Opportunities for Action
R E P R I N T
C O N S U M E R
Systematic Value
Creation in Retail
Creating shareholder value has been a frustrating challenge for retailers. Over the past ten
years, retailers have pursued growth opportunities aggressively. Yet despite a few well-known
success stories—Wal-Mart, the Gap, Home
Depot—retail equities as a group have lagged
behind the stock market. In contrast, consumer
goods manufacturers considerably outperformed
the market during the late 1980s and have
matched it during the 1990s (see Exhibit 1). For
retailers to systematically earn high returns, they
must shift from a tactical focus on operations to
a more strategic focus on value creation. For
many, this will require new metrics for their
businesses.
&
R E T A I L
In contrast, consider a broader measure, such as
cash flow return on investment (CFROI). In
addition to accounting for margins, CFROI also
reveals asset characteristics, turnover, and other
factors that affect business performance. CFROI
can help managers determine strategic direction
and allocate resources across a portfolio of busiExhibit 1. Retailers Have Lagged Behind Consumer
Goods Companies and the Stock Market
1985–1990
Relative 180
TSR
160
+65%
140
120
100
–5%
80
60
1985
Choosing the Right Metrics
1986
Stock market
In the past decade, many retailers developed
complex product lines, formats, and portfolio
mixes in the belief that growth would follow and
would create value. But when growth didn’t
materialize, the retailers turned their attention
to day-to-day operations. Consequently, the
growth opportunities they did pursue tended to
be incremental.
The metrics that retailers used to measure their
performance heightened this focus on shortterm, incremental opportunities. Consider two of
the most common measures: gross margin and
sales per square foot. Although useful for determining near-term operating performance,
they reveal very little ab out critical value
drivers, such as growth, profitability, and capital
efficiency. In fact, because gross margin doesn’t
show product, segment, or business profitability,
it is one of the least useful measures in retailing.
1989
1988
1987
Retailers
1990
Consumer
goods
manufacturers
Relative 180
TSR
1990–1997
160
140
120
+3%
100
80
–17%
60
1990
1991
1992
Stock market
1993
1994
Retailers
1995
1996
1997
Consumer
goods
manufacturers
The graphs show the total shareholder returns (TSR is
defined as capital gains plus reinvested dividends) of the
retail and consumer goods industries in relation to the stock
market. (The market TSR is indexed to 100.) From 1985 to
1997, consumer goods outperformed the market by 68
points—driven almost entirely by the performance from 1985
to 1990—while retailers underperformed by 22 points.
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Opportunities for Action
R E P R I N T
S Y S T E M A T I C
C O N S U M E R
V A L U E
C R E A T I O N
I N
&
R E T A I L
R E T A I L
nesses, but it can also be used to drill down into
an individual business to identify the investments that are earning above or below the cost
of capital.
Linking Performance to Shareholder Value
Exhibit 2. CFROI Highlighted True Economic
Performance at the Store Level
CFROI spread 15
(CFROI minus
the cost of
capital) 10
(%)
5
Earning high returns, and thus creating value for
shareholders, usually depends on three activities:
growing successful businesses, inventing concepts or categories that provide high returns and
are hard to copy, and improving or divesting
weak businesses. Wal-Mart and Sears provide
real-world examples. Wal-Mart grew its discount
retail business aggressively during the 1980s,
increasing the number of stores from 230 in
1979 to more than 1,300 in 1989. The company
created enormous value for shareholders in the
process. But when the concept of discount retailing matured in the early 1990s and growth
slowed, shareholder value flattened. Wal-Mart
responded by adding supermarkets to its general
merchandise stores, and returns and stock price
started to rise again.
Sears faced an entirely different situation.
Diversification and the emergence of new competitors (Wal-Mart and specialty stores) weakened some of its businesses. Sears exited a few of
them—most notably, it closed the catalog operation in 1993—and spun off others. This allowed
it to focus on fixing the store’s core retail business by developing the highly profitable “softer
side” in apparel.
Wal-Mart and Sears didn’t necessarily use
C F RO I, but they did focus on their most
successful businesses, they invested in categories
that would provide high returns, and they
got rid of weak performers. Those are the
very activities that CFROI pushes companies
to pursue.
0
–5
–10
The chart shows the CFROI for individual stores in a local
market as a function of gross investment for each store. The
width of each bar indicates the level of gross investment in
that particular store.
In addition to measuring return on investment,
CFROI can also be applied to more tactical
issues within a business. We recently calculated
the CFROI for each store within a retail client’s
local markets (see Exhibit 2). No surprises there.
The analysis confirmed the retailer’s suspicions
about which stores were strong and which were
weak. But when we linked a store’s performance
to shareholder value, the real power of the
methodology emerged. Several of the underperformers did much worse in terms of actual cash
flow and shareholder value than the
retailer had believed.
That perspective forced the company to consider
store investments in a new light. Before,
the retailer had taken a strictly incremental view:
if a new project—say, a store renovation—was estimated to have a positive net present value
(NPV), the retailer would make the investment.
What N PV fails to measure, however, is
whether an investment has paid off. The renovated store, for example, might still be returning
below the cost of capital, and its market value
might not be improved. In other words, the
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Opportunities for Action
R E P R I N T
S Y S T E M A T I C
C O N S U M E R
V A L U E
C R E A T I O N
I N
Drilling even deeper into the retailer’s
businesses, we applied a similar approach to its
merchandise categories. We looked at each category’s CFROI and at its growth in investment
(see Exhibit 3). We found little relationship
between the two, which meant that the retailer
was neither identifying growth opportunities for
high-return categories nor fixing or exiting lowreturn categories. As a result of our finding, the
retailer now requires demonstrated returns
above the cost of capital before approving investments. And it is also looking more closely at the
strategic issues within its portfolio: which categories are core to the business and how to
increase their value, the costs of keeping underperforming categories, and what new categories
might be worth entering.
Exhibit 3. Category Investments Were Not Linked
to Profitability
Develop
strategy
to grow
ip
sh
n
tio
la
0
d
ire
re
s
De
R E T A I L
R E T A I L
investment would not deliver value to shareholders. CFROI changed the retailer’s judgment
about which stores to operate and which to shut
down. Once the company saw how some stores
were damaging the overall value of the business
(in dollars per share), it was ready to take the
unpleasant but necessary steps it had been
avoiding.
Average
CFROI
(%)
&
Delivering Shareholder Value
To make the right strategic and portfolio decisions day to day, retailers must link operating
and performance metrics to the creation of
shareholder value. CFROI is one of the best
measures for helping them achieve this objective.
General and line managers could be evaluated
on CFROI performance, while employees could
be evaluated on one component of CFROI, such
as sales, customer returns, or inventory turns.
CFROI as a single, all-encompassing valuebased metric can also help motivate a change in
strategy. One retailer recently described it this
way: “We were too focused on net income.
When we began concentrating on cash flow and
the balance sheet, people saw specific things they
could do to unlock value, such as increasing
margins, speeding up processes, and reducing
investments. People were able to understand
the impact of their efforts on CFROI and, ultimately, on shareholder value.”
For the past two decades, retailers have failed to
deliver the value that shareholders expect. In
light of the overcapacity in the industry, the low
barriers to entry, and the ease with which new
concepts can be replicated by competitors,
reversing that trend will require new strategic
frameworks and competitive levers. Retailers
must reevaluate their portfolios through the critical lens of shareholder value. They must grow
high-return businesses, fix or divest underperformers, and develop the high performers of
tomorrow. And to make sure that tough, valuebased decisions bear fruit, retailers must link
daily operations to value-based metrics.
Fix, shrink,
or exit
Matthew A. Krentz
Kevin Waddell
.
0
Growth in gross investment
(%)
The matrix contrasts the CFROI of different merchandise
categories (represented by the points on the graph) with the
growth of the gross investment in each category.
Matthew A. Krentz is a vice president and Kevin Waddell a manager in the Chicago office of The Boston Consulting Group.
© The Boston Consulting Group, Inc. 1999
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