The Secret to Retail Store Profitability
One retail client of ours had a small boutique business unit (selling upscale French clothing) that was a real puzzler. They were seeing great profitability in their New York boutique, significant losses from their Los Angeles boutique, and moderate profitability just down the street in Orange County. They were not sure how to move forward.
The business had three choices:
- Stay the course: Renew their leases on their three boutiques and maintain the relationship with their French supplier
- Expand nationwide: Add several boutiques throughout the country and invest heavily to grow the operation
- Shut down entirely: Close the three boutiques, sublet the stores (at a significant loss) and terminate the relationship with their French supplier
Profits in New York and Orange County were largely offset by the losses in LA, so all three options were legitimately on the table. They asked us to dig into the operation and help them make the right decision.
Profit per Square Feet: Margin vs. Rent
We considered five factors that might be driving their vastly different results in each boutique:
- Were their rental costs different?
- Were they selling a different mix of products?
- Were they pricing differently?
- Were they staffing the stores differently?
- Were they selling to a different demographic mix, with different buying patterns?
We found that factors 2-5 had only modest impact on boutique profitability. Since rental costs were one of their largest line items, we hypothesized that rental costs would be the biggest driver. Surprisingly though, their most profitable boutique (New York) actually had the highest rental costs per square foot.
Digging deeper, we found that the biggest driver of boutique profitability–by far–was the ratio of sales per square foot vs. rent per square foot.
Key Profit Driver:
Sales/Rent Ratio = Sales per Square Foot/ Rental Costs per Square Foot
The New York boutique was paying very high rent but on a relatively small footprint. This was apparent when we visited the store:
- The space was packed floor to ceiling with inventory
- The aisles were small and crowded
- The stock room was quite small, requiring 90 percent of the inventory to be kept on the shelves
- Due to space limitations, the store stocked only 60 percent of the available SKUs
Despite those challenges, the boutique was generating roughly the same level of sales as the LA boutique, which was three times the size. The big lesson: a smaller store does not mean proportionately smaller sales.
Could the New York boutique have generated higher sales with a larger footprint? Probably. But if they expanded their footprint by 25 percent, and sales grew by 10 percent, they would have lost money. At the end of the day, there was only so much demand for fashionable French clothing in the New York City area; a more spacious boutique might have delivered a better shopping experience, but would not have been nearly so profitable.
By contrast, the LA boutique was one of the more spacious and pristine shops we had ever seen. The aisles were wide, and the shelves were tastefully stocked, with a spacious stock room to hold the bulk of the inventory. As a result, the store carried 90 percent of available SKUs, with a wide and deep selection.
The LA boutique certainly offered a much better shopping experience. However, their sales/rent ratio was one-third that of the New York store. Our client had locked in losses the day they signed the lease. There was simply no way to achieve a profitable sales/rent ratio in the LA store.
If you have retail operations, ask yourself: Could I create more value per square foot by shrinking my footprint? That’s what our client did. We set them on a 4-step process for sizing boutiques in potential new markets:
Step 1: Estimate the total demand in the local market (more on that in a future article)
Step 2: Estimate total store sales based on capturing a reasonable share of that demand
Step 3: Based on rental rates in the local market, determine the maximum boutique square footage
Step 4: Design the store to fit in the footprint allowed
Based on this approach, the boutique was able to confidently and profitably expand, and is now up to 15 locations in North America.
KARL STARK AND BILL STEWART | Columnist | Co-founders, Avondale
Karl Stark and Bill Stewart are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree.