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Has ecommerce put the high street out of fashion?

Senthil Alagar Senthil Alagar

We look at the story behind online retailers ASOS and Boohoo's strategic acquisitions of big-name high street brands. Will the ultimate winner be the one who walked away?

There’s been a lot of media comment about online retailer ASOS’s acquisition of four Arcadia brands – Topshop, Topman, Miss Selfridge and HIIT – for £265 million, and competitor Boohoo’s double swoop to buy Debenhams’ intellectual property for £55 million, and three Arcadia brands – Dorothy Perkins, Wallis and Burton – for £25 million.

The media focus has been on the fact that in all cases, these deals will leave the new owners with the brands, but not the hundreds of stores that once formed the bedrock of the Arcadia empire, nor the 126 remaining Debenhams department stores.

This is said to be yet another indication that the high street retail industry is all but dead, and that the future is online. But how can ecommerce companies, which generally make lower margins than the best brick-and-mortar retailers, make these costly acquisitions work? Why don’t Boohoo and ASOS just keep growing their online sales organically?

Different levers driving offline and online retail

To explain what’s going on, it’s worth looking at two fundamental differences between traditional retailers and their online-only competitors:

1 High fixed costs of bricks and mortar versus higher variable costs of online

Bricks-and-mortar retailers carry the high fixed costs of a store estate, but generally make bigger profit margins on each incremental sale they make. Online pure players, operating from lower cost premises with fewer staff, tend to have lower fixed costs, but make lower profit margins on each item they sell. This is because of higher variable costs such as marketing, shipping individual items to consumers, and dealing with returns that are likely to be greater in the online business.

2 Higher brand awareness of bricks and mortar versus lower brand awareness of online

The strength of physical retail stores is that they are seen by hundreds more passers-by than actually cross their thresholds. Consumers become aware of the different stores and may take the opportunity to step inside, especially if they see something interesting in the window. Physical retailers historically spent very little on marketing, using their stores as advertising to develop brand awareness and attract new customers.

The biggest retail name you've never heard of

This type of brand recognition and incoming footfall just doesn’t happen with online retailers. Unless the brand is known to the consumer, or the retailer targets them with advertising, the brand will remain unknown.

For example, the most successful online retailer in the UK, in terms of sales growth and profitability over the past five years, is a name most people have never heard of. Gymshark, started by Ben Francis when he was still a teenager in 2012, is now a global phenomenon worldwide, and recorded annual sales of £176 million to July 2019. Beyond its devoted customers and a handful of retail analysts, the name is hardly known, however.

What online retailers seek with high street buys

It’s these two components that are coming into play with the recent headline acquisitions. Neither ASOS nor Boohoo want to be saddled with the high fixed costs of the barely profitable store estates of Debenhams and Arcadia. Typically, the costs of shop leases, rates and people in a profitable fashion retailer represent about 35% of turnover and, as recent times have shown, if sales decline, it is very hard to reduce the store costs by much.

Buying the brands and then developing them online means that they can be plugged into the online companies’ highly efficient distribution and logistics models. And, although the new sales will inevitably attract variable costs of advertising, warehousing, distribution and returns, they will be highly cash generative and help to grow sales rapidly. For both ASOS and Boohoo, this is probably more of a priority than profitability alone.

That is where the second lever of our two fundamental differences comes into play.

Cost of acquiring new customers

ASOS and Boohoo have already driven significant sales from their existing customer bases, which mostly comprise of fashion-conscious, under 35-year-old women. Many online retailers experience the same challenge as they mature and reach a larger proportion of their target customers in any market: the cost of acquiring new customers increases. Indeed, it increases often to a point where the cost of acquisition – in terms of advertising, buying consumer data and enticing new consumers with special offers – exceeds the revenue generated in the first year from each new consumer.

So, it makes perfect sense for businesses like ASOS and Boohoo to acquire brands that give them immediate access to huge databases of existing loyal customers. They can also further exploit the existing high brand awareness that, in the case of Topshop, for example, is global and well aligned with ASOS’ goal to become the “number one destination for fashion-loving 20-somethings worldwide”.

ASOS and Boohoo chasing different strategies

The two companies are following very different strategies with these acquisitions, however.

ASOS will close all the acquired brands’ online sites and bring the Arcadia brands in-house, with an aim to transform them into digital-first labels. ASOS notes that they are “strong” consumer-facing brands. It also sees a “significant” opportunity to drive further growth, by increasing the brands’ reach and accelerating its US strategy through an ongoing partnership with US department store chain Nordstrom.

Boohoo’s strategy is different. Buying the Debenhams brand, customer database and the opportunity to develop it as an online-only business is more complex. There will be a period of transition as Boohoo rebuilds and relaunches Debenhams as a standalone online retail business. This will complement its existing Boohoo, PrettyLittleThing and Nasty Gal business units, and will carry these and other Debenhams-branded collections, the recently acquired Coast and Karen Millen brands.

Opportunities in new markets and routes in

In particular, the Debenhams beauty business could be a particular prize for Boohoo. Debenhams held a 22% share of the £2.8 billion premium beauty and cosmetics market, and the product assortment provides the perfect bridge between Boohoo’s existing young, fashionable consumer and Debenhams’ more mature customer base.

Boohoo has also stated that it plans to expand the range of products sold via the Debenhams marketplace by maintaining “existing marketplace brand relationships” and adding new brands over time. Additionally, the relaunched marketplace will also provide a “new route to market” for the group’s existing brand portfolio.

These acquisitions carry implementation challenges. ASOS has already said that it expects any incremental EBITDA in the 2021 fiscal year to be offset by this initial investment and ramp up costs.

But if successful, Boohoo could be transformed from a profitable niche online fashion retail business to a broadly based internet retailer and marketplace. And ASOS could see its brand portfolio reach droves of new consumers worldwide.

Is real winner the one who walked away?

Which will prove to be the better deal? Ironically, one of the biggest winners from this buying spree could be the business that walked away from the Arcadia deal.

Next plc chose to drop out of the bidding for Topshop and Topman and allow ASOS to claim the spoils. It also has a beautifully balanced omnichannel business, with half its sales in a normal year coming from online retail and half from its well invested store estate.

The complete loss of Debenhams' store estate from the UK high street, and the £1.8 billion sales it generated, represents an enticing opportunity for Next, whose UK store sales are remarkably similar in value to Debenhams’. Most former Debenhams store shoppers will not migrate online and, when shops reopen in a few months’ time, Next will undoubtedly gain sales as a result of Debenhams’ and Arcadia’s demise.

If Next can rapidly develop its beauty business, launched in 2018, it could become a legitimate competitor to Frasers Group and the John Lewis Partnership in this lucrative category. It has already acquired five former Debenhams sites in which to do so.

Opportunities in prime locations and falling rents

Next will also be a winner in that most of its stores are in prime locations, and it has already agreed deals with many landlords to ensure that it profits from any general rental reductions afforded to its competitors. With multiple vacancies on the high street and in shopping centres, rental levels may fall sharply in the next 12 months and beyond.

Of course, the loss of the better part of 18 million square feet of occupied retail space from the closure of the Debenhams and Arcadia retail stores is a huge challenge, and it won’t be the first or last of the closures. But retailers like Next, JD Sports and even M&S are likely to benefit from the reduced competition and costs – once shoppers return, as they inevitably will.

By Patrick Woodall and Senthil Alagar.

For further information on the UK retail sector, online retail and the topics discussed here, contact Senthil Alagar.


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