Profitable Productivity

Measurements of retailer management effectiveness have included widely applicable metrics such as Return on Invested Capital (ROIC) and Return on Net Assets (RONA), as well as retail-specific metrics such as same-store sales, or “comps,” and sales productivity per square foot. Both of these traditional retail-sector measurements, however, can yield misleading results, largely due to inconsistent definitions of comparable base figures, the potential for artificial manipulation of top-line results through excessive sales promotion, and the omission of Internet and other direct-to-consumer channels.

To facilitate more meaningful comparisons of management performance across a wide span of retailers, Customer Growth Partners of New Canaan, Conn., has identified and tracked a superior metric: operating earnings per square foot, or True Operating Productivity (“TOP”).

The TOP benchmark is intended to address the deficiencies of conventional retail productivity metrics by including the impact of direct-to-consumer channels, stripping out the effects of nonproductive promotion and pricing tactics, and focusing instead on profitable productivity.

TOP is calculated by dividing operating earnings, which is defined as gross profit less SG&A (selling, general and administrative), depreciation and amortization, by retail square footage. The TOP metric is based on gross square feet to eliminate disparities in retailer definitions of net selling space that variously exclude non-selling space designated for receiving, storage, office or vacant space. Additionally, it includes Internet and other direct-to-consumer sales to reflect retailers’ increasingly integrated multichannel sales strategies.

In short, the TOP benchmark is designed to measure management effectiveness across the core retail mission: generating earnings through the sale of merchandise and associated services.

Retail leaders: Based on its TOP metric and a review of the nation’s largest general merchandise, hard lines and apparel retailers, Customer Growth Partners identified nine retailers that emerged from 2006 as the most effective in building profitable productivity.

Under the category of large-format, general merchandise retailers, Neiman Marcus led with a TOP of $76.35 per square foot, followed by Nordstrom at $45.12 per square foot and Wal-Mart at $32.26 per square foot.

In the large-format, hard lines arena, Best Buy, at $47.41 per square foot, The Home Depot, at $46.04 per square foot, and Staples, at $43.80 per square foot, were the high performers. The three top performers in specialty apparel were American Eagle, at $113.10 per square foot, Abercrombie & Fitch, at $98.36 per square foot, and J. Crew, at $81.60 per square foot.

The higher TOP ratios for the specialty apparel retailers reflect the traditionally higher sales intensity per square feet in smaller-format stores, as well as the higher margins available in these predominantly private-label teen and young adult-oriented retailers. Despite the mixed public perceptions that several of the high-performing, large-format retailers have recently achieved, all nine chains share the common trait of being remarkably effective at generating cash from retail operations.

How well the TOP metric reflects Wall Street performance is also significant. It is, of course, difficult, given the many factors affecting stock prices, to establish a statistically causal relationship between the TOP ratio and market valuations. However, a look at the 20 largest apparel specialty merchants is instructive. Stocks at the three “TOP” leaders rose an average of 39% in the year ending May 25, 2007. During that same period, the S&P 500 rose 18%, while stocks at the three apparel “TOP” laggards declined by an average of 4%.

In summary, increasing retail sales productivity is important, but the true challenge—and the true benchmark of retail management performance—is to build productivity profitably.