John Lewis and Waitrose – A changing business

First, a caveat. I used to work on John Lewis, ostensibly as a Comms Planner but later as an “in effect” Marketing Strategist and Consultant. I have great affection for the business but I’m also (and was) clear sighted about the problems that had been building up for several years before the recent visible financial troubles. I’ve been out of the business for over a year now. December 2019 was the last time i was at Head Office but whilst i attended meetings in 2020 they were under the auspices of the ‘intermediary’ restructure instigated prior to Dame Sharon White taking over and implementing her vision.

Anyway on to the update and it’s an interesting one. Part of this is because as a private business there is no nessecity for the John Lewis partnership to publish this sort of information. One of the first casualties of this was the weekly sales results they used to publish. It was a fascinating bellwether for the business but also a wonderful source of useful data that i imagine analysts at all the competition (what’s left of it) used. That said we still get the twice yearly updates and the unaudited full years have just dropped. There have been changes to how the data is structured and the emergence of a little more corporate obfuscation which i would suggest is linked to Dame Sharons background as an economist. Also it makes sense. Why give your competition the financial keys? Reading a few of the summaries yesterday (i don’t work Thursdays) and reading the announcement today, I’m caught by how many have failed to point out some of (what i would see as) the salient points. So into that….

To start with its worth looking at the revenue figures. When people say that high street brands are dead its worth looking at the amount of money these so called “failing” businesses are actually doing. In John Lewis’ case, they still managed to post est. £3.7bn which i’ve got as around 1% down YoY . It should be noted that this includes an extra week of trading but we’re still talking about a huge business from a consumer perspective. Also worth noting that the L4L is posted at 0%.

To put this into context I estimated that Debenhams was a £1bn business last year, whilst i estimated that M&S would do £1.7bn (discounting for a successful Xmas) and Next has suggested its profit would be circa 2/3rds of total which when applying a simple scale up (plus Covid cost estimates) suggests around £3bn. So John Lewis pull in a lot of cash and on this benchmark they’ve done/doing very well!

On the Waitrose side its been decent too with a 10% increase in revenue to £7.044bn. As a flavour for the rest of the market its remarkably consistent and whilst most of these results aren’t full year and are therefore extrapolations they are fairly uniform and paint a good picture for Waitrose. When i say uniform, we’ve seen the following at Tesco (8.5%), Sainsbury (c8%), Morrisons (8.6%) and CO-OP food (8.8%)….

I’ve charted the figures up over the last few years to give you a sense of what’s happening –

Yep, its down but nowhere near what you’d expect
A significant jump due to covid

The next step of this analysis jumps into how this actually converts into profit though. Historically i’ve used Operating Profit excluding exceptional items and the bonus (and tax) as the ultimate figure. Exceptional items are a “funny one” although historically they’ve not really appeared all that often, although in recent years it seems like its been open season. 2020 was when it started to get complicated though.

There are two reasons for this. One is strategic whilst the other is legislative. The legislative one is related to the value of leases (IFRS 16) and therefore there is an argument that we should go back through the numbers and estimate the historic “book value” that we’re seeing. This isn’t going to happen. Therefore it can only really be seen in the new figures. This creates a bit of an apple and pears situation, not idea but unvoidable it seems. JLP flag this in their recent report and there is a (£53m) effect (page 7) and its all against the JL estate, rather than Waitrose.

The other element is strategic and there are lots to this one. Firstly there are the emergence of group efficiencies which mean that going forward we won’t be able to view segmental Operating profit (it will be one figure) which applies one level of opaqueness to separating the two businesses. Secondly we had some whopping exceptionals. The first is a £249m addition caused by closing the final salary pension scheme. I’m not an accountant but this is booked against 2020 in its entirity. This isn’t real money as such and the benefit will be felt for years to come in increments rather than all at once. There is also the presence of a (£63m) amount which is related to strategic operations and redundancies AND a (£110.3m) write down of the John Lewis estate due to the shift to online business (we saw this again this year). You can see why the pension scheme amount is useful. It basically allowed JLP to add £107.4m into the year as exceptional. Without this we’re talking about a (£150m) amount in a year where the profit before tax was £146m. (see all this here). So whilst 2020 looked decent, we’re already on less steady ground, although the cash generative nature of the business is still strong with £753m generated with £600m on the balance sheet.

One of the big changes to JLP reporting is that they no longer provide segmental breakdown at a profit level (few public businesses do) from 2020/21 onwards. We have historic data so we can work with these margins to estimate though. This is where it gets a bit more interesting. For the first iteration i’ve left off 2021 as there is a lot more going on.

A few things of note here (as i’ve split the data by Half too) is that John Lewis are truly a H2 brand. All the profit now comes from H2 and most of this will come from the golden quarter. Everyone sees them as a Christmas brand and this is what that looks like. Waitrose on the other hand (bar 2018 when there was a price hike and Waitrose refused to pass over the price rises to consumers) are clearly moving back to where they were and seem to be well positioned.

So what about 2021. How do we estimate that? The best place to start is H1. Now the headline for H1 was a £580m loss due to a write down (we’ll saw this again in the full year results naturally). Stepping back to the figure that JLP use before exceptionals gives us some insight. This totalled -£55m. So prior to the huge write down they were making a not insignificant loss as a group. Looking back at prior years we can see that Waitrose has cross subsidised the John Lewis business before but not this year. With this in mind we can estimate the contribution to this loss by brand. We know that Waitrose was up around 10% in revenue terms. Taking the 2020 H1 ratio between Revenue and Net profit of 34.8% we can apply this to the 2021 figure to give us our estimate. We can also then simply work out the differential between this and the -£55m. This gives us +£128m for Waitrose (£3.7bn revenue at 30% conversion) and therefore a figure of (£183m) for John Lewis. That is a BIG loss in H1 and also includes some £50m from the Govt, for furlough.

Then we come to the full year view. Again, the comparison is difficult so assumptions have been made but we can estimate that Waitrose made £104m in H2 on revenue of £3.3bn. This looks like this –

What does that mean for the John Lewis brand? Well bearing in mind that the total group profit for the year was £131m we can run through the following calculation. Waitrose contributed est. £232m to the pot in the year. We previously suggested that the H1 loss to John Lewis was (£182m) so simple maths says that the John Lewis total year loss was (£101m) which means that H2 was actually positive at £81m. BUT, £190m of this was government cash. There has been much debate about whether JLP should hand back some of the Govt. money as Waitrose benefitted disproportionately (remember its up 10% vs other brands at 8.5%) and this is why they won’t. Essentially the group comes in at (£59m) without this. Then you add in the write down of the estate on top (it halved in value) of (£648m) and you can see where the headlines came from. Without government help the business would have written an £707m loss. Obviously the huge caveat is that Im not a financial analyst so i can’t absolutely guarantee these figures are perfect. You’ve also got an increase in cash generation to £832m.

OK. So why does someone with a background in marketing look at all this stuff. Well, i’m interested for a start. That and by following the money you understand the business better. It also allows you to disabuse yourself of narratives.

So what are the implications for all of this? It’s clear that the business is inefficient. John Lewis especially has struggled to convert good revenue levels into profit. There is too much cost and I would imagine the closures represent stores which have struggled to provide any sort of profit. Too big, too expensive, not enough demand. The closure of the bullring store in Birmingham is telling. 5 years old and flagship status (until Westfield), paints a very poor picture of the historic decision making processes. Like M&S before them, closing these stores will benefit the business hugely BUT; are JLP missing a trick? It’s last man standing now (Debs and HoF having “disappeared”) and there will surely still be a place for city centre malls, especially when John Lewis have never really had the large scale footprint of the others i.e. more manageable. This puts them in an enormously powerful position to renegotiate rents and leases as there is no-one else. The business is also still driving significant demand i.e. revenue as well. People still buy from John Lewis and even if that’s via the website, its a remarkable strength especially relative to their competitors.

So where does marketing come in? The John Lewis brand is very well known. It’s CEP (category entry point) is clearly Xmas but it has to be more than that really, they can’t keep carrying H1 as a passenger. The issue is more about the future and the Prime Ministers partner Carrie Symonds was recently quoted as suggesting that she wanted to get rid of “the John Lewis furniture nightmare” is probably an accurate representation of what many believe to be behind the John Lewis doors. Expensive (relatively) but also quite beige. Black Friday is now a major electronic goods period but essentially acts as a black hole before Xmas and whilst the returns policy is probably what drives demand, as cohorts age the awareness of this will drop (and electronics are hugely online and price sensitive as a result, not a good place to hang their hat). Clothing is an odd fellow within JLP. They have lots of brands (their own and 3rd parties) but there is no one real style or reason. You know why you buy at M&S but do you know why you’d buy at John Lewis? What are people buying when they go in? Could John Lewis have bought Jaeger for example? If fashion is to continue then a clear reason needs to be built. Brilliant basics has been a clarion call for many in fashion retail for years but this is a very competitive area. A Best of British position, could be an interesting platform through which to create distinction and support young DTC companies that are desperate to increase their distribution (acquisition in this space could also be investigated…)

The official documentation suggests a reinvigorated focus on Nursery and Home. It does feel as though there is a John Lewis effect when you start a family. You’re stressed enough as it is and therefore you benefit from an “all in one” shop, it’s a shame that when i bought it up buying up the UK Mothercare franchise there wasn’t the decision making apparatus in place. Ultimately JL is a lifestage brand and leveraging this for new cohorts would be a good idea whilst refreshing the older groups who have lost their lustre. You hit the John Lewis age range as a 30 something and then you’re in….

The suggestion of smaller more accessible stores is interesting but leveraging Waitrose is a better idea and should be prioritised. Small stores would only work as specialists and we already know from closures that the home-alone model doesn’t work. As to financial services and rentals, this is where the direction veers a bit. John Lewis Finance is profitable but it’s not distinctive in market. There are suggestions of new products being released but they’re playing with commodities in home insurance. Its not a game changer. Becoming a Peabody trust for the modern world is a fun idea but again this is a whole new unfulfilled area and the point with Peabody is that its a charity and therefore not cash generative, what’s the benefit to John Lewis here? It all feels as though the answer is being sought outside retail. Thats quite a leap for a retailer who is currently struggling to get the basics right (and by basics i mean generating profit from large revenue streams).

As for Waitrose. It seems like its on a reasonable course. All the grocers have benefitted and there was certainly a fortunate element to Covid and the handover from Ocado which forced immediate scale up. The issue with Waitrose is long standing and thats the quality/price differential. As value retailers increase their quality the gap reduces whilst the prices remain the same. You’ve then also got the “return to local” & “farmers market” elements that push against its positioning as the place for quality food.

The relationship between JL and Waitrose is also interesting. If you look at Sainsburys and Argos (plus multiple other brands) you can see a strategy in place that is founded on monetising shop floor space. Tesco and Morrisons are vertically integrated whilst Co-Op are local. Lidl and Aldi are opening lots of stores (and running up lots of debt). So how can the JLP work better together? Operationally there are clearly cost benefits that we’ve mentioned previously. The horizontal integration approach of Sainsburys seems to be an easy win but even Sainsbury’s had to try to merge with ASDA to supplicate the city (and that failed too) but here is the rub. JLP doesn’t have to profit maximise. It only has to keep running in the mid term and keep its partners happy in the short term. The £400m target for profit is just over half what Next does in a normal year and JLP is twice the size when you roll the two businesses together. There does seem to be a lot of cost within the business as mentioned but if this cost is used to provide elevated services then there is no reason why it cannot return to its thriving state. This is the key. It may not have to be efficient but it must invest the efficiency gap into something that consumers want and value, that could be pricing (which is alluded too), quality of product or simply expensive signalling. Its worth remembering that Selfridges wrote a £80m op profit last year from a handful of stores. Harrods does very well too, whilst Frasers is going all in on Flannels. Luxury (or mass premium in the John Lewis world) is something people will pay for however first of all your have to fix the inefficiencies in the operations and that’s easier said than done. The forward guidance of £800m investment does sound interesting though! Let’s just hope it’s spent more wisely than the £35m spent on John Lewis store in Birmingham.


The rise of E-commerce, changing expectations and the great unbundling (Retail and motor)

A few weeks before Christmas I was invited to the annual “future of technology series” run by . It was a great line-up and the videos are all here for your perusal including my own short presentation. I took the opportunity to present on how changes in consumer expectations are likely to drive structural changes in logistics and last mile fulfilment and why understanding the commercial impact brands can mitigate through their businesses strategies. I specifically focussed on the Motor in this presentation but some of the insights are cross-category. It was whistle stop and i’ve certainly gone deeper here than i did for the 10mins i had then, with some more examples, so hopefully it may help spark some interesting thoughts of your own…

So, the first slide started with ONS data showing the shift in share of retail (online vs offline). Obviously grocery is overwhelmingly offline (penetration is around 13% which is double pre-covid but still low) but even total retail excluding grocery only comes in at 27% i.e. lets not accelerate the decline of offline by believing its dead already. That said, there appears to be a step change of around 7.5% which is not insignificant and a new baseline.

That said, the previous chart is in % terms and when offline retail effectively closed in LD1 (lockdown 1) its perhaps unsurprising that e-commerce saw a % increase. To add more colour to the scenario its worth looking at actuals and as you can see whilst there has been a clear acceleration, the total offline retail dwarfs the online world. When you hear people calling for Amazon to be broken up because of the stranglehold on retail, its worth remembering this chart. Amazon is only a proportion (and a small one) of that red line. Its certainly not a monopoly here.

Something that this change has affected though is consumer expectations. When it comes to e-commerce and delivery the biggest impact Amazon have arguably had is on perceptions of service. We expect cheap, quick delivery with the minimum of fuss. I’ve written previously about e-commerce and how fulfilment is expensive and hard and how the costs of decent delivery have to come from somewhere but its worth reiterating

Fulfilment networks are costly. The set-up is vastly different from a retail outlet and the limited distribution required to stock fixed units plus they have “last mile delivery” issues too. The “hub-and spoke” model of Argos and the regional and local hubs operated by Next are designed to mitigate this and improve efficiency/reduce cost. Interestingly the key, non-covid, statement in last years Next company report, for me, is “The focus will be on systems that consolidate items, quickly and accurately, into individual parcels”. Why is this important?

What do i mean by this? Well its about distribution, especially that last mile. Its one of the problems with the food delivery businesses like UBER and Deliveroo and explains why they are trying to shift into broader logistics because what’s that problem?.. marginal costs. Let me explain, a van or bike (plus driver) represents a cost and as soon as you have a single package this cost is incurred. The first parcel is always the most expensive whilst subsequent packages reduce that cost by spreading it, that’s marginal cost, the extra cost incurred for each subsequent unit.

In traditional store based logistics this is fine. You fill the lorry to its capacity and off it goes. In the new e-commerce model where parcels are being delivered to multiple houses in a small geographical area plus the expectations for instant delivery (and cheap) set by AMAZON you have a problem, because its unlikely that you’ll be able to send that package out on a full truck, ergo its highly cost inefficient. This is happening all over the country too in multiple locations, every day. As a business you could hire 3rd parties to do this part for you, but; even with multiple potential clients this can still be a problem and there is an elevated cost for utilising their network because they know this and clients pay for the inefficiency. This is what I mean by “stepped” because each vehicle started is contributing marginal cost that is not optimal, kranking up the negative effect on margins and explains why brands that operate in the mid-low end of margins struggle with e-commerce and have to find the savings somewhere else in their business (see the BOOHOO paper again for the wrong way to do it). Back to that mention in NEXTs report. They’re looking to cross subsidise this uncontrollable aspect by focussing on their own operations and reducing inefficiency there. clever stuff eh!.

So, why did i leap to bundling and unbundling. Well everything above is fairly general. This is an actual trend and its fuelled by consumer expectations with clear commercial impact. This is also where the implications start. So, a reminder, if the logistics scenario above is the the case, businesses have a choice. Either continue to run their own logistics networks or utilise someone else, a good example in modern retail is NIKE vs Adidas.

Over the Summer Nike were raving about the rise in e-commerce, they’d pulled off some of the big ecomm platforms and the shares were skyrocketing. Read the company reports again and you’ll notice that margins declined and admin costs also declined hugely (including demand generation or marketing). In simple terms a huge cost centre was removed which lended a glossy glow to the bottom line figures BUT also; despite full price sales increasing (this is a function of an excellent stock management system) margins have consistently declined. check here, here and here for more info. I’m digressing from my original point a bit here but if you remove £3bn (combination of operating expenses, they namecheck flights!! and marketing here) from £10bn revenue its going to look good on the bottom line (and its also likely to come storming back when covid is over) but also that consistent 1% drop in margin is due to the owned e-commerce focus and represents how difficult it really is to cross subsidise the old world with the new and stay the same. Adidas on the other hand are currently piloting using Zalando to do their fulfilment. How does this relate to bundling and unbundling, well its simply do your logistics or don’t?

The bundling vs unbundling example Is clear in this example. Hiut the specialist jeans maker from Wales who “ONLY DO JEANS” and make a virtue out of it or Tesco and Booker and a vertical integration play that is arguably Sir Dave Lewis’ finest gift to the TESCO business. Especially when you remember the context of the business he came into, with multiple acquisitions struggling to do anything other than drag. He made one BIG play and it was a step up the chain I.e. a big bundle. So onto the car market…

Its worth reminding everyone at this point that the thesis of this presentation was e-commerce has risen (but not as much as you’d think), but its real impact is on the expectations of service. E-commerce is a drag on margins because of marginal cost inefficiency and therefore businesses have a strategic choice to make, do they bundle or unbundle…. So Motors and motor sales, a market ripe for disruption.

There has been an acceleration of new brands in the car buying space in recent years but the two that catch the eye are Alex Chestermans Cazoo and BCA’s Cinch. Why is this and how does the above trend feed in? Simply put, if buying a car is shifting to the e-commerce model then imagine the commercial implications of the “last mile”. The car has to be dropped off at a house. Its going to be either driven (in which case you need a following car) or via a truck (which has only one car on board for residential streets, probably with a HGV driver and a sales person on board) which means the marginal costs are steep. The opportunity costs are also huge because that sales exec can only service ONE delivery/sale during his time on the van vs the multiple ones he can manage when on the forecourt. You can see how costs are going to rise exponentially! Now i’m not saying that buying online is going to be mainstream anytime soon, its still a tiny % but combine this with the national coverage of online sales (imagine i’m in London but buy a car in Glasgow) and the whole regional/local garage model is under significant pressure. OEMs (original equipment manufacturers) for new cars can’t do this and whilst they often handover control to sales networks, that becomes complicated too as they’re often not fully national.

So (longwinded) that leaves the door open for the aggregators to step in and they’re perfectly placed to dis-intermediate the sales networks by building out their logistics back end + a digital forecourt front end and cover the whole of the UK, essentially bundling sales and logistics up and leveraging economies of scale. BCA already do logistics for the motor industry (and they own We Buy Any Car) but Cinch is them entering the new car sales marketing (they’re a £2.5bn business) whilst Cazoo are coming from the other direction and going sales platform, supported by a logistics network (and then they’ve bought some forecourts, probably as a holding pen).

If i were to conclude this rather rambling section I’d say that size matters in the e-commerce sphere to mitigate those changing expectations and bundling sales plus logistics plus forecourts/warehousing is the future. OEMs would be better placed to just give up sales (unbundle), whilst the sales networks themselves face an existential threat.

Ah yes TESLA. They can do it. They sell direct after all (despite Elon backtracking on closing his forecourts) Well can they? They’re already losing money and as we’ve set out the e-commerce model doesn’t help here. In fact it does the opposite. So its really not the DTC model you need to be worrying about. It’s the aggregators who bundle.

WOW. I definitely added loads of other stuff in there that was in my head especially as the original video was only 10 mins long. I summarised here and i still think this is the best overall way to do it, so i’ll leave it at that.