kurt salmon review - march 2013

KURT SALMON REVIEW

IN THIS ISSUE

Five trends driving deals and strategy in the retail and consumer products industry. 6

How to get stores to live up to their part of the omnichannel equation. 12

Why footwear will be one of the hottest M&A areas of 2013. 49

Retail. Consumer Products. Private Equity. Strategy.

Welcome to the first issue of the Kurt Salmon Review. In this bi-annual publication, we will highlight the most important strategic issues for retailers, consumer products companies and private equity sponsors. We will provide in-depth examples and analyses to help sponsors invest wisely and retailers remain on the cutting edge.

When I co-wrote The New Rules of Retail just over two years ago, my co-author and I laid out three rules for success:

1 Developing products and experiences that fuse connections with consumers on a deeper level

2 Reaching customers first, fastest, most effectively and most often

3 Maintaining value chain control from inception through delivery to the customer and back again

In the past two years, these rules have become more important as competitive pressure mounts and consumers grow savvier.

Our belief is that understanding these forces will be fundamental in deals and strategy development in 2013 and beyond.

In this issue, we discuss deal opportunities in the footwear segment and new distribution channels, plus new diligence tools that help accurately measure brand strength. We also explore strategic issues like omnichannel retailing and the calculus of brand distribution.

These are just a few of the articles you’ll find in this issue. We hope you enjoy it, and we’re interested in hearing your thoughts on any of the articles within it.

Best,

Michael Dart Senior Partner and Director, Private Equity and Strategy Practice

Introduction

FEATURES

Assessing Turnaround Opportunities 6 Sixty percent of retailers with at least two years of negative comps turn them positive. Here’s how. The Omnichannel Customer Experience In-Store 12How to create a compelling cross-channel experience and beat pure-play competitors.

Five Trends to Know 18 The most important factors driving deals in the retail and consumer products industry.

TABLE OF CONTENTS issue 01

IN BRIEF

STRATEGY

Power Brands 38Striking the right distribution balance is even more critical when building a power brand today.

Margins or Growth? 47 Which is a better indicator of strong performance—and a good investment?

DEAL OPPORTUNITIES

Influencer Channels 28 Are doctors’ offices, salons and gyms the next big retail channels?

Footwear 49 Why the fashion and lifestyle footwear market will continue its hot streak in 2013.

NEW RULES OF RETAIL REVISITED

Patagonia 32 How the brand makes money by encouraging consumers not to spend.

Distribution 2.0 34 Why preemptive distribution is one of the most important retail concepts you’ve probably never heard of.

DILIGENCE TOOLS

Fad or Trend? 42 How to spot the difference between the next Beanie Baby and the next Barbie.

Net Promoter 53 Forever 21 and the problem with net promoter scores in isolation.

Digital Footprint 58 Assessing a brand’s online presence in a due diligence.

Hard Bodies Inc.

Hard Bodies Inc.

Har

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odie

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c.

Dr. JonVitamin

6

Assessing Turnaround Opportunities Two years of deep same-store sales declines can easily feel like a death sentence for most retailers. However, the data suggests it is indeed far from that.

We analyzed all specialty retailers with suffi-cient public data over the last 20 years—nearly 70 retailers—and found that the majority of retailers who substantially underperformed the market ended up turning their comps positive in relatively short order.

First, sustained poor performance is more common than many would think. Eighty-eight percent of the retailers we studied had at least one year of double-digit negative comps. And 47% of our set followed that bad year with another negative one.

But all hope is not lost for this set. In fact, we found that 51% of those poor performers averaged positive comps in the two years after their slump. And 60% of the set had turned positive within five years.

This analysis has been adjusted for changes in personal consumption expenditures by category, so we were able to distinguish between retailers struggling from individual decisions and those struggling as a result of macroeconomic factors.

7

Per

cent

age

of

Co

mp

anie

s w

ith

Wo

rst-

Year

Co

mp

s b

elo

w T

hres

hold

Worst Year of Adjusted Comps, 1990–2011 (%)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0%–5%–10%–15%–20%–25%–30%

EXHIBIT 1: Percentage of Companies by Worst Year of Adjusted Comps

We found that 51% of poor performers averaged positive comps in the two years after their slump. And

60% of the set had turned positive within five years.

8

Next 2 YearsAverage Growth

24%

24%

18%

34%

24%

16%

32%

28%

100% 100%

Next 5 YearsAverage Growth

Higherthan 5%

Lowerthan –5%

0% to 5%

-5% to 0%

47%

53%

100%

Companies that did not experience at least two consecutive years of negative comps

Companies with one year of double-digit declines, followed by another negative year

EXHIBIT 2: Charting the Progress of Poor Performers

9

We found that overcoming such a significant slump is made more challenging by four factors:

1. Tarnished brand. Once-desired brands can lose advocacy or cachet as a result of changing trends or a loss of quality control. TGI Friday’s is one example.

2. Rapidly increasing market competitiveness. The popularity of a given category encoura- ges a sea change in the number of brands and retailers playing in it, as well as e-com-merce influences like Amazon keeping prices relatively low.

3. Secular shifts or a changing industry. An obvious example is the shift from physical to digital books—Barnes & Noble is an interest-ing investment opportunity in this space.

4. Operational missteps. Risky management decisions with lasting consequences can do as much damage as any macro trend. Sears and JC Penney are both currently experienc-

ing headwinds created by past decisions.

None of these challenges alone means that a brand is beyond hope. They simply mean that reinvigorating the brand will require major strategic changes and time.

The following case studies help illustrate some of these strategic changes.

2003–2007: J. CREW

ISSUE: J. Crew experienced -16% comps in 2001 and -11% in 2002. These results were symptomatic of significant internal strife and turnover, including three CEOs in five years, and poor merchandising and real estate decisions. At the same time, its competitive landscape only intensified.

SOLUTION: Starting with significant man-agement changes, including hiring Mickey Drexler as CEO, J. Crew sought to instill a design-driven focus throughout the organiza-tion. It also revamped its products to include more color and added new higher-end pieces, categories and a bridal collection. J. Crew also upped its product flow and improved the store experience.

RESULTS: J. Crew turned in 16% same-store sales growth (SSSG) in 2004 and 13% in 2005, plus a 17% increase in total revenues to $804 million and a gross margin increase of 15%. It was taken public in 2006 with a market capitalization of $1.1 billion and has since spawned several successful new businesses, including Madewell and crewcuts.

Case Studies Great Turnarounds

10

2006–2011: KATE SPADE

ISSUE: Kate Spade faced double-digit comp declines as a result of suffering retailer rela-tionships, internal strife and real estate in poor locations.

SOLUTION: When it was purchased by Liz Claiborne, Kate Spade underwent signifi-cant management changes. New leadership redeveloped its core products, making its traditional designs more contemporary through bold colors, and entered new catego-ries—jewelry, apparel and denim. Kate Spade also launched a new advertising campaign to promote these products, as well as a best-in-class social media strategy. Finally, the brand focused on improving its distribution, both by strengthening relationships with retailers like Nordstrom and Bloomingdales and by revamping its e-commerce site.

RESULTS: Kate Spade’s SSSG increased 24% in Q2 2012, and total sales were up 86% to $313 million. The brand’s e-commerce sales are growing at over 30%, and it is carried by over 300 premier department stores, plus 50 full-price and 30 Kate Spade outlet stores.

2007–2012: EXPRESS

ISSUE: Express had experienced many ups and downs in SSSG over the past decade as a result of misaligned products, assortments and store execution. It also suffered from a lack of focus and too many strategic changes, which left it unable to withstand the pressures of increased competition.

SOLUTION: Golden Gate Capital acquired Express in 2007 and started by hiring a new CEO. Management then implemented a new merchandising strategy that was more responsive to consumer preferences and launched an e-commerce site in 2008. Finally, Express rationalized its store fleet, combining men’s and women’s stores to use fewer square feet but growing their overall store base.

RESULTS: SSSG was at 10% in 2010 and 6% in 2011, total sales increased 11% to $2.1 billion and gross margin increased from 26% to 36%. It was taken public in 2010 with a market capitalization of $1.3 billion—60% more than when it was originally purchased. Express was also able to reduce markdowns from 20 million items in 2007 to 14 million in 2009, resulting in a 4% increase in merchandise margins.

11

AUTHOR

Drew Klein has significant strategy and due diligence experience, specializing in the apparel, footwear and sporting goods industries. He can be reached at [email protected].

Many of these strategic decisions are best conducted away from the intense glare of the market. For private equity sponsors, the lesson is clear: Brands that have a strong heritage but are suffering from several years of bad performance may not be forever doomed. In fact, some may be hidden investment gems. v

13

Some industry analysts and investors say it’s nearly impossible for retailers with stores to win against their online-only competitors, saddled with a massive store fleet and losing on price. We believe the opposite.

In fact, omnichannel retailers should be in a better position than their online-only compet-itors to win in this hypercompetitive world. True, the U.S. is overstored, foot traffic is declining and traditional brick-and-mortar retailers face increased pressure from online competitors. As one client put it, although their in-store conversion rate of about 18% is on par with the industry average, that figure will need to double in the very near future so stores can remain competitive.

But omnichannel retailers are well positioned to achieve such a significant increase. Why? For starters, it’s well known that cross-chan-nel shoppers are more profitable.

For example, one department store retailer found that customers who shopped only on its website browsed it an average of three times a year. Customers who shopped exclu-sively in-store, on the other hand, shopped an average of 7.5 times a year. But customers who shopped both channels shopped an average of 1.7 times a year online and 7.3 times a year in the store, to get a total of nine times a year. This number demonstrates that online shop-ping was not cannibalizing in-store shopping; online was purely additive.

shopped only on its website

shopped exclusively in-store

shopped both channels—shopped an averageof 1.7 times a year online and 7.3 times

a year in the store

+

3 TIMES A YEAR

7.5 TIMES A YEAR

9 TIMES A YEAR

14

The retailer found that these omnichannel customers not only shopped more, they purchased more often. Generally, about 23% of the retailer’s purchases are returned. So when direct delivery and direct-to-DC returns are the only options for online purchases, the retailer nets about 77% of its sales. But if the retailer offered in-store returns, it found that customers spent an extra 18% on top of their original order when they were in the store returning the original product, which boosted the retailer’s net sales back up to 95%. And if the retailer offered in-store pickup, it found that customers purchased 12% more when they were in the store picking up their order. So if the retailer offers both in-store pickup and returns, it will recoup 107% of its sales. This means that this retailer’s cross-channel customers purchase nearly 40% more than its single-channel counterparts.

Stores also have other advantages, including their ability to be a powerful distribution as-set. As customer expectations around delivery speed continue to increase—especially after Amazon, eBay and Walmart’s recent forays into same-day delivery—stores can be the ideal vehicle for fulfilling these orders.

100%

23%

77%

sales returns net

100%

23% 18%

sales returns

purchasesduring

in-storereturns

net

95%

100%

23% 18%

sales returns

purchasesduring

in-storereturns

purchases during pickup

12%net

107%

DIRECT DELIVERY & RETURNS

IN-STORE RETURNS

IN-STORE PICKUP & RETURNS

15

But stores’ true advantage comes with their ability to act as an effective piece of an over-arching, compelling omnichannel customer experience. New technology is now enabling retailers to bring the personalized customer experience once found only online to life in their stores, creating one-to-one retailing experiences. Doing this will help increase conversion rate and basket size by improving customer engagement, making a retailer’s store fleet more profitable.

What will these one-to-one retailing experi-ences look like from a customer’s perspective? They will include four key building blocks:

1. Connected marketing.

In the very near future, the store will

become one more distribution point for

the kind of personalized marketing now

found online and on mobile devices. For

example, a customer looking at a certain

pair of jeans on a retailer’s website would

be shown those jeans on interactive dis-

plays when she entered the store later.

2. Presence awareness.

Similar to the cookie concept online,

technology is now enabling retailers to

know which customers are in the store

and which products they’re interacting

with. Retailers can already push person-

alized offers to customers when they’re

near or entering the store, but this idea

can extend to any given display or

fitting room.

3. Product awareness.

Not only can retailers know who is in the

store and where they are, they can know

exactly what products they’re handling.

For example, a consumer in a bookstore

picks up a novel and a nearby screen

displays product reviews pulled from

the customer’s social media networks.

4. Personalized recommendations.

The in-store experience can be tailored

and targeted at the individual level by

combining presence and product aware-

ness with location and personal data

and using predictive analytics. For

example, a consumer can be shown

shoe recommendations based on the

pairs she already has in her closet and

the styles she has been exploring online

and in the store that day.

And the true advantage of omnichannel retailers is the ability to combine online, in-store, mobile and other

channels to create an unbeatable customer experience.

16

The Technology behind 1:1 Retailing

Geofencing. Geofencing, or creating a virtual “fence” around a set physical space to monitor movement near and within it, helps retailers track customers’ movements around and within the store’s four walls. Combine that power with a loyalty app or smart card and you’ve got the ingredients for a truly personalized interaction with your customer. By knowing who is in their store, retailers can use individual purchase histories or customer profiles to dynamically change recommendations, visual merchandising presentations or promotions.

RFID. RFID allows retailers to see exactly which products each customer is handling or trying on at a given moment. Beyond that, RFID allows a retailer to know exactly what items, sizes and styles they have in stock in the store or backroom. Combine this with the geofenced loyalty app or smart card and retailers have the power to make personal-ized, real-time shopping recommendations and offers.

Interactive displays. Only a year or two ago, installing and communicating interactively with immersive video displays in a retail environment was prohibitively expensive. But now, the cost of display technology is dropping rapidly. More importantly, person-alized in-store experiences enable significant sales and margin improvements, creating attractive returns on the investments required to deliver them.

Implementing these technologies will help improve customer engagement, which in turn drives increases in traffic, conversion rate and basket size, completely changing store financial performance and making the omnichannel retailer even more profitable versus its online-only competitors.

Traffic. Successful one-to-one retailers will use integrated channel communication to bring customers to stores with targeted events and promotions. The immersive experience will begin right at the store threshold, drawing in higher traffic from customers looking for a new experience as well as increased loyalty revisit rates.

Conversion rate. The more time a customer spends in a store engaging with the retailer, the more likely they are to make a purchase. For example, we studied the behavior of several specialty retailers’ customers and found that 45% of customers walked into the store and left within two minutes without ever engaging with the products or sales associates. But when customers were engaged by an asso-ciate or started interacting with the products, they were nine times as likely to try something on. And once they tried on a product, they had a 52% chance of buying it. So we determined that by engaging with just 30% more custom-ers, retailers could increase their conversion rates by 50%.

17

Basket size. While retailers can guarantee 100% of shoppers see companion products on their websites, only 8% to 15% of shoppers in the stores of the specialty retailers mentioned above were upsold. Yet when the retailers could find the staffing and time to do it, 75% of customers who were offered additional items converted, and their average basket size increased by 25%. Imagine the benefit of upselling to more than that 8% to 15%.

Of course, enabling this level of omnichannel experience will not only require new technol-ogy but also significant organizational change. Saks Fifth Avenue, Gap and Macy’s are leading the charge to make their organizations more channel agnostic, increasing coordination and improving the customer experience at the same time.

We believe there are five key factors that should inform any discussion about omni-channel organizational design:

1. Consumers

» Target customer profile

» Main purchase drivers

» Shopping habits in each channel and across them

2. Offering

» Assortment overlap between channels

» Primarily core or quick turn and high fashion

» Level of commoditization of products

» Price elasticity

3. Brand

» Level of exclusivity

» Competitive set

4. Business maturity

» Absolute size

» Growth rate

5. Marketing and selling

» Role of store—more for service or for selling?

With all the benefits of a well-executed omnichannel experience, not to mention stores’ tremendous distribution advantages, it’s no wonder Amazon CEO Jeff Bezos said in a recent interview that even he would love to open Amazon stores. If the world’s biggest online retailer is thinking about opening a physical store, retailers who are already blessed with hundreds of stores should be cel-ebrating their good fortune, not wringing their hands about the demise of bricks and mortar. v

AUTHORS

Michael Dart has extensive expertise in both strategy and due diligence. He specializes in retail, consumer products, footwear and sporting goods. He can be reached at [email protected].

Al Sambar specializes in supply chain and store operation strategies for specialty apparel retailers and wholesalers and department stores. He can be reached at [email protected].

Implementing these technologies will completely change store financial performance and make the omnichannel retailer even

more profitable versus its online-only competitors.

18

Five Trends to Know

It’s a great time to be a part of the retail and consumer products industry.

U.S. retail deals shot up 124% to $19.7 billion in the first three quarters of 2012, while overall U.S. PE-backed M&A fell 20% in the same time period, according to Dealogic. Globally, there was $324.6 billion in consumer and retail M&A activity in 2012, up 33% from the prior year, making it the busiest year since 2007.

These deals represent a wide range of sectors and segments, from Savers to Party City to Cole Haan. Looking forward to the rest of 2013, retail and consumer M&A shows no signs of slowing down, with the $23 billion acquisition of Heinz kicking off the year in a big way.

These deals come in the midst of dramatic industry-wide changes. Retailers are taking innovative steps to respond to these changes, from JC Penney’s ongoing reinvention to Etsy’s recent purchase of collage maker Mixel for its mobile talents to Target’s online price- matching offer.

Driving these changes are five key factors that all investors and retail strategists should use in determining value: macro demographic changes, lifestyle shifts, technological trends, new business models and intensified competi-tive dynamics.

1. Macro Demographic Changes

Growing income gap. The income gap between top earners and lower-income consumers is now the highest it has been since the Great Depression, according to a 2012 study by UC Berkeley economists. On one end of that gap, luxury is booming. For example, Michael Kors recently reported fourth-quarter comps of 45%. And Neiman Marcus and Saks Fifth Avenue have averaged 8.1% comps in 2011 and 2012, well above the mid-range department store average of 1.8%. At the same time, lower-income consumers will be increasingly pressed. The median household income dropped 1.5% in 2011 to the lowest level since 1995 when adjusted for inflation. This has led to the success of dollar stores and discount chains like Ollie’s, plus growth of private label to make up roughly 25% of most grocery store shelves.

The most important factors driving deals in the retail and consumer products industry—and four compelling investment opportunities.

19

Urban migration. Nearly 80% of the U.S. population lives in major metropolitan areas and, according to the Census Bureau, cities are now growing faster than their suburbs for the first time in a century. This trend will drive several important changes. First, con-cepts like The Container Store that help peo-ple make the most of small spaces will thrive. Secondly, traditional big-box retailers are figuring out how to reach this growing market. This has led to a rise in small-format stores like Walmart Express, City Target and Best Buy Mobile, but will also fuel the continued popularity of dollar stores and c-stores, both of which will expand their assortments to more closely resemble their mass and grocery competitors.

A population shift. Currently, 13% of Amer-icans are 65 or older; that will grow to 18% by 2030. As baby boomers age, there will be new demand for leisure activities and convenience because of limited mobility, including deliv-ery services for basic needs like groceries and drugs. This trend will also drive closer inte-gration between traditional retail settings and health care services—like CVS’ MinuteClinic. On the other hand, millennials are growing rapidly—30% of all retail sales will come from this group by 2020.

Racial and ethnic diversification. The U.S. is becoming increasingly racially and ethnically

diverse, with the non-Hispanic white pop-ulation projected to shrink 23% by 2050, according to the U.S. Census Bureau. At the same time, the African American population is expected to increase by 11%, the Asian pop-ulation by 74% and the Hispanic population by 57%. This demographic shift will lead to the continued diversification of store shelves to meet changing tastes.

2. Lifestyle Shifts

Personalization. From news to music to advertisements to credit card rewards, com-panies of all kinds are using consumer data to craft personalized recommendations and experiences. So it’s no surprise that consum-

U.S. Population Changes by 2050

Non-HispanicWhite

AfricanAmerican

Asian

Hispanic

–23%

11%

74%

57%

20

ers are beginning to expect the same level of individualized treatment from retailers. Of course, we’ve all heard about Target sending promotional offers to pregnant women, but other retailers are using less controversial—but equally effective—methods. For example, Walmart’s Shopycat Facebook app provides recommendations based on customers’ social media habits. In one promotion, Walmart saw a 42% conversion rate for users allowing the app and 50% of users shared it with their friends. Retailers are also seeing incredible success when it comes to personalized prod-ucts. For example, Nike has built NIKEiD, which lets customers design their own shoes, clothes and gear bags, into a $100 million business.

Technology is no longer a luxury. Even lower-income consumers are allocating large shares of their incomes to purchasing technology. In fact, 43% and 59% of lowest and second quintile households by income had cell phones in 2005, the last year for which data is available. And these numbers have likely only grown since then. This has led to the success of companies with products accessible at a variety of price points, like Apple. EBay is another beneficiary, as mobile transactions through its app doubled in 2012 to $13 billion. From point-of-sale technology to mobile apps, every consumer expects better technology solutions.

Renewed emphasis on health. Sedentary lifestyles and growing waistbands have led consumers to seek healthier options, from wellness products like vitamin supplements and organic food to services like yoga classes. Whole Foods has benefitted from this trend, averaging 8.3% comps from 2001 to 2011 versus 2% for the rest of the grocery industry. Juice cleanses, gyms and active apparel are all growing.

3. Technological Trends

Moore’s Law continues. Moore’s Law—which dictates that the number of transistors on a computer chip will double every two years—is widely applicable to technological change in general, in that the pace of change accelerates

“The days of trying to get a consumer to come to you are over. You really have to be in the consumer’s world,

wherever, whenever and however.” —Mindy Grossman, CEO, HSN

Percentage of Households withat Least One Cell Phone

Highest quintile

Fourth quintile

Third quintile

Second quintile

Lowest quintile

92%

86%

76%

59%

43%

INC

OM

E

21

over time. Consider that it took 28 years for the TV to be adopted by 50% of consumers, but it took social media only three and a half years to reach the same level of adoption. From RFIDto mobile POS, technological changes will continue to shape the future of retail. For example, Tesco has installed virtual store walls in South Korean subway stations. Consumers scan QR codes next to each prod-uct, check out on their mobile phones and the products are delivered by the time they get home.

The push for omnichannel. Creating a consistent experience—and delivering prod-ucts—across channels is the industry’s biggest mandate and challenge. HSN was an early leader in developing an integrated experience across channels. As CEO Mindy Grossman puts it, “The days of trying to get a consumer to come to you are over. You really have to be in the consumer’s world, wherever, whenever and however.”

Analytics. Technological advances are enabling retailers to collect and analyze data quickly and cost-effectively and use it to drive better decision-making. For example, Walmart scans the prices of competitors’ websites every 20 minutes and uses the data to adjust its own prices accordingly.

Rise of smart products. Smart products—like Under Armour’s shirt that can monitor the wearer’s heart rate and Nike’s shoes that track movement—will grow in popularity as consumers increasingly value personalized products and experiences.

4. New Business Models

New and now. Product development cycles continue to shrink as the demand for super-current products increases, led by retailers like Zara and Forever 21. This push also translates into distribution, with Amazon, eBay and Walmart all venturing into same-day delivery.

Near-shoring. Bringing manufacturing closer to home can help reduce cycle times, save money on transportation and labor costs, and engender goodwill. Retailers from Target to The Children’s Place to Zara are near-shoring. Some brands, like Nine West, choose to near-shore only a small portion of a given assortment, handing the full order to China if the initial sample sells well.

Time to 50% Consumer Adoption

Television

Social Media

28 years

3.5 years

22

Blurring the lines between retail and wholesale. Retailers are becoming more vertically integrated to save money and boost efficiency—like Party City, which manufactures its own balloons. Similarly, the percentage of manufacturers selling directly to consumers is expected to grow 71% over the next year, according to an Economist Intelligence Unit Survey.

Department stores become mini-malls. Excess capacity inside big-box retailers and department stores will fuel the growth of “stores within stores,” such as Apple’s stores in Best Buy, Sephora’s branded boutiques within JC Penney and Home Depot’s part-nership with The Container Store.

5. Intensified Competitive Dynamics

Increased pricing pressure. The rise of Amazon and the ubiquity of smartphones have led to increased pricing pressure on commoditized products. To combat show-rooming, leading retailers are creating unique products or experiences that cannot be replicated online, like Abercrombie & Fitch’s perfume-heavy nightclub feel or Costco’s free samples and treasure hunt vibe.

Excess industry capacity. The U.S. is over-stored and inundated with websites. In fact, the U.S. has 20 square feet of retail space per capita, versus three in the U.K. and two in France and Brazil. The same is true online,

where 9,675 daily deal sites have sprung up. This means that large chains will shrink, while smaller formats like dollar stores will grow. There will be a similar shakeout on the Web.

Four Promising Investment Opportunities

We believe that all attractive investment opportunities in 2013 and beyond will lie at the intersection of the above trends.

Those who are able to capitalize on multiple trends will see the highest economic returns. Here are a few possible scenarios:

Reimagining the convenience store. C-stores are uniquely positioned to exploit new demands for convenience and increasing urbanization. They’re already closer to con-sumers than any other type of physical store, but there are still opportunities to improve the experience and assortment.

Retail Space per Capita (square feet)

U.S.

U.K.

France

Brazil

20

3

2

2

23

First, margins and consumer loyalty can be improved by growing private-label offerings beyond packaged goods. C-stores are already starting to more closely resemble quick-serve restaurants in their offerings. For example, Casey’s General Stores recently started offer-ing fresh pizza.

But there is still tremendous opportunity to expand c-store private-label offerings to in-clude more general merchandise, transform-ing c-stores into one-stop shops for modern urban consumers. For example, 7-Select at 7-Eleven in the U.S. includes more than 250 food items from donuts to frozen pizza. But in Taiwan, 7-Select also includes a much wider assortment of general merchandise, including clothing, laundry detergent and light bulbs. And the strategy is paying off, with 7-Eleven’s operator in Taiwan reporting a 27% increase in net income in the third quarter.

And new technologies can also help make the c-store shopping experience easier and faster. For example, retailers could deploy RFID tags to let consumers check them-selves out. Or U.S. c-stores could take a page from Tesco’s book and build virtual stores. Finally, online ordering and in-store pickup would help make the experience even easier and give first adopters an incredible compet-itive advantage.

Retailers to watch: 7-Eleven, Alimentation Couche-Tard, Pantry, Casey’s General Stores and Wawa

Customizing and localizing the high-end supermarket. Perfectly positioned at the in-tersection of luxury, health and convenience, high-end supermarkets have tremendous growth potential.

Gourmet supermarkets offer both wealthy and aspirational consumers a valued escape from their everyday stresses into a luxuri-ous world, which will become increasingly important as consumers work longer hours and become increasingly urban. In addition, they typically offer higher-quality and high-er-priced products, meaning they can easily cater to the demand for more organic and healthy products.

For example, Wegmans, a $6.2 billion, 72- store chain, sends hundreds of its employees on trips around the globe so that they will become experts in their products.

And cashiers can’t start work until they have completed 40 hours of training. The result is a highly specialized, differentiated experience. Larger chains also have much to gain from offering localized assortments. For example, one $20 billion national grocery chain saw comps increase 2% to 7% across stores with

Those who are able to capitalize on multiple trends will see the highest economic returns.

24

localized assortments, and that was with only 10% to 15% of each store’s assortment differ-entiated from the core.

Retailers to watch: Sprouts, Wagshal’s, Wegmans and Balducci’s

Creating an integrated wellness one-stop shop. Consumers leading a sedentary lifestyle are searching for ways to maintain their health into old age, a trend that is also supported by growing incomes and an aging population.

Athletic product sales, especially apparel and footwear, have been fueled by smart products. And the demand for knowledgeable sales associates to inform customers about the benefits of these products has kept pace. Com-panies have emerged to cater to health-con-scious consumers at both ends of the econom-ic spectrum. At the higher end, sports clubs like Equinox and retailers like lululemon and Athleta provide a luxurious experience and fashion-forward products. At the lower end, gyms like Blink create a supportive feel, while Champion provides high value through its C9 line at Target.

But a retailer who can bring everything a health-conscious consumer needs under one roof could gain significant competitive

advantage. Offering apparel, sporting goods, healthy pre-prepared food and nutritional supplements at a gym or exercise facility would appeal to busy, urban consumers and combine cross-functional expertise in one location.

Retailers to watch: Life Time Fitness, Town Sports International and Equinox

Accelerating the diffusion of luxury. Combining luxury with experiential, deal-based shopping experiences that create a sense of urgency is helping to fuel significant top-line growth for luxury brands and intro-duce them to new customers.

For example, high-end menswear seller Bonobos has had incredible success creating comfortable, good-fitting men’s clothing in dozens of colors, encouraging shoppers to find their fit and stock up. The model has helped Bonobos become the largest U.S. apparel brand ever built online. In 2011, the company expanded into the brick-and-mortar space, creating showrooms called Guideshops that help customers select the right fit before buying. And Nordstrom recently invested $16 million in Bonobos to sell its merchandise on Nordstrom.com and inside 20 Nordstrom stores. Bonobos has Web sales of $15 million, according to Internet Retailer estimates.

But a retailer who can bring everything a health- conscious consumer needs under one roof could

gain significant competitive advantage.

25

Custom suit maker Indochino has taken a similar approach, recently opening limit-ed-time pop-up stores in cities around the globe. In 15 minutes, customers are measured, pick out their fabric and pay—roughly $500— and in three weeks, the suit arrives from China. Indochino has 40,000 customers in 60 countries and its revenue has doubled year over year since it was founded in 2007.

Clearly, there is significant room to grow lux-ury concepts by diffusing them to aspirational customers across a range of more accessible price points and formats. But it’s important to separate the experience and quality of these diffusion concepts from the core luxury brand to avoid alienating high-end consumers. For example, Vera Wang at Kohl’s couldn’t be further from Vera Wang’s high-end wedding dresses, and Missoni was so popular at Target that it shut down the mass retailer’s website, but this has not tarnished Missoni’s reputa-tion in luxury circles.

Retailers to watch: St. John Knits, Christian Louboutin, Burberry and Intermix v

AUTHOR


In BriefQuick looks at key strategic issues, hot deal opportunities and new ways to evaluate success

DEAL OPPORTUNITIES

Influencer Channels 28 Are doctors’ offices, salons and gyms the next big retail channels?

Footwear 49 Why the fashion and lifestyle footwear market will continue its hot streak in 2013.

STRATEGY

Power Brands 38Striking the right distribution balance is even more critical when building a power brand today.

Margins or Growth? 47 Which is a better indicator of strong performance—and a good investment?

NEW RULES OF RETAIL REVISITED

Patagonia 32 How the brand makes money by encouraging consumers not to spend.

Distribution 2.0 34 Why preemptive distribution is one of the most important retail concepts you’ve probably never heard of.

DILIGENCE TOOLS

Fad or Trend? 42 How to spot the difference between the next Beanie Baby and the next Barbie.

Net Promoter 53 Forever 21 and the problem with net promoter scores in isolation.

Digital Footprint 58 Assessing a brand’s online presence in a due diligence.

Hard Bodies Inc.

Hard Bodies Inc.

Dr. JonVitamin

28

Are Doctors’ Offices, Salons and Gyms the Next Big Retail Channels?

One of the biggest mandates in the retail industry right now is reaching consumers wher-ever they are and through whichever formats they prefer. Take that to its logical conclusion and the importance of “influencer” channels —like doctors’ offices and salons—isn’t so far- fetched. As more and more consumers come to expect customized products and experienc-es tailored to their wants and needs, channels that service a specific community of highly involved consumers may be the next big in-vestment opportunity for private equity firms.

Why? First, there’s the difficulty of investing in product brands that are battling it out in traditional channels. In traditional channels, such as grocery, mass and department stores, power brands owned by strategics dominate many categories and benefit from the scale of their parent business. Private label plays a big role, turning a brand’s retail custom-ers into direct competitors. And most retail channels are overstored, with the resulting margin pressures transferred from retailers to brands.

As a result, private equity opportunities in traditional channels are often limited to secondary brands struggling for share, few of which have the heritage to mount a comeback.

In contrast, brands flowing through influencer channels offer distinctive investment oppor-tunities and a potential new angle for private equity sponsors to consider when assessing potential deals. Example channels include:

> Specialty sporting goods (including golf/

tennis clubhouses, specialty running shops

and gun clubs)

> Health and wellness (GNC, Vitamin Shoppe

and thousands of independents)

> Pet care (PetSmart, Petco and thousands

of independents)

> Hair salons (chains and independents selling

hair treatment products and accessories)

> Dermatologists’ offices (for skin care products)

> Physical therapists’/chiropractors’ offices (for

pain relief products and exercise equipment)

Hard Bodies Inc.

Hard Bodies Inc.

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Hard Bodies Inc.

Hard Bodies Inc.

Har

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s In

c.

Dr. JonVitamin

Hard Bodies Inc.

Hard Bodies Inc.

Har

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odie

s In

c.

Dr. JonVitamin

29

> Dance studios (for costumes, footwear and practice apparel)

> Recreational sports teams (for uniforms and equipment)

Unlike traditional channels, which offer mainstream assortments to a broad audience, influencer channels appeal to a niche group of consumers and are known for their innate expertise and distinctive assortments. Con-sider the respect people have for their trusted doctor, golf pro and hair stylist and how that respect can reflect positively on brands they recommended.

The dynamics for brands in influencer chan-nels are quite attractive. The channels are surprisingly large and growing. (See Exhibit 1.) Competition is fragmented, supporting strong brand margins. And for channels like doctors’ offices and recreational groups whose reason for being is not retailing, this incremental profit stream is often underdeveloped. Help-ing these new influencer retailers to succeed creates incredibly sticky relationships.

From an investment standpoint, attractive brands operating in influencer channels will demonstrate four characteristics.

EXHIBIT 1:

Influencer ChannelsIndustry

Pet Care Products

Nutritional Supplements

Athletic Footwear

Tennis Apparel and Equipment

Guns & Ammunition

Skin Care Products

Hair Care Products

CAGRSales ($Bn)

Durable Medical Equipment Specialty service providers (via doctor’s prescription) $29.7 3%–5%

Pet stores $14.2 2%–4%

Health food stores, health practitioners $11.2 5%–8%

Specialty running stores $3.7 2%–3%

Hair salons, specialty hair care retail $1.9 -1%–1%

Dermatologists’ o�ces, specialty skin care retail $1.9 11%–15%

Specialty gun stores, gun ranges/clubs $1.8 20%–24%

Tennis pro shops, specialty tennis stores $0.4+ 6%–8%

30

Credibility. Credibility is often the very foundation of brands operating in influencer channels: These brands thrive because their customers trust their expertise and in turn recommend the brand to other consumers. The credibility of Clean Bottle, a manufac-turer of water bottles targeted to cyclists, is certainly central to the company’s success. The founder is an avid cyclist who designed a better water bottle that has been adopted by many professional racers. The brand markets at many bike races and 10% of profits go to charities favored by cyclists. These factors bolster the brand in the eyes of independent bike shops and devoted cyclists.

Quality. Consumers in influencer chan-nels are passionate about their purchases and expect very high-quality products. This demand for quality helps drive higher price points, which is a critical factor in influenc-er channels given their cost structures. The importance of quality can be seen in Merrick Pet Care food products. The high-end brand touts its all-natural ingredients and boasts of ingredients derived from superfoods, with de-boned meat as its main ingredient, and is made in the U.S. with no ingredients from China. As a result, Merrick is well positioned to tap into the super-premium and natural pet food segments, which are already at $6.2 billion and are growing faster than the rest of the pet food category.

Differentiation. Consumers in influencer channels also expect the latest, most innova-tive products. Influencer channels embrace offerings with limited distribution—they want brands consumers can’t get anywhere else. For example, Inov-8 minimalist running shoes realized dramatic growth by tapping into the rapidly growing CrossFit training trend. This footwear was hard to find in tradi-tional channels but took off through specialty running stores. In fact, a Kurt Salmon survey of these specialty running stores found that Inov-8 was recommended for CrossFit more often than any other competitive brand, in-cluding much larger brands like Brooks, Nike, Asics and New Balance. This observation, among others, led Kurt Salmon to conclude that Inov-8 can achieve 100% to 150% unit growth over the next five years.

Go-to-market capabilities. Influencer channels are often highly fragmented and distributors hold significant sway. So, to be successful, brands typically need two distinct go-to-market capabilities. One involves devel-oping effective relationships with key distrib-utors. The other requires creating deep bonds with the influencer retailers themselves. This includes product training, business support (teaching influencer “retailers” like doctors and dance studio owners how to run a retail business) and cultivating relationships with influencers (such as educators of physical

Credibility is often the very foundation of brands operating in influencer channels.

31

therapists or hair stylists) so that eventual advocates are introduced to the brand preemptively.

In nutritional supplements, for example, educating store associates on the value of a brand is critical since con-sumers often rely on store associates’ advice. Sales associates at inde-pendent nutritional retailers are more likely to recommend a brand like New Chapter because it deployed more sales reps than its competitors to train store associates on their products’ benefits.

Brands possessing these traits will likely grow readily as their influencer channels expand, but private equity sponsors can drive even stronger returns several ways:

Drive for share. Private equity firms can fund key growth drivers. First, they can enhance go-to-market capabilities by invest-ing to create a telemarketing capability or funding sponsorships at prominent teaching or training institutions. They can also fund new product development. And private equity investors can leverage their experience to reduce sourcing costs and plow the resulting savings back into shared growth initiatives.

Channel transition. Some brands will grow so much that they or their derivatives can enter larger traditional channels (directly

or via licensing). But traditional channels are very different from influencer channels and are often difficult to navigate. Private equity firms, especially those with traditional channel experience, can help capture this new revenue stream in ways that manage the risk of alienating existing influencer channel customers.

Management transition. As these brands grow, they may surpass the experience of their entrepreneurial management teams. Private equity sponsors can again draw on their ex-perience and network of executives to ensure proper guidance and smooth transition to new managers as needed.

Operating outside the confines of traditional channels can be lucrative for certain brands and their private equity sponsors. As more consumers demand personalized, high-qual-ity niche products, the importance and allure of influencer channels will only continue to grow. v

AUTHOR

Todd Hooper has more than 25 years of consulting experience, focused in retail, consumer products, food and restaurants. He can be reached at [email protected].

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Patagonia’s Trailblazing Approach to Growing SalesHow the brand makes money by encouraging consumers not to spend

Every year around the holiday season, it’s easy to feel awed by the U.S. retail industry. This past year was one for the record books, with consumers spending $59 billion on Thanks-giving and the three days following it, accord-ing to NRF, and another $1.5 billion spent on Cyber Monday, according to comScore. To put that into perspective, that’s more than the GDP of Luxembourg, and all spent in five days.

Retailers went to all kinds of lengths to drive these sales—staying open 24/7, offering profit-ability-sucking promotions, spending millions on advertising. But one retailer, Patagonia, took a different approach.

Patagonia is an exceptionally profitable retail-er and wholesaler, generating $400 million in revenue annually and maintaining a larger gross margin than its competitors. And it has done this in part by encouraging consumers not to buy its products.

For example, last year, Patagonia ran a full-page ad in The New York Times on Black Friday with the headline “Don’t Buy This Jacket.” It was an advertisement for its Common Threads Initiative, which trumpets environmental sustainability, high-quality products made to last and, of all things, not buying products you don’t need.

Patagonia also has a tool on its website that allows users to trace the environmental impact of its supply chain. In an age when several retailers didn’t even know their products were being produced at the Bangladesh factory that recently burned to the ground, it’s refreshing to be able to see each and every textile mill and factory Patagonia uses arrayed on a map.

COMMON THREADS INITIATIVETogether we can reduce our environmental footprint

TAKE THE PLEDGE

DON’T BUYTHIS JACKET

33

How does this anti-consumption approach pay off for Patagonia? Of course, some of Patagonia’s environmental initiatives actually save money directly—reduced packaging, for example. But beyond that, Patagonia has found a way to make money without explicitly trying to while staying true to its brand promise at the same time.

In The New Rules of Retail, Robin Lewis and I detail the concept of neurological connec-tivity—how leading brands and retailers are connecting with consumers on a far deeper, almost subconscious, level and how these consumers are then much more loyal to that retailer.

One of the best ways to achieve this neuro-logical connectivity is by aligning a retailer’s values with those of its customers. Great products or an exceptional customer experi-ence is no longer enough—consumers have too much information, too many choices and precious little to spend. But they will be much more likely to spend on brands with values that mirror their own.

There’s a lesson here for all retailers. Develop-ing deep connections with consumers based on shared values is perhaps more important—and a better sales driver—than all the adver-tising, promoting and midnight openings in the world. v

AUTHOR


One of the best ways to achieve this neurological connectivity is by aligning a retailer’s values with those of its customers.

34

Preemptive Distribution: One of the Most Important Retail Concepts You’ve Probably Never Heard Of

Preemptive distribution, or reaching customers first, fastest, most effectively and most often, may not be at the top of most retailers’ minds. But it should be.

Why? The world’s biggest retailer was out-maneuvered by a bunch of smaller compet-itors who were able to harness the power of preemptive distribution.

By losing the convenience battle to dollar stores—and failing to compensate on price or assortment—Walmart has made itself vulner-able to competitors who seek to steal share. Walmart’s struggle is evidenced by the retail giant’s comps, which have averaged 0.5% from Q1 2009 to Q3 2012.

Convenience Because many of their products are often undifferentiated and prices are generally low, there is a very high level of cross-shopping across dollar stores and big-box competitors, often driven by convenience. During a recent due diligence, we found that 87% of one dollar store’s current customers had shopped at Target in the past six months, while 95% of them had shopped at Walmart. And these cross-shoppers primarily chose a competitor due to convenience.

Dollar stores are well positioned to win that convenience battle and steal more share away from the big boxes than is stolen from them, in part because dollar stores are everywhere.

The average round trip to a dollar store is six miles versus 30 miles for a typical Walmart trip. This means the cost of gas represents 11.4% of the cost of a dollar store transaction and 15.1% of a Walmart transaction. Our research shows that about 30% of customers across all dollar stores shop them at least twice a month—so the cost of gas can add up quickly.

And dollar stores are only getting closer to home. Dollar General plans to open more stores in the next 24 months than any other retailer, according to a survey by RBC Capital Markets. With over 9,600 locations

35

already, the retailer plans to open another 1,200 in the next 24 months. Second only to Dollar General is Family Dollar, which plans to open 1,000 new stores on top of its current 7,000. Sixth on the list is Dollar Tree, which plans to add 600 stores to its 4,000-store fleet. In contrast, Walmart plans to add only 300 stores to its 3,981 existing locations in the U.S.

But it’s not only that dollar stores are physi-cally closer, they are also more convenient to get into and out of, and their smaller formats make it easier for them to penetrate an increasingly urban and suburban society.

In response, Walmart has stepped up open-ings of its smaller-format express stores, generally about 15,000 square feet, or rough-ly a tenth of the average store’s footprint. Although it initially planned for a launch of only 30 to 40 locations, President Bill Simon now says the retailer is planning to roll out hundreds in the coming years.

Price Price could be a way for Walmart to fight back against dollar stores, except our research shows that dollar stores are generally able to beat Walmart on price.

Our research found that a basket of more than 40 food, health and beauty, cleaning, and household products in three regions was 22% more expensive at Walmart than it was at an average of four large dollar store chains—Family Dollar, Dollar General, Dollar Tree and 99¢ Only Stores. The same basket at Target was 6% more expensive than at the dollar stores.

Assortment Walmart’s massive assortment could also be a potential reason for consumers to choose it over dollar stores. But dollar stores are fighting hard to keep up, especially in grocery and health and beauty.

99¢ Only Stores sees 79% of its sales from consumables, while Dollar General has ex-panded its consumable mix to 72% of its total assortment and has doubled the number of its stores with frozen and refrigerated sections. Family Dollar has doubled the size of its food section over the last five years and recently reported 16% growth in consumable sales, helping to temper continued weakness in discretionary categories.

But it’s not only that dollar stores are physically closer, they are also more convenient to get into and out of, and their smaller formats make it easier

for them to penetrate an increasingly urban and suburban society.

36

Competitive Basket Price Comparison—Actual Retail Price

n Home/Hardware

n Seasonal/Party/Toy/Other

n Non-Food Consumables

n Non-Perishable Food

n Perishable Food

Dollar store average Walmart

$104—22% More

$32

$18

$20

$25

$9

Target

$90—6% More

$7

$15

$35

$22

$11

$85

$14

$18

$28

$15

$10

37

The story is similar in health and beauty. Dollar General recently expanded its health and beauty assortment by more than 350 SKUs, and Family Dollar expanded its health and beauty assortment by 25% last year and gave it a more prominent space in stores.

In contrast, Walmart cut its grocery offerings dramatically to create sparser, tidier shelves to attract wealthier consumers during the recession. But Walmart has reintroduced these items post-recession and is fighting for its core consumer base with renewed strength as a result.

The importance of preemptive distribution holds true regardless of segment. For exam-ple, in the apparel space, this has manifested itself in the rise of fast fashion and Kohl’s success at stealing share from JC Penney by moving in closer to JC Penney’s core custom-ers. Recent same-day delivery offers from Amazon, eBay and Walmart are its latest manifestation.

Walmart’s story, and other cases of preemptive distribution, show us that it is no longer sufficient for a retailer to conquer one area—say, a great assortment or low prices—

and rest on its laurels. It will only be a matter of time before its com-petitors are encroaching on its territory—literally. v

AUTHOR


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One of every growing brand’s critical goals is developing a distribu-tion strategy that supports its long-term growth. But this is often easier said than done, especially as retailers increasingly demand exclusive products that set them apart.

Your Distribution Defines You: The Power Brand Balancing Act

THANK YOU

HAVE A NICE DAY

39

For brands, distribution segmentation is reaching a diverse group of consumers through multiple distribution channels and price points. Often, this requires creating distinct products and experiences at each price point, diffusion label and distribution channel to avoid overexposing the core brand.

The road to building a successful power brand is littered with brands that have not managed their segmentation effectively. Recently, brands like Quiksilver, Billabong, RVCA, Ed Hardy and Liz Claiborne have all been criticized because they have become too ubiquitous and have not managed their channel strategy well or differentiated themselves across channels and have lost appeal as a result. The challenge exists even for fast-growing Michael Kors (which has recently enjoyed 45% same-store sales growth) to avoid the risk of growing too quickly and becoming overextended and too readily available in the wrong channels.

But there are also incredible segmentation success stories. Brands like Nike, Hugo Boss and Marc Jacobs have successfully maintained their premium positioning while reaching a larger audience at lower price points.

In fact, two of the biggest success stories today—Polo Ralph Lauren and Converse— had ventured dangerously close to over- exposure but took action to correct it.

Polo Ralph LaurenWhen the company went public in 1997, its brand name and logo were overextended, appearing on too much low-end product and damaging the company’s cachet. Ralph Lauren later described the time as the company “resting on its Laurens.” As its stock price dropped, the company pulled out of some of its lower-price channels

40

and instead focused on building luxurious flagship stores, penetrating high-end depart-ment stores and expanding abroad.

Today, Polo Ralph Lauren has mastered walk-ing the line between luxury and mass. Con-sumers can buy into Ralph Lauren’s vision of aspirational American luxury via a $19.75 Chaps polo at Kohl’s or a $22,500 crocodile handbag. The company has segmented the market by using its “label” strategy, with its Polo Ralph Lauren label at Macy’s and upscale purple-and-black labels at luxury department stores. And the company is well insulated against a tough economy thanks to its outlet stores. They were the company’s fastest-grow-ing division over the past four years, with rev-enues increasing an average of 18% annually.

Polo Ralph Lauren has also continued to build its global brand, taking advantage of the zeal many international consumers have for American luxury brands. Its chief strategy in doing this is regaining control to ensure that quality and brand experience are high. In 2010, Ralph Lauren acquired its licensed apparel business in China and Southeast Asia and closed 60% of its distribution network, including stores run by local partners, with the plan to replace them with its own stores. In the

next decade, the company hopes to see a third of its business come from Asia and another third from Europe, double its current sales.

Converse (Nike)

Converse enjoyed a near monopoly before the 1970s, but lost significant market share as a wave of new competitors, including Puma, Adidas, Nike and Reebok, entered the market. This led them to file for bankruptcy in 2001. Nike bought the company for $305 million in 2003 and applied its very successful seg-mentation strategy to Converse, helping to position Converse as a lifestyle brand instead of an athletic brand.

This repositioning paid off, and Nike’s decision to leave the shoe’s basic design intact helped give it a retro cred. Converse also benefits from a move toward greater personalization, with over 100 different colors of shoes avail-able, plus a popular “design your own” feature.

Today, Converse is effectively segmented across price points—a core playbook utilized by Nike across its businesses—with leather Converse by John Varvatos at Neiman Marcus and Saks Fifth Avenue for $170 and Converse One Star at Target for $35. And this segmenta-tion strategy is paying off. In a recent earnings

41

call, Converse was celebrated as one of Nike’s top performers, with revenues up 17% in 2012 on especially strong performance in China and the U.K.

These cases illustrate how critical the right distribution strategy is to success and that all is not necessarily lost for an overextended brand. In fact, some suffering brands could be attractive investment opportunities if a solid segmentation strategy is put into place to save them. v

AUTHOR

Jay Agarwal specializes in strategy, corporate development and advisory work in the apparel, footwear and sporting goods industries. He can be reached at [email protected].

42

How can potential investors tell if a product is more Atkins or organic, classic Oreo cookie or three-dollar cupcake? The investment can be profitable either way, but knowing the difference upfront will help determine the correct multiple and drive favorable post- deal economics.

In general, there are three key differentiating factors between a fad and a trend.

Fad vs. Trend FrameworkReason for rise. Trends generally have identifiable and explainable rises, driven by consumers’ functional needs and consis-tent with other consumer lifestyle trends. In contrast, fads are driven by an emotional need to purchase, based on hype and idealistic product perceptions. The benefits are ether-eal or ill-conceived and don’t turn out well for consumers.

Incubation period and life span. Trends rise slowly, whereas fads spike—and die out—quickly. For example, demand for multiple fashionable handbags and accessories for each occasion has grown slowly and steadily over

the years, fueling Coach’s decade- long growth and healthy 11-year compound annual growth rate (CAGR) of 19%. Beanie Babies, on the other hand, went from $400 million in sales in 1997 to $1.3 billion in 1999, a CAGR of 77%, before dropping to $850 million the next year. (See Exhibit 1.)

Scope. A trend usually encompasses sever-al brands or products that are applicable to many different consumer segments, while a fad typically includes only a single brand or product and has limited appeal outside of one narrow consumer segment. A trend possesses some agility and consumers have granted it permission to expand beyond its current platform while maintaining authenticity.

The Atkins Diet is the perfect illustration of the difference between fad and trend. Healthy eating has been important to a certain part of the population for a long time, but Atkins was a fad within that trend. Atkins’ emphasis on fat and protein went counter to the larger trends at the time—ones that mandated lean protein, whole grains, and plenty of fruits

Beanie Baby or Barbie?How to spot the difference between fads and trends

43

and vegetables. Millions of consumers tried the diet—15 million alone purchased Dr. Atkins’ books—but the fad soon burned out as those consumers realized that the diet was hard to sustain. In this way, a fad experiences rapid adoption among consumers with a weak level of commitment to the concept (or high dropout rate), as many consumers hop onto

the bandwagon only to find the product or experience more difficult or less useful or beneficial than they thought it would be.

We used our fad-trend framework to evalu-ate two recent retail and consumer product opportunities—the handbags and accessories and gluten-free market segments.

A trend usually encompasses several brands or products that are applicable to many different consumer segments, while a fad typically includes only a single brand or product and has

limited appeal outside of one narrow consumer segment.

(licensed sales)

’89 ’90

2-yearCAGR:772%

’91 ’92 ’93

$25

$500

$1,900

$1,200

$500

(wholesale sales)

’83 ’84

2-year CAGR:154%

’85 ’86 ’87

$90

$550 $580

$200 $150

’95 ’96 ’97 ’98 ’99 ’00 ’01

$25

$1,250$1,000

$750$850

$400$250

2-year CAGR:77%

EXHIBIT 1: FAD GROWTH

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Trend: Casual fashion handbags for multiple occasions In 2006, we were asked to evaluate whether Vera Bradley, the maker of women’s handbags, purses and backpacks, often made out of col-orful, quilted fabric, would be a good invest-ment. Using our framework, we determined that Vera Bradley bags were a lasting trend, not a fad.

Why? First, Vera Bradley had a compelling reason for its rise. It was in line with the larger trend of women wanting different handbags for each occasion and it also filled a niche in the market among classic consumers at mid-range price points.

Secondly, Vera Bradley exhibited the attrac-tive, steady growth of a trend in the years leading up to 2006 and had a five-year CAGR of 27%. (See Exhibit 2.)

Beyond that, Vera Bradley has grown its scope, expanding distribution channels to include 48 full-price and eight outlet stores, an international presence, and a growing e-commerce site. Vera Bradley’s wholesale future also looks bright, with distribution in 3,300 independent specialty retailers and a further penetration into department stores, like Dillard’s.

Vera Bradley is also expanding its reach, adding new products and lines to help it meet different price points and target more age groups—from teenagers to their grandparents

(one recent addition is an all-black cross-body bag called “The Hipster”).

Because of these factors, Vera Bradley has continued its steady growth. Its sales were approximately $460 million in 2012, for a CAGR of 13% since 2006.

Trend: Gluten-free delivering benefits Most gluten-free products were originally designed for sufferers of celiac disease, which afflicts about 1.8 million Americans. Even with such a small portion of the population diagnosed with the disease, the gluten-free business is booming. Sales have been rising steadily since 2006 and are expected to sur-pass $5 billion by 2015.

And gluten-free products are becoming more widely available. Mintel data shows that product launches with a gluten-free claim nearly tripled in 2011, to roughly 1,700 products. Walmart has dedicated gluten-free displays in approximately half of its U.S. stores, and gluten-free menu items have also increased 280% from Q3 2008 to Q3 2011.

This proliferation of products and channels is a good sign that the gluten-free trend has staying power. Gluten free is also consistent with the healthy eating trend mentioned previously, and many consumers purchase gluten-free products as healthier alternatives, not because of any medical condition. In fact, in a survey of consumers who regularly buy quinoa (a gluten-free pasta), more than half

45

said they ate it for its nutritional benefits, not because of a medical condition. But it is important to note that any one gluten- free product could be vulnerable to fad-like run-ups. That the success of gluten-free products does not hinge on one small part of the population or a single product cements its trend classification.

Making the Most of a Fad Of course, even if something is a fad, it can still be a good long-term investment if it has uses outside of its narrow original purpose. Take scrapbooking. Scrapbooking itself seems to have been a fad in retrospect. Sales peaked in 2004–2005 at $2.5 billion and have since declined to $1.4 billion. But scrapbooking companies and retailers can still be viable

2002 2003

5-year CAGR: 27%

2004 2005 2006

$59 $69$94

$123

$197

EXHIBIT 2: VERA BRADLEY SALES($ millions)

2012

$460

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investments if they are able to position themselves to cater to the needs of new fads and trends—such as paper crafting and mixed media—as they arise. In these cases, the key to success is using the brand for the long-term consumer-serving capability it has created, not for one category-specific product.

Crocs is another interesting case study. For many, the iconic rubber clog was clearly a fad as consumers rushed to buy them and the market value of the company soared, peaking in late 2007 at nearly $70 a share. But once sales started to decline, the value of the company fell dramatically, plummeting to just over $1 a share by early 2009, when the company nearly went bankrupt. The fad was over and many assumed Crocs would continue to shrink.

But that has not happened. Instead, Crocs has successfully expanded beyond just clogs and kids’ shoes—clogs make up 40% of sales now, down from more than 75% in past years, and the proportion of adult sales has doubled. As a result, the brand has broadened its reach and made itself less susceptible to big swings in the popularity of one product. It now has a market capitalization of $1.37 billion, which speaks to the possibility of finding great value in transforming fad-like businesses.

But, in any case, it pays to understand whether a product is destined to be a steady, burning success or rise and fall quickly in a blaze of glory before you make any deal.

2013 promises to include many hot products and brands that could go either way. From Kombucha to juice cleanses, TOMS to J Brand, knowing what to look for can help private equity sponsors invest with confidence. v

AUTHOR

Bruce Cohen has more than 20 years of consulting experience, including deep experience in food and beverage, consumer products and specialty retail. He can be reached at [email protected].

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One common question both operators and investors find themselves asking is, “Which is more important, high same-store sales growth (SSSG) or high margins?” Obviously, it’s nice to have both, but that’s an increasing-ly difficult objective as retailers decide when to promote, how deeply to discount and what their target margin structure should be.

To shed light on this issue, we analyzed five years (2008–2012) of SSSG, margin and valuation data for 89 retailers across a variety of segments.

We found that the top 20% of retailers by SSSG saw comps grow by an average of 9.8% per year, while companies in the middle 50% saw average comp growth of 2.9% per year.

As a result, the top 20% of retailers by SSSG were rewarded by the market for their per-

formance to a greater extent than the middle 50%—with annual market cap growth of 13% and 8%, respectively.

However, the performance of the top 20% of retailers by SSSG ultimately came at the expense of profits, as these companies saw flat margin growth (-0.3%) from 2008 to 2012. In contrast, the middle 50% of retailers by SSSG saw margins grow by 10% in the same period.

For example, in the department store space, Kohl’s averaged -0.5% comps from 2008 to 2012 but grew margins 5%. Still, its market cap grew at an average annual rate of only 4% from 2008 to 2012. Macy’s, on the other hand, averaged 5% comp growth during the same period while its margins stayed flat, and it was rewarded with an average annual market cap growth of 59%.

Which Is Better, Margins or Growth?

AVERAGE MARGINS AND COMPS FROM 2008 TO 2012

VS.

Comps Margins Market Cap Growth

-0.5%

5% 5%

59%

4%0%

48

In the hard lines space, Walgreens and Family Dollar are two other good examples. Family Dollar averaged 4.8% comps from 2009 to 2012 but its margin stayed flat. In that time, its annual average market cap growth was 86%. Walgreens, on the other hand, averaged 0.8% comps during the same time period, and despite its ability to grow margins 2% in a highly commoditized segment, its market cap dropped an average of 21% from 2009 to 2012.

And perhaps the best example of this trend is Amazon, which has razor-thin margins, especially on many of its media products. Yet its stock price shot up in the days after it announced its profits fell 45% in Q4 2012.

Of course, many factors influence margins, but we believe the biggest driver of increased margins for the middle 50% was an attempt to raise their average unit retail numbers and avoid responding to aggressive promotional activity. While they did just fine, those who were prepared to either hold margin levels or allow them to fall slightly while sales grew were rewarded with the most value.

Based on this analysis, investors and retailers looking to drive market value should focus on sales growth over margin growth. Flat margins and high same-store sales growth are better rewarded by the market today.

However, companies with moderate SSSG that have grown their margins may be good investment opportunities for private equity sponsors who can then begin to grow sales more aggressively and reap the market’s rewards. v

AUTHOR

Matt Allessio specializes in sporting goods, apparel, specialty retail and food. He can be reached at [email protected].

Based on this analysis, investors and retailers looking to drive market value should focus on sales growth

over margin growth.

49

Fashion and Lifestyle Footwear

Footwear sales in general have outpaced apparel sales in recent years, growing at a combined annual growth rate (CAGR) of 2.3% from 2010 to 2012 versus apparel’s CAGR of 1.4%.

And within the footwear category, premium footwear has grown faster than more mod-erately priced and value-priced footwear in

the past three years, with premium footwear growing at a CAGR of 6.9% in 2012 versus 0.3% for value footwear. (See Exhibit 1.)

Plus, the footwear market is highly fragmented, with many brands and retail chains ripe for private investment. And we’ve seen plenty of activity in the sector recently, including:

The fashion and lifestyle footwear industry will continue to be an attractive M&A market in the next few years, owing to strong category growth and a highly fragmented landscape.

EXHIBIT 1: U.S. Footwear Retail Sales

Premium Footwear($60+)

Moderate Footwear($30–$60)

Value Footwear(Under $30)

$13.7

LTM September 2010 ($ billions) LTM March 2012 ($ billions)

$17.0

$16.7

$13.7

$17.9

$18.5

$47.4 $50.1

6.9%

CAGR3.7%

3.3%

0.3%

50

> Nike’s sale of Cole Haan to Apax Partners

for $570 million

> Deckers Outdoor Corp.’s acquisition of Sanuk

> Steve Madden’s recent acquisitions of Cejon

and Topline

> Golden Gate Capital and Wolverine World-

wide’s purchase of Collective Brands

> Goode Partners’ purchase of Sneaker Villa

> South Korean firm E-Land World’s

acquisition of K-Swiss

Even Amazon recognizes the importance of footwear with its purchase of Zappos.

Within the fashion footwear space, we see two particular areas that deserve a second look from investors:

High-growth brands and concepts These brands may be small now, but they are growing quickly—and can grow even faster with private equity sponsorship.

There are two particularly attractive high-growth categories: youth lifestyle and outdoor. For a youth lifestyle example, take TOMS Shoes, which has an estimated $100 million in sales and has recently expanded into eyewear and apparel and has plans to start selling footwear priced from $100 to $140, a far cry from their typical near-$50

prices. The retailer also plans to open its first flagship store in Venice, California.

Or consider OluKai, the makers of high-end, environmentally conscious, comfort-focused outdoor footwear like sandals and boots. The brand has recently had success selling $200 to $300 shoes at Neiman Marcus while still seeing explosive growth in its shoes closer to the $100 price point.

Another bright spot is Shiekh Shoes, which serves the rapidly growing—but under-served—urban footwear sector. Shiekh bene-fits from its license to distribute limited-edi-tion Nike and Air Jordan products and has 136 stores across the U.S.

Shoe Palace also caters to the urban foot-wear and street sector and benefits from its position as a core account for premium street and skate brands. With a growing e-commerce business and 34 stores in California, Texas and Nevada—plus plans to open five more—this retailer could be an attractive target to take nationally.

Road Runner Sports, the self-proclaimed world’s largest specialty running store, is also another attractive potential target. The retail-er is well positioned to benefit from a running resurgence—running participation grew 18% from 2009 to 2012 versus declines in more

Even Amazon recognizes the importance of footwear with its purchase of Zappos.

51

traditional team sports—thanks to its deep inventory and technology that helps custom-ers find the right fit. The running shoe market is massive—running shoe sales are about $7 billion and make up 27% of total footwear sales—and Road Runner Sports could contin-ue to grow to serve this market. The retailer currently has 22 stores, mostly located on the West Coast, but could benefit from greater national reach.

Larger established companies There are also plenty of brands with strong equity like Crocs and Deckers Outdoor that are currently undervalued by the market and have significant growth potential. For example, Deckers is currently trading at 5.9x EBITDA. But its brands—Teva, Ugg and four others—still have incredible equity and global growth opportunities.

Another brand cashing in on the tremen-dous growth in the comfort footwear sector, privately owned ECCO claims to be the only major shoe manufacturer in the world that owns every step of the shoe-making process and has about 4,000 branded doors in over 90 countries, including the U.S. Forbes estimates the brand is worth about $1.5 billion.

Crocs nearly went bankrupt in 2009 and is now trading at 4.9x EBITDA. It is in the midst of being remade into a lifestyle and casual footwear brand and is expanding interna-tionally. These efforts are beginning to pay off—American sales made up 59% of its total sales in 2007 and now comprise only 45%. Di-rect-to-consumer now makes up 30% of their sales versus 9% in 2007. And perhaps most significantly, clogs make up 40% of sales now, down from more than 75% in past years, and the proportion of kids’ sales has been halved. (See Exhibit 2.) There is still tremendous opportunity for Crocs if they can continue this trend and break out of the clog and kids’ spaces and continue to expand internationally.

EXHIBIT 2: The Future of Crocs

AmericanSales

Direct-to-Consumer

Clogs 75%

2007 2012

9%

59%

40%

30%

45%

52

These brands could be reinvigorated through aggressive expansion in a private setting. Take a page from Steve Madden’s book. The retailer went on an acquisition spree last year, buying accessories company Cejon, footwear company Topline and becoming the exclusive licensee for the athletic-shoe brand Superga, which it then tapped the Olsen twins to design.

Steve Madden is also enlarging its retail footprint. After purchasing its privately held Canadian licensee earlier this year for $29 million, the company expects to add 20 Canadian stores to its current seven within the next five years. A U.K. expansion is also in the works, through retail partners House of Fraser and Topshop. Steve Madden is also growing its off-price outlet division and began selling at Nordstrom in 2012.

Another interesting opportunity is Shoe Carnival, which operates over 400 stores that carry leading brands and cater to a mass audience. After a strong performance in 2012, averaging 5.5% comps in the first three quar-ters, the retailer plans to open 30 to 35 new stores in 2013. But owing to the hypercom-petitive and promotional nature of the space, Shoe Carnival is currently trading at 5.2x EBITDA—likely understating its true growth potential.

The footwear sector promises to be a high-in-terest M&A area in 2013 and beyond, and investors who explore these opportunities now will be well positioned to benefit as the industry continues to grow. v

AUTHOR

Jay Agarwal specializes in strategy, corporate development and advisory work in the apparel, footwear and sporting goods industries. He can be reached at [email protected].

53

Since it was created, the net promoter score (NPS), which measures how likely a consumer is to recommend a given retailer or brand to a friend, has been a cornerstone of measuring brand strength.

But despite its popularity, NPS is not with-out its detractors. Academics and market researchers have questioned whether it is a good predictor of growth and whether it really captures a brand’s relative trajectory when taken in isolation. Some have also challenged the basic math behind net promoter because different sample sizes of positive, neutral and negative consumer sentiment can all generate the same score even though the underlying dynamics may be dramatically different.

Forever 21 presents an interesting case example on why it is potentially misleading to put too much weight on just one metric, even when that metric is NPS. In several recent studies, Forever 21 had fallen to near the bottom of the range of net promoter scores for women’s apparel retailers.

This is, quite frankly, a stunning result, given that Forever 21 is obviously a wildly successful retailer. It has grown its store base by a combined annual growth rate (CAGR) of 7% from 2007 to 2012, far above the average

of 2%. Its brick-and-mortar sales grew 29% during the same time period and its e-com-merce sales increased at a CAGR of 21%. Plus, during our ethnographic studies—one-on-one detailed interviews with consumers—many consumers gushed about the brand, shopping experience and value. How then is it possible that the net promoter scores have frequently shown up near the bottom of recent surveys?

Problem 1: Sampling and getting the right mix of consumers in the survey

Classic net promoter methodology would suggest that by taking a sample of the broad population aware of the brand, you can get a reasonable and reflective score. Obviously, this creates major sampling problems because the score will be driven by the size of different

Net Promoter Scores and the Problem of Forever 21

54

cohorts within the survey. We have consistently seen that those who have interacted with any brand more recently will score it higher than those who have not. The recent election showed the problem of polls with the wrong mix of likely voters—as Nate Silver will attest. Even when the survey focuses just on “ever” or “current” purchasers, this problem still exists if the comparative brands have different sample sizes of recent or more distant shop-pers. One obvious rule is to never trust surveys unless the sampling is in the thousands.

Problem 2: Cult followings

In many studies, we have found brands with a “love it” or “hate it” following. In a broad net promoter score approach, the brand may well score poorly, but within that score there is a cult following that adores it. Historically, brands like Juicy Couture and Abercrombie & Fitch have experienced this, even during their boom times. Getting the right segmentation is critical, as we discuss below.

Problem 3: “I buy it, but I would never

recommend it.” This problem has shown up for multiple retailers including Walmart and Forever 21. Here consumers find incredible value, but when asked if they would recommend the store to friends, they often give it a mid-

dling score because there are aspects of the shopping experience that they don’t want to recommend to their friends. For example, in one-on-one discussions with shoppers at Forever 21, we often heard comments like, “I love them, but I would not recommend them strongly to my friends because some-times it’s hard to find the right fit or get any help and they might not like that.” In this case, the very nature of the question triggers a con-sumer score that is lower than how they really behave—in part because of the distinct and highly differentiated nature of the retailer.

So what are the solutions to these problems?

We have used NPS for years and believe that it is valuable, but have always advocated looking at brand strength and consumer sentiment through many different lenses and using segmented NPS scores in conjunction with several other evaluation metrics to get a truly accurate picture.

Clearly, the way a survey is written as well as how the data is analyzed can have significant impact on the value of the NPS. There are four key dimensions to consider when deciding how much weight to place on a brand’s NPS.

1. Competitive set. Whether they realize it or not, consumers’ answers often change relative to the set of retailers they are asked to rate.

We have used NPS for years and believe that it is valuable, but have always advocated looking at brand strength and

consumer sentiment through many different lenses.

55

For example, in a set that included mostly higher-end women’s apparel brands like Coach, 7 For All Mankind and Ralph Lauren, Forever 21 ranked second to last with 35%

NPS. But in a set that included mostly teen and discount retailers like H&M, American Eagle and TJ Maxx, Forever 21 ranked first with NPS of 45%. (See Exhibit 1.)

EXHIBIT 1: Forever 21’s Varying NPS Scores

63%

52%48%

45% 43% 42% 40% 39% 38% 37% 37% 36% 35% 35% 35%

45%

35% 35% 34% 32% 28% 25% 23%18% 16% 12% 10%11% 9%

–9% –13%

7 For AllMankind

JuicyCouture

RalphLauren

Lucky H&M J. Crew BCBG CalvinKlein

Gap Bebe TommyHilfiger

Forever21

Express

NPS Among Higher-End Apparel Brands

Coach Levi’s

H&MHollister

AéropostaleCharlotteRusse

WetSeal

Kohl’s TJMaxx

OldNavy

Maurices TargetGap Justice DressBarn

Walmart

NPS Among Teen and Discount Retailers

Forever21

AmericanEagle

56

2. Brand interaction. Measuring NPS for everyone aware of the brand doesn’t get you much because it includes many people who have never truly interacted with the brand, but examining NPS among “ever-purchasers” (current and lapsed consumers) can give a broad snapshot of sentiment among those who have actually experienced the brand. Focusing on current purchasers and, specifi-cally, frequent purchasers will provide a more accurate picture of how the brand’s most important and profitable customers see it. Of course, it’s critical to have a large enough sample to ensure that the different cohorts reflect the general population mix.

3. Demographic and psychographic segmen-

tation. Forever 21’s core customers tend to skew younger and to be female and lower to middle income. So it follows that these segments report higher NPS for the retailer. For example, in one survey, Forever 21 scored 41% NPS among those earning under $50,000 annually, but only 16% among those earning over $100,000, highlighting the importance of testing NPS against the brand’s target consumers. Adding psychographics into the mix helps clarify the results even further. For example, women we identified as “fashionis-tas” and “price-conscious” rated Forever 21 twice as high as those who said they were “basic shoppers.”

4. Usage occasions and product categories.

Layering on product and occasion details can shed light on a brand’s strengths and weaknesses when it comes to assortment. For example, Forever 21 is more highly ranked for accessories (51%) than shirts (32%), owing to its massive, prominently displayed accessory section. And, as would be expected, Forever 21’s NPS was lower for work (22%) and casual (26%) occasions than for going out (34%).

While these four filters help ensure NPS is focused and a more accurate reflection of a brand, we like to think more holistically about measuring brand strength through a mix of consumer surveys, digital chatter assess-ments, ethnographic studies, shop-alongs and trade interviews. Together, these tools can help uncover a more complete picture of a brand’s strength.

» Overall awareness of the brand

» Overall conversion rate and by occasion

and category

» Psychographics such as whether the

brand is favored by fashion-lovers or

frugal consumers

» Focused NPS

» Head-to-head comparisons between

a brand and its primary competitors

Focusing on current purchasers and, specifically, frequent purchasers will provide a more accurate picture of how the

brand’s most important and profitable customers see it.

57

» Whether consumers identify a brand

as “for them”

» Likelihood that a consumer would

repurchase from that brand

» Level of positive buzz about the brand

in the market

» Strength in certain key attributes like

fit and quality

» Social media chatter about the brand

The brand strength gauge (see Exhibit 2) shows that Forever 21 is clearly a hot brand, which is much more on par with its historical performance and growth trajectory.

So, when evaluating a retailer or brand, go beyond a basic NPS or risk missing out on the next Forever 21. v

AUTHOR

Dan Goldman has expertise in due diligence and sell-side support, growth and turnaround strategy development, brand and category management, marketing, and new product development, as well as marketing mix and trade promotion optimization. He can be reached at [email protected].

EXHIBIT 2

Brand Strength Gauge—Forever 21(Women)

Awareness

Conversion

Net Promoter Score

Age

Psychographics

Products

Head-to-Head

Comparisons

Brand for Me

Repurchase Intent

“Buzz” Rating

Attribute Strength

Digital Chatter

Not<25th%

Hot>75th%

In the Middle25th%–75th%

OVERALL

AGE 23+

AGE 13–22

TOPS ACCESSORIES

FASHIONISTAS

BASICSHOPPERS

STORE LAYOUT STYLISH

58

Measuring the ImmeasurableUsing a company’s digital footprint to measure brand strength

59

Companies are becoming increasingly skilled at using online data to guide their mar-keting efforts, but online metrics can prove exceptionally important for private equity funds in the due diligence process as well.

Examining a brand’s digital footprint is a valuable way to evaluate it above and beyond traditional consumer-based research. A dig-ital diligence captures consumers in a more organic environment than consumer surveys, one-on-one interviews or focus groups. Plus, analysis of online data can lend insight into changes in consumer sentiment and intent over an extended period of time, whereas surveys represent a snapshot of a moment in time. Finally, a digital diligence can help uncover potential brand issues and consumer concerns that may not be on a private equity firm’s radar.

But for all its benefits, assessing a brand’s digital footprint can also be challenging. First, there is the sheer number of metrics available—deciding which are important can be daunting. And beyond that, decoding the link between any given metric and overall brand health can be difficult.

To solve that, we recommend evaluating a brand’s reach and strength across social media, search and its website. Each of these three online spaces provides a different per-spective on consumer interest and sentiment.

Social media is consumers’ own space for talking peer to peer, while search is a shared space and the website belongs to the brand. Taken together, they can constitute a holistic picture of brand power.

Social media. Social media can provide a treasure trove of key insights about consumer sentiment in an organic environment. But it is also one of the most difficult digital elements to judge, as there is a massive amount of consumer chatter spread across a wide array of sites, from Twitter and Facebook to Tumblr and Pinterest. However, social media has proven to be an accurate leading indicator of a brand’s sales. For example, consider JC Penney. Many customers complained about the department store’s new pricing structure on Facebook and Twitter before the company’s performance took a serious hit.

To measure reach, start with a basic analysis of the number of fans or followers a compa-ny has. But beyond that, we have found that measuring fan engagement—creating compel-ling, emotionally engaging content that drives likes, comments and retweets—is a better indicator of a strong social media platform. To that end, measure the number of Facebook interactions per fan and Twitter mentions per follower relative to a brand’s competitors.

60

Measuring strength should start with a look at how the brand is perceived on social media via an analysis of the most often used words and phrases, which provides a picture of consum-ers’ perceptions of brand equity. Next, look at sentiment and whether a particular brand has more positive versus negative social media mentions now as well as sentiment momentum over time. For example, Forever 21 has a very high ratio of positive to negative social media mentions and has been able to sustain this solid performance over time. (See Exhibit 1.) Also examine which themes are driving the negative sentiment to identify potential strategic issues and brand concerns.

Search. Search is an important online space to analyze because it can provide key insights on how consumers think of a brand relative to its competitors in key product categories. To understand reach, analyze search volume relative to competitors, plus the number of searches for a given brand over time, as illustrated in Exhibit 2. To measure strength, one of the most important metrics is organic search. A brand with a low percentage of its searches from organic search versus paid like-ly means it has low top-of-mind awareness. Key search terms can also reveal how a partic-ular brand fares in certain product categories. For example, the most popular search terms for Forever 21 include “sale,” “bargain” and “fashion,” which is consistent with its reputa-tion as a low-cost, trendy retailer.

Percentage of Tweets Mentioning Forever 21 in a Positive Context

EXHIBIT 1: Positive Twitter Sentiment

45%

55%

65%

75%

85%

95%

Oct. 2012Jul. 2011 Oct. 2011Jan. 2011 Apr. 2011 Jul. 2012Jan. 2012 Apr. 2012Oct. 2010

EXHIBIT 2: Forever 21 Search Interest Over Time

0

10

20

30

40

50

60

70

80

90

20122007 20082005 2006 20112009

2004–2012CAGR 29.7%

20102004

61

Website. A website is a company’s only truly “owned” space online and is an invaluable tool for bringing the brand to life. To understand reach, measure how a site’s unique traffic compares with its competitors’ in terms of current volume and change over time. (See Exhibit 3.) Assessing strength involves looking at repeat traffic to measure loyalty, consumer engagement (in terms of page views and time on the site) and online cross-shopping overlap.

Translating the Data into Actionable Insights To get a complete view of digital brand power, analyze reach and strength metrics across all

three spaces—social media, search and a brand’s website. Then, index key reach and strength metrics to a brand’s competitive set.

This provides a full picture of the brand’s pow-er relative to its competitors’, as illustrated in Exhibit 4, and can help reveal brand momen-tum and drivers of negative sentiment. Taken together, these metrics arm private equity sponsors with a holistic digital perspective of a diligence target that complements offline analysis.

So although determining a brand’s digital power may seem murky, it’s actually quite measurable in a due diligence and is well worth taking a closer look.

EXHIBIT 2: Forever 21 Search Interest Over Time

0

10

20

30

40

50

60

70

80

90

20122007 20082005 2006 20112009

2004–2012CAGR 29.7%

20102004

62

EXHIBIT 3: Forever 21 Unique Website Tra�c Growth

0

10

20

30

40

50

60

70

80

90

20122007 20082005 2006 20112009

2004–2012CAGR 22%

20102004

Potential Rising Stars Market Leaders

Challenged Brands Market Laggers

HighLowLow

High

DIGI

TAL S

TREN

GTH

DIGITAL REACH

EXHIBIT 4: Digital Brand PowerThese online metrics not only paint an

accurate picture of a brand’s health and

momentum, they also have omnichannel

implications. As retailers are increasingly

tasked with providing compelling, hol-

istic experiences across channels, just

as important as measuring online brand

strength itself is determining how that

strength links to and supports the com-

pany’s omnichannel brand by enabling

cross-channel customer experience,

pricing, merchandising and marketing.

63

E-commerce capabilities are an incredibly im-portant aspect of a brand’s growth potential, especially as online sales increase (Forrester Research predicts they will swell 62% by 2016). Evaluate these eight key attributes to deter-mine whether a brand has the opportunity to disproportionately grow its e-commerce sales by leveraging best practices.

1 Website navigation. The best sites have clear website navigation, plus constant search and cart visibility.

2 Product descriptions. Look for sites that include in-depth descriptions of product features plus customer reviews.

3 Usage inspiration. Leading sites feature content about how to use the product, such as how-to videos, expert commentary, or even lists of everything needed for one par-ticular project or look.

4 Transaction optimization. Suggesting related items, matching looks or other products necessary to finish a common project can in-crease the likelihood of purchasing multiple items by 36%.

5 Customer loyalty. Look for sites that rec-ognize customers when they return and let them stay logged into their account for easy access to past orders and quick ordering. The best sites also offer a loyalty rewards program that integrates across channels.

6 Mobile. Leading retailers have both a dedi-cated mobile site and a mobile app. Loca-tion-based functionality allows retailers to push personalized offers to customers near a store and can also generate maps that help customers navigate through stores.

7 Social media. Best-in-class sites include social media apps that allow consumers to share potential—or recent—purchases with their social media networks, generating additional traffic and buzz for the brand.

8 Shipping. When assessing shipping, be sure to analyze charges and speeds—and their restrictions and limitations—relative to the competitive set. And measure the effec-tiveness of a company’s customer support, including online assistance, live chat capabil-ities and customer support center effective-ness (call abandonment rate, average hold time and average email response time). v

AUTHORS

Matt Allessio specializes in sporting goods, apparel, specialty retail and food. He can be reached at [email protected].

Dan Goldman has expertise in growth and turn-around strategy, private equity due diligence and sell-side support, brand management, market-ing strategy, and new product development, as well as marketing mix optimization, category management and trade promotion. He can be reached at [email protected].

E-Commerce Best Practices

64

JAY AGARWAL

Jay Agarwal has more than 14 years of strategy, corporate development and advisory work in the retail and consumer products industry. He has led and directed teams in developing and executing growth strategies, strategic planning, mergers and acquisitions, due diligence, licensing, and new ventures. Prior to joining Kurt Salmon, Jay was a senior investment banker with the Demeter Group, and prior to that he was head of M&A at Nike and a senior director of corporate strategy at Gap, Inc. He can be reached at [email protected].

MATT ALLESSIO

Matt Allessio has more than a decade of experience in consulting, private equity and investment banking. During his time at Kurt Salmon, Matt has worked on a variety of due diligence and strategy projects in a range of consumer- related categories, including sporting goods, apparel, specialty retail and food. He has conducted due diligence on e-commerce operations on behalf of private equity clients and worked with corporate clients to help develop their e-commerce business strategy. Prior to Kurt Salmon, Matt was an associate with Weston Presidio. He can be reached at [email protected].

BRUCE COHEN

Bruce Cohen is a partner in Kurt Salmon’s Private Equity and Strategy Practice and a North American practice director. With more than 20 years of consulting experience in the consumer products industry, Bruce has worked with executives and boards focused on mergers and acquisitions, due diligence, and devel-oping and implementing strategies to drive profitable growth. He is regularly quoted on retail and consumer topics in the Wall Street Journal, Bloomberg and The New York Times, among others. He can be reached at [email protected].

Authors

65

MICHAEL DART

Michael Dart is a senior partner and leads the firm’s Private Equity and Strategy Practice. In his more than twenty years of consulting, Michael has worked with many leading retailers, consumer products companies and private equity firms. He is also the co-author of the industry-acclaimed The New Rules of Retail. He is frequently quoted in the Wall Street Journal, Financial Times, global and national media, and trade journals. Consulting magazine recognized Michael as one of its Top 25 Consultants of 2010. He can be reached at [email protected].

DAN GOLDMAN

Dan Goldman has expertise in private equity due diligence and sell-side support, growth and turnaround strategy development, brand and category management, marketing, and new product development, as well as marketing mix and trade promotion optimization. In addition to his experience at Kurt Salmon, Dan’s broad background includes brand marketing experience with Procter & Gamble as well as prior consulting experience with Cannondale Associates (now Kantar Retail) and Hudson River Group. He can be reached at [email protected].

TODD HOOPER

Todd Hooper is a partner in Kurt Salmon’s Private Equity and Strategy Practice. Todd has more than 25 years of experience working with leading retail and consumer products companies and private equity investors. He has also authored dozens of articles for business and trade publications and spoken at numerous industry events in North America and Europe. He can be reached at [email protected].

66

DREW KLEIN

Drew Klein has conducted dozens of strategy and due diligence projects in the retail and consumer products space, many in apparel and footwear. Prior to Kurt Salmon, he worked at UBS Investment Bank in the retail group, where he specialized in apparel and the sporting goods and health club industries. He can be reached at [email protected].

AL SAMBAR

Al Sambar is a partner and director of the firm’s Soft Lines Practice. He has more than 25 years of experience advising the world’s leading retail and consumer products companies. Al specializes in supply chain and store operation strategies for specialty apparel retailers and wholesalers and depart-ment stores. He is frequently quoted in leading publications and speaks at top industry conferences. He can be reached at [email protected].

Authors

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