about saving money by scrutinizing headcount, systems, real estate, warehouses, the supply chain and the like.

But what happens when PE firms focus on both the backend and the customer side of the business? The story of New York City pharmacy chain Duane Reade helps illustrate the potential upside of such a comprehensive approach. As you might remember, PE firm Oak Hill Capital sank millions of dollars into Duane Reade after acquiring the chain and eventually launched a major push to burnish the brand and remake the customer experience inside its well-located stores. The effort entailed, to name a few, the rollout of new store designs with wider aisles and hip, appealing décor and signage; shopper-friendly changes to the pharmacy (where the intimidatingly high counters were lowered amid a revamp of the overall look and feel); the introduction of store-within-store prestige beauty counters and, in select locations, features like beer growlers, sushi counters and frozen yogurt machines; and the launch of a host of high-quality private-label brands such as DR Delish.

When Walgreen Co. moved to acquire Duane Reade in 2010, the deal gave Oak Hill a return of about 1.5 times its approximate $400 million investment in the pharmacy chain. Given that just a few short years prior to this, New York consumers almost universally gave Duane Reade’s customer experience a thumbs down (or worse, depending on their mood) this was a remarkable success.

These kinds of strategies involve a broader view of what constitutes an asset on the balance sheet, a tacit realization that brands can be every bit as valuable as real property. Indeed, Oak Hill arguably transformed the chain’s nameplate from something approaching a liability to an asset admired by both consumers and retail insiders alike. Today, in fact, Walgreens is rolling out Duane Reade’s brighter, more relevant store brands across its portfolio.

Dollar General’s story is similar. Acquired by KKR in 2007 (right as the U.S. economy was about to go into free fall), the chain needed some work on the customer side, and KKR rose to the task. Among other changes, it moved to make the stores “fresh, bright and clean” and rebranded them with shiny yellow carts and baskets, as well as signage that made shoppers feel smarter and savvier for spending their money in a value-retail format. Much like Duane Reade’s revamp, this effort included revamped store formats, wider aisles, speedier checkout and new offerings, along with a raft of profit-boosting, private-label brands that were predictably popular with Dollar General’s throngs of bargain-hunters.

The result? Dollar General’s November 2009 IPO was the biggest of its kind in nearly 14 years.

The moral of such stories is clear: By shifting their focus to the customer-facing side even as they ramp up efficiencies on the backend, PE firms can put themselves in a better position with respect to the eventual ROI. This is even more important now that we have entered the age of Amazon, eBay and the commerce-enabled smartphone. In fact, the trend toward omnichannel retail, which so heavily emphasizes the importance of a uniform approach to customer service and the customer experience regardless of whether you’re selling online or in the store, means that retailers everywhere are working hard on being more precise about the customer-facing side of the business. Chains that neglect this do so at their peril, whether controlled by private equity or not. Indeed, market surveys show that shoppers now rank the customer experience as the No. 1 factor that determines whether they will be loyal to a particular brand.

The customer-facing side of the business is neither a static nor an inconsequential part of this puzzle. Rather, retail brands should be viewed as strategic assets with potentially every bit as much value as, say, machinery and equipment, real estate or inventory. If that sounds like an exaggeration, imagine what the IP of a brand like Coca Cola would fetch on the open market. Likewise, some would point to the manifold threats now facing brick-and-mortar retail. These are certainly real and worth contemplating, but most of us feel in our gut that retail stores will always be around in some form or fashion. Rather than defining retail as a potential “bad bet,” in other words, PE firms could instead focus on holistic approaches to these investments. Bargain-hunters get a rush by finding a good deal in a pleasant and easy-to-shop store. Likewise, savvy PE firms, by focusing as much on brands and customer as they do on the systemic side of things, stand a good chance of emerging from retail deals with hefty returns — and winning smiles.

Todd Maute is a partner at branding agency and retail design consultancy CBX. He can be contacted at [email protected]. CBX continues to work with Duane Reade on its private label, store design and other branding initiatives. The firm has not been involved with Dollar General.

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