Likely Economic Impact of Demonetization

On November 8, the Indian government announced that the two largest denominations of notes (Rs. 500 and 1000),would be discontinued immediately. These accounted for 86% of the Rs. 17.54 Trillion currency in circulation (amounting to Rs 15.08 Trillion in value).

It has been acknowledged as a bold move by many economists and citizens. The objectives of the policy were to root out black money, to discourage future generation of black money, and to root out counterfeit currency that was being used by terrorists.

I have been thinking about what could be the likely economic impact of demonetization. 

Demonetization is likely to have the following impacts:

1) Reduction of black money: This manifests itself in two ways:

• New disclosures of unreported income and government seizures: So far Rs. 11.5 Trillion has been deposited (until December 6) in bank accounts. The Income Disclosure Scheme (IDS) which was operational before November 8 had yielded disclosures of more than Rs. 0.67 Trillion. Rs. 2000 crores of unreported income disclosures and Rs 130 crore of seizures have been reported from depositors after November 8 so far. The tax revenue to the government from this is likely to be Rs. 958 crores (as of Dec 7). This number is expected to rise as more disclosures and seizures are made. Future seizures of real estate, gold and other assets bought from unexplained sources of income is an area of great promise.

• Old currency not deposited back in the banks. This leads to a reduction in the liability of the RBI (India's central bank) and could create an extraordinary profit for the RBI. Given that the deposits in the first 30 days since November 8 account for 76.3% of the value of old notes in circulation on November 8, many analysts and economists feel that less than 5% of the old stock of currency will remain in private ownership on December 31. The RBI Governor has clarified that old currency not returned back will not decrease the liability of the RBI, and therefore will not be recognized as income.

2) Printing cost for the new stock of currency (net of scrap value of old notes): According to the RBI , there were 16.5 billion ‘500-rupee’ notes and 6.7 billion ‘1000-rupee’ notes in circulation on November 8. Each 2000 Rs note costs Rs. 3.73 to print whereas a Rs. 500 note costs Rs. 2.97 to print. Due to the movement towards digital and plastic transactions, we could assume that the currency required to run the country's business could be reduced by 25-50% (Note that 26% of the deposits made till Dec 3 have already been withdrawn by citizens. That number is likely to rise as withdrawal limits ease and currency is made more available). My estimate is that the cost of printing an adequate stock of new currency would be between Rs. 3000 crores and 5000 crores. 


3) Decrease in value of housing and land stock: According to PropEquity research, (a real estate data and analytics platform covering over 83,650 projects of 22,202 developers across over 42 cities in India), valuation in the top 42 cities in India, sold and unsold, will take a tumble and fall up to 30 per cent ( approximately  Rs 8,02,874 crores. If we were to include older urban housing, rural housing and land, the impact will be several times more.

4) Impact on GDP: Demonetization is likely to effect national output in several ways:

• Liquidity Reduction: As the availability of legal tender to conduct transactions is constrained for few weeks after the policy announcement, it impacts the ability of citizens and corporations in conducting transactions. This impact will get reduced only when adequate supply is made available and/or when citizens and corporations move to account-based transactions. As of October 2015, 233 Million citizens were still 'unbanked'. Even at full-capacity, the RBI printing presses will not be able to replace 50% of the stock of old currency in the next 4 months. This will impact cash-sensitive industries such as retail trade, hotels and restaurants and transportation, and in the unorganized (including agriculture) sector. These constitute collectively more than 50% of the economy, by my estimates.
• Confidence Reduction: As liquidity got sucked out of the system in one fell swoop, consumers and purchasing managers become more frugal. Their confidence in spending their savings/income/profits gets impacted. This is visible in the latest Nikkei/Markit PMI Survey released in early December. The Nikkei/Markit Services Purchasing Managers’ Index sank to 46.7 in November from October’s 54.5, the first time since June 2015 that the index has gone below the 50 mark that separates growth from contraction.It was also the biggest one-month drop since November 2008, just after the collapse of Lehman Brothers triggered the global financial crisis.“The latest set of gloomy PMI figures for the Indian service sector shows that companies were heavily impacted by the Rs500 and Rs1,000 banknotes ban,” said Pollyana De Lima, economist at survey compiler IHS Markit. The reduction in confidence will manifest itself across all sectors of the economy but particularly in luxury goods, automotive, jewelry, home appliances, and capital goods. These sectors have seen a 20-30% dip in business since November 8.
• Activity Reduction in Construction: As real estate prices are expected to fall by 20-30%, construction of new homes will slow down. This will impact activity in the housing/ construction sector. As secondary transactions dry up in the remainder of the fiscal year, the registration taxes collected by state governments will also take a significant hit.
• Productivity Loss: As people line up in queues for many minutes/hours per week (particularly in rural areas), there will be a significant loss in labour productivity. This impacts the unorganized and self-employed sectors more than other sectors.
• Economic stimulation by increased government spending: The government can negate the impacts of the above effects by increasing spending. The Finance Minister, Mr. Jaitley has already proposed an increase in budget spending of Rs 35,170 crores to fund rural jobs development, the RBI Monetary Stabilization Scheme, farm subsidies and higher pensions. However this number is less than 1% of the quarterly GDP of India, and is unlikely to fully negate the other effects.
• Vicious cycle effects: Even when liquidity is restored to 'acceptable levels' in 4 months, the ripple effects of the GDP de-growth will continue for a few months as people adjust to the 'new normal' (lost jobs/income in the unorganized sector, lost wealth for asset holders, etc). Of course, every government official and banker will try to convince the public that the future will be more rosy as the past, so that these vicious cycle effects are negated.

Various economists have indicated a 50 to 200 basis points reduction in GDP growth due to demonetization in FY'16-17. Due to the magnitude of the effects stated above, I personally believe that the impact will be much more. Even if the GDP for the 140 day period in FY'16-17 after the announcement reaches the same level as the GDP during the same period last year, the GDP growth for the year will have been impacted by more than 290 basis points. In my mind, it is likely that GDP impact is more than the gloomiest analyst's estimate (Ambit Capital's estimate of 330 bps impact in FY'16-17). Even if we assume that GDP growth is impacted by 330 bps in FY'16-17, that impact would total Rs. 4,95,000 crores!! Considering that taxes in India amount to 17.7% of GDP on average, the government's revenues for the last 2 quarters of the year will take a significant incremental loss.

Other Impacts: While I considered the impact of demonetization on future corruption and counterfeit currency, I believe these impacts will be short-term and insignificant. Counterfeit currency in circulation is estimated to be less than Rs. 400 crores. Counterfeiting will continue to be a challenge as counterfeiters find ways to duplicate the new currency.

What should the government do now?

1. Increase government spending in the rural and unorganized sectors. The 37,000 crore relief being planned may not be enough!
2. Increase social and welfare scheme funding to protect the weaker sections of society
3. Aggressively mine data from bank depositors to identify tax cheats. Raid premises to seize gold/jewelry/property documents that have not been disclosed in tax statements
4. Ensure that there is a taxable entity (PAN number) associated with each piece of real estate. Follow up with step 3.
5. State governments should reduce property registration fees and property tax to prop up the secondary market, and to disincentivize creation of future black money.

(Disclaimer: Please note that I am a business analyst and not an economist. So please do take my analysis with the requisite amount of caution. It is definitely not an advice to buy or sell any assets.)

In the 'Big Data' rush, let's not forget our 'Large Data' problems

As the Big Data hype cycle has swelled over the past two years, all sorts of people (hardware vendors, marketers, software vendors, business analysts, social media analysts, data scientists, etc) have jumped on to the bandwagon. Everyone wants a piece of Big Data on their resume, it seems.

Of course Big Data solutions (involving a NoSQL database and analysis to solve business problems that involve high velocity, variety, and volume of data) do have a huge potential to revolutionize marketing, customer care and supply chain in a host of industries.

However it seems to me that in this rush to find and solve problems involving 'Big Data', many companies are overlooking the potential to use large structured data-sets to transform their business. One of the applications of 'Large Data' is in real-time marketing. By 'real-time marketing', I am referring to the ability of the marketer to customize and automate marketing campaigns on a real-time basis.

If you think this is a trivial issue, answer the following questions:

1) How many marketers (OK, let's count Amazon, Macy's and Tesco out) send offers that are personalized to the browsing and transactional activity of each customer?
2) How many marketers put in an effort to customize their website landing page to the prior purchases of the customer or to the search term the visitor came from?
3) How many marketers customize the banners on their website to the preferences and the search history of the customer?
4) How many marketers follow the rule of not sending email to someone who hasn't responded to the last X offers? or set a rule for not sending more than Y communications to any particular customer?

...As it turns out, not a lot!

So as I said before, please get your 'Large Data' real-time marketing in order before you jump on to the Big Data bandwagon.

My 2 bits about the Bitcoin phenomenon

There is a lot of discussion about the BitCoin, the digital currency which is to be issued in finite quantity (21 MM Bitcoins in the next few years). The BitCoin has seen a sudden rise (and then a significant reversal) in its value over the past 2 months.

People who try to justify the value of the BitCoin point to its advantages:
1) Frictionless medium of commerce, devoid of banking interchange fees
2) Ability to conduct commerce across borders and circumvent local governmental/regulatory money restrictions

This logic holds good if the BitCoin holds its value over time or has a mildly increasing value over time (as was the case from its inception till early April 2013). Merchants who held the currency had the added advantage of BitCoin appreciation in addition to the 2 points above.

But the last few days (the decline from $266 to $120 per BitCoin) shows the risk of this 'asset' for merchants. Imagine a merchant that sold a widget worth $266 for a Bitcoin at the peak of its value. If the merchant held on to the BitCoin and exchanged it for dollars today, he would have to take a loss of more than 50%!

Clearly the lack of stability is a bigger negative than the 2 points noted above (unless you are a merchant in a country where you are willing to take the risk of getting an X% lower payment in an international currency than your local currency).

Thus I feel the usage of the BitCoin for international commerce will diminish.

Some of the latecomers to the party don't seem to fully comprehend the economics of this 'asset'. They think that the finite liquidity of the BitCoin, along with the divisibility of the BitCoin (upto 0.00000001 Bitcoins) make this a viable 'asset' class and medium of exchange (along with points 1 and 2 noted above).

I think the whole BitCoin phenomenon is similar to the Dutch Black Tulip bubble in the 17th century.

Companies that solve complex problems are issued BitCoins (similar to lucky or meticulous Dutch farmers who produced a single deviant tulip). This process is called 'mining'. These 'miners' are the only group of people on the planet who are given economic benefits by a herd of cheering 'investors', for doing an activity that adds no economic value to humankind (solving meaningless math problems).

I think this is going to end badly unless the Central bankers/ Governments caution investors against the perils of this digital tulip.

Sign-up discounts: Bad strategy for eCommerce firms

A lot of eCommerce players in the Indian eCommerce industry offer  up to 25% discount coupons on sign-up which give discounts up to Rs. 2000 (~$35). These include Jabong, Myntra, and fashionara, among others.

The logic that these players might be using for this strategy may be:
1) The discount coupons allow them to acquire new customers, that may remain loyal after the initial discounts are over.
2) They operate mainly in the apparel category where regular gross margins are 30-40% to begin with. So a 25% discount would not lead to a negative gross margin on each sale.

I think this is not a good long-term strategy because:
1) Based on chatting with a few young friends, I feel that most have figured out that they can use multiple email addresses to get multiple coupons. They don't use the same email address to purchase after the discount coupons are exhausted. This also leads to a problem of customer duplicates in the database of the eCommerce retailer.

2) A 25% discount on an item which had an initial gross margin of 35% may not sound like unprofitable business. However that calculation ignores the free shipping given to the customer and the cost-per-action commissions (up to 10% of the sale!) given by the website. This implies that the items purchased by these 'acquired customers' are often being sold at a negative margin. The terms of the discount coupons (e.g., 'Cannot be combined with other offers') mean that most signups occur for fully-priced merchandise during the regular season. This is clearly a double whammy.

3) Most of these online apparel retailers are getting into accessory businesses. The discount coupons are often valid on accessories. This converts what should be a regular, high-margin, attachment business into a money loser.

4) I imagine there would be a significant sales backlash when the sign-up discounts are eventually withdrawn.

My advice: The industry needs to move from rewarding customer sign-up to rewarding long-term customer loyalty.

Retail discounts and the illusion of success

I came across a blog post for a retail software product (which I will not name here), which said the following: "We have achieved great success with our product implementation at a European online auto parts retailer. Our product was able to deliver a 15% sales lift with an effective discounting of only 2.17%..."

I thought that sounded very good.

But then I indulged myself in a thought experiment: 'What sales lift does a retailer need to breakeven on an initiative which discounts the price by 2.17% below the regular price?'. Stop for a moment and answer that question within 5 seconds without pen and paper....

Now let's look at the math behind a 'successful' promotion

If you are an online retailer with gross margins of 20%, average CPA commission of 1% and net shipping costs (shipping costs less shipping charges to customers) of 6% of revenue, then your 'effective' margin is 13% of revenue.

To breakeven on a 2.17% discount, you would require a sales lift of 20% (!!!).

Here is a What-if scenario table which calculates breakeven sales lift for various levels of effective margin and discount:

Said in another way, to breakeven on a 2.17% discount with a sales lift of 15%, the European retailer would need an 'effective' margin of 16.7%. With 1% average CPA commissions and 6% net shipping costs, they would need a gross margin higher than 23.7%.

I doubt whether the European retailer broke even on the discount, because my thought experiment doesn't even include the cost of the software (which claimed 'great success').

The thought experiment is an eye-opener for eCommerce and retail companies who are willing to spend a lot on discount programs. Remember that even a harmless looking 5% discount requires a sales lift of 63% if your 'effective' margin is 13% (refer to the table above).

So that set off another thought in my mind: "What long-term strategic reasons would merit making an apparent loss on a discount program?"

Here's what I think are potentially valid strategic reasons for any retailer:

1) It is a short life-cycle/ shelf-life product (clothes, shoes, books, mobile phones, cameras, laptops, perishables) which is approaching the end of its season/life-cycle/ shelf life. As a retailer you are taking a strategic call that the cost and the risk of carrying inventory beyond the end of the season/life-cycle/ shelf life would be too high. However it is critical to distinguish long life-cycle products in short-life cycle categories (e.g., plain blue jeans, basic dress shoes, text books, reference books, etc) and ensure that you are not discounting those as much as the short-life cycle products.


2) Competition is discounting the same product heavily and you assess that you will not be able to sell the product at a 'regular price' later. This reason may often play along with reason 1. However it makes sense to use price comparison frequently (at least daily) to ensure that you are not pricing well below competition.

3) By discounting the product and taking a short-term loss, you estimate that you will be able to acquire new customers who will be loyal beyond the short-term. Many eCommerce companies seem to be thinking this way. My good wishes for pulling this strategy off :-)

Would love to hear your thoughts. If you need a copy of the spreadsheet behind the breakeven table (which has a more detailed working based on gross margin, CPA commissions, and shipping costs), please email me at raj AT knowledgefoundry.net

JC Penney's pricing experiments (continued)

I had written about JC Penney's failed experiments with reducing discount sales a few weeks ago (click here). I had made 4 points:
1) Everyday Low Price needs to be tested before being implemented
2) Need to continue store-in-store concept
3) Need good exclusive designers
4) Website needs major overhaul

I heard that they are getting discount sales back in the store (click here). They are also showing price comparisons for comparable products and maximum suggested retail price for each product.

While I think this is a good move, it will take significant effort to turn-around JC Penney. They will have to convince shoppers who have struck JC Penney off their shopping list to visit the store again...and that's not an easy task.

JC Penney's experiments with pricing and holiday season discounting

Around a year ago, JC Penney's CEO Ron Johnson announced their 'Fair and Square ' pricing policy, to wean customers off discounts and move towards a three-tiered pricing strategy that focused on 'Everyday Low', 'Monthly' and 'Best' price levels. This was supposed to reduce the number of annual promotions from 590 to 12, thereby simplifying the shopping experience (and allowing customers to 'shop anytime on their terms'). In August, they moved completely to an Everyday Low pricing scheme.

The strategy seems to have failed...last week JCP announced that their sales have dropped 26% year on year for Q3 and have dropped 23% year on year for the first nine months. Even the online business seems to have shrunk significantly (37% year on year in Q3!). It is burning through its cash reserves and may need to raise capital soon.

In the backdrop of these bad numbers, JCP announced that they will not be using holiday season discounting this year, choosing instead to hand-out 8 Million buttons that allow customers to get freebies. Shoppers can redeem the buttons online for a chance to win one of 20 million gifts by entering a unique code located on the back of the button at jcp.com/Christmas. On Black Friday, 100 vacations to U.S. destinations will be awarded, including trips to Los Angeles to see a taping of JCPenney spokesperson Ellen DeGeneres' show. One additional trip will be awarded each day through Christmas Eve, along with gift cards, holiday certificates and merchandise.

However Ron Johnson also announced that they will offer the company's lowest prices on Black Friday and Cyber Monday.

All this begs the question: Is JCP doing the right thing on the pricing strategy front? What else can it do before it exhausts its cash reserves?

1)  While Everyday Low pricing may be a great idea in grocery and household purchases, it may not be such a great idea in apparel because customers have different price perceptions for different brands. If most customers prior to January 2011 were drawn to stores by the discount sales on the jcp brand, they are unlikely to change their behavior abruptly. JCP needs to conduct focus groups and surveys to understand the pricing preferences of their customers (since their current understanding of their customers' preferences seems to be flawed). While modeling apparel sales using price data, we always model the 'price effect' (the effect of the effective discounted price) and the 'sticker effect' (the effect of the X% off sticker). An item marked at everyday $15 price may have lower sales than if marked at 25% off from a $20 price.

2) JCP needs to aggressively continue the store-in-store concept which seems to be working well for them.

3) They need to sign up good designers to design exclusively for them (like Target does).

4) The JCP website needs a major overhaul:

• The landing page has fewer merchandize displayed than most other apparel websites. While the uncluttered look may suit Apple stores well (with its limited range of products), it does not suit an apparel website very well. 
• The quality of in-image zooming is much inferior to the out-of-image zooming in other apparel websites. 
• Finally, the checkout page does not have recommendations for 'People who bought X also bought Y" which is usually very useful while purchasing clothes

Let me know what you think

Will Windows 8 hybrids kill laptops and ultrabooks?

Most PC companies are lining up tablets, hybrids and Touch-screen ultrabooks using the Windows 8 and Windows RT operating systems to be launched in October 2012 (click here for a Technically Personal article on the topic).

I wonder whether the Windows 8 hybrids will kill the Ultrabooks category? and what will happen to good old non-SSD laptops?

While I think that there is ample room for tablets and hybrids, I still think that Ultrabooks, non-SSD laptops, and even desktops will survive for a while. Here's why:

• Price: While few companies have given any indication of pricing, Samsung has announced a $1,199 price for the Series 7 hybrid (11.6" screen, Intel Core i7, 4 GB Ram, 128 GB SSD) and a $649 price for the Series 5 tablet (11.6" screen, Intel Atom, 2 GB Ram, 64 GB SSD). These are significantly higher  price points compared to today's Ultrabooks ($700-1000), non-SSD laptops ($200-700) and desktops (even lower). The tablet is priced lower than the current generation of high-end tablets (64 GB iPad at $699), but with bigger screen, and more memory.

• Screen size: There is a significant segment of corporate workers that do need a screen bigger than 14" for their work. I am sure 14" hybrids will eventually be announced. However I expect the price points to be much higher.

• Emergence of the touch-screen Ultrabook: HP has announced yesterday (click here) that it will be launching the Spectre XT TouchSmart (15.6" touch screen, with NFC for $1,399) and an Envy Ultrabook 4 (14" touch screen Ultrabook). This sub-category seems like a compromise between touch-screen, media-creation using keypad and large screen size. I personally don't see why many folks wanting a fixed keypad would want a high-priced touch screen. Imagine stretching out and touching the screen to consume media while the keypad is still fixed to the computer...too un-ergonomic :-(

For these reasons, I feel non-touch Ultrabooks, non-touch non-SSD laptops and the good old desktops still have ample market potential. Of course, I do expect the price war going on in non-SSD laptops and desktops to soon affect non-touch Ultrabooks... which means even better deals for consumers!

Let me know what you think!

What should Best Buy do to survive?...part deux

I blogged recently about Best Buy's problems and what I think it should do (click here).

Best Buy has come up with a new branding, service and store layout strategy in June (explained here in an Ad Age article).  Their new tagline is "Making technology work for you". They will change store layouts to aid customer decision making using Central Knowledge Desks, and will move the Geek Squad to the front of the store.

I recently read a Fast Company article by David Brier, a brand identity expert, about Best Buy's branding (click here). Here are some excerpts of the article:

Best Buy, your culture is about unloading inventory, not helping the customer. Taking a page from Apple’s retail strategy by adding “Central Knowledge Desks” will not replace doing something real and authentic. My personal experiences unfortunately have not changed what is inbred into your culture.

But let’s get more fundamental: That slogan is not only tired, it is a death sentence that is bland, old, worn, uninspired and not reflective of a single strand of your customer’s aspirations. It reeks of “marketing speak” and “committee-itis.”

The strongest brands stand for something as well being opposed something else...

• Apple is opposed to technology that sets the rules and asks people to adapt; it champions technology that adapts to the needs of the people.
• Nike stands for athletic achievement and is opposed to sitting on your ass.
• Dyson stands for no loss of suction and is opposed to stagnant complacency, first making obsolete the old guards of vacuum cleaners and then doing the same with their own technological solutions.

.. Best Buy, what do you stand for? Also, what are you opposed to? Until you answer those questions, the likelihood of rising from the ashes is grim at best.

Only after answering those questions can you honestly determine what to sound like, what to look like, what your design aesthetic is, and why anyone should care.

And if the best you’ve got is “Making technology work for you,” then the likelihood anyone will care is very slim.

 I tend to agree with David that a brand needs to clearly communicate what it stands for and what it does not. It is one of the essentials of clear differentiation in the customers' minds.

So how should Best Buy differentiate itself (and communicate what it does and does not stand for)?

As I discussed in the previous post, I think services should be a key part of Best Buy's revival (and survival) strategy. I feel, they should be saying "We sell, install, maintain and replace (if broken) technology devices. We do not  just stock the devices and leave it up to you to figure out which product you need, and handle the shipping, unwrapping, installation, maintenance and replacement of the device (unlike our competitors)."

I think "Making technology work for you" does capture parts of this message (and in this sense I disagree with David's assessment). Maybe Best Buy can do better by reinforcing the full extent of the differentiation message in their commercials.

Let me know what you think.

What should Best Buy do to survive?

Best Buy just announced a bad Q2 (click here). Same store sales are down in the US and significantly down internationally. Their operating income has shrunk 87% on falling margins and rising SG&A. Their services, mobile and tablets sales are the only bright spots in a fairly sad story on declining TV, gaming and computer sales. Even the shutting down of stores does not seem to have enabled them to stem the tide.

Here are excerpts from their earnings release:

FISCAL SECOND QUARTER PERFORMANCE SUMMARY
(U.S. dollars and square footage in millions, except per share and per square foot amounts)
	Three Months Ended
	Aug. 4, 2012		July 30, 2011		Change
Revenue	$10,547		$10,856		(3%)
Comparable store sales % change1	(3.2%)		(3.8%)		60bps
Gross profit as % of revenue	24.3%		25.4%		(110bps)
SG&A as % of revenue	23.1%		23.0%		10bps
Restructuring charges	$91		$0		N/A
Operating income	$33		$260		(87%)
Operating income as a % of revenue	0.3%		2.4%		(210bps)
Diluted EPS from continuing operations	$0.04		$0.39		(90%)
Adjusted (non-GAAP) Results2
Operating income	$124		$260		(52%)
Operating income as a % of revenue	1.2%		2.4%		(120bps)
Diluted EPS from continuing operations	$0.20		$0.39		(49%)
Key Metrics3
Total U.S. big box retail square feet	41.0		42.6		(4%)
Revenue per square foot (Domestic segment)	$857		$846		1%
Adjusted operating income per square foot (Domestic segment)	$41		$45		(9%)
Adjusted return on invested capital4	11.1%		10.7%		40bps

Fiscal Second Quarter 2013 Highlights

• Domestic comp store sales decline of 1.6 percent improved compared to fiscal first quarter decline of 3.7 percent 
• Domestic estimated market share maintained year-over-year 
• U.S. big box square footage reduced by 4 percent year-over-year; Domestic revenue per square foot up 1 percent year-over-year 
• Similar to the first quarter of fiscal 2013, International segment year-over-year operating income decline driven primarily by lower revenue in China, Canada and increased competitive conditions in Europe 
• Domestic segment total Services category revenue increased approximately 6 percent 
• Momentum grows in Domestic services with key partnerships announced recently: AARP, Verizon and Target  
• Domestic segment online revenue growth of 14 percent 
• Domestic segment connections growth of 11 percent 
• Domestic segment mobile phones comparable store sales growth of 35 percent 
• Domestic segment comparable store sales growth in tablets, mobile phones, appliances and eReaders more than offset by declines in gaming, digital imaging, televisions and notebooks 
• Adjusted (non-GAAP) Domestic segment year-over-year operating income decline driven primarily by lower gross margins in computing, mobile phones and televisions 

Best Buy today announced GAAP net earnings from continuing operations were $12 million, or $0.04 per diluted share, for the three months ended August 4, 2012 compared to net earnings from continuing operations of $150 million, or $0.39 per diluted share for the prior-year period. 

Revenue

	Three Months ended Aug. 4, 2012						Prior-Year Period
($millions)	Revenue		Change YOY		Comp. Store Sales		Comp. Store Sales
Domestic	$7,803		(2.2%)		(1.6%)		(4.1%)
International	2,744		(4.7%)		(8.2%)		(2.8%)
Total	$10,547		(2.8%)		(3.2%)		(3.8%)

The Domestic segment comparable store sales decline of 1.6 percent was driven by declines in gaming within the Entertainment revenue category, digital imaging and televisions within the Consumer Electronics revenue category and notebooks within the Computing and Mobile Phones revenue category. These declines were partially offset by comparable store sales growth in tablets and mobile phones within the Computing & Mobile Phones revenue category, the Appliances revenue category, and eReaders within the Consumer Electronics revenue category. The Domestic segment online channel revenue grew 14 percent compared to the prior-year period.

The International segment comparable store sales decline of 8.2 percent was driven by the lower growth in consumer spending in China and the continued impact from the expiration of government sponsored programs, which negatively impacted sales in Five Star. Market softness in notebooks, digital imaging and home theater in Canada also contributed to the International comparable store sales decline.

Gross Profit

	Three Months ended Aug. 4, 2012
($millions)	Gross Profit		Change YOY		% of Revenue
Domestic	$1,896		(6%)		24.3%
International	668		(9%)		24.3%
Total	$2,564		(7%)		24.3%

Domestic segment gross profit decreased 6 percent, reflecting a rate decline of 110 basis points compared to the prior-year period. The Domestic segment rate decline was primarily due to three factors. In mobile phones, connection growth and a mix into higher price point smart phones resulted in strong comp sales and gross profit dollar growth, although at a lower overall rate. Second, industry softness in computing resulted in increased promotional activity in the quarter to stimulate consumer demand ahead of the second half of fiscal 2013, which will include the Windows 8 launch. Finally, there was less favorable product mix within the television category.

International segment gross profit declined 9 percent, reflecting a rate decline of 130 basis points compared to the prior-year period. This rate decline was driven by Best Buy Europe and due primarily to increased mix of lower margin wholesale sales and promotional activity within a price competitive environment for mobile phones.

Operating Income

	Three Months ended Aug. 4, 2012
($millions)	Operating Income		Change YOY		% of Revenue
Domestic	$83		(65%)		1.1%
International	(50)		n/a		(1.8%)
Total	$33		(87%)		0.3%

What should they do to survive the onslaught of online retail (and the show-rooming effect) and of discount retailers?

I think the following measures would make sense:

• Continue to aggressively expand the services business by extending tie-ups to a wider range of partners (much like their VZ, TGT and AARP alliances). Become the preferred service partner for as many telecom and cable companies, and computer/ TV manufacturers as possible so that customers look to Geek Squad irrespective of the brand of device or service being consumed.
• Improve online buying experience. Bestbuy.com does not have a good recommendation engine ("People who bought this product also bought Y", "People who viewed this product bought X"), unlike Amazon.  Also BestBuy.com should clearly state its free shipping policy and clearly highlight the value of the store pick-up option.
• Continue to close down unprofitable stores
• Focus more on small kiosks at airports (mp3 players, DVDs, headsets) and on smaller store formats -- these locations have lower SG&A

Let me know what you think!

Pricing issues for Abercrombie & Fitch

I had blogged 3 years ago (click here) about why Abercrombie & Fitch should consider using selective (and end of season discounts) to increase volume so that it does not have an inventory pile-up. Most of the world might have considered me silly for saying that... A&F was hot, had raging sales growth and industry-high margins.

After 3 years, I hear this from a Reuters article in May 2012 of its Q1 report:

Abercrombie & Fitch Co (ANF.N) posted a sharp drop in profit and its first quarterly decline in sales at established stores in more than two years, leading to concern that a growing inventory could mean future discounting.

Its shares fell 13 percent to touch their lowest in more than two years on the New York Stock Exchange.Same-store sales, or sales at stores open at least a year -- an important measure of retail growth -- fell 5 percent in the quarter, and the teen clothing retailer forecast a tepid year ahead.

"While management didn't quantify international comparable sales ... we estimate total international comparables were down double digits," Paul Lejuez, an analyst with Nomura wrote in a note to clients. He noted this was the first negative quarterly comparable sales for the company's Hollister brand in Europe.

Net sales rose 10 percent to $921.2 million, but even that missed estimates.
Abercrombie said it ended the quarter with inventory up 44 percent, against the 10 percent rise in sales. Lejuez said that could signal more markdowns were on the way.
Abercrombie said margins were expected to improve throughout the year, but if it had to resort to discounting while rivals were selling clothing at full price, it could affect margins.

Earlier this month, American Eagle Outfitters Inc (AEO.N) raised its profit expectations for the first quarter sharply as it sold more clothes at full price.
Most clothing retailers, especially those that cater to teens and young adults, were expected to post strong sales for the first quarter as wardrobes were updated for spring breaks and warm weather.

For the first quarter that ended April 28, Abercrombie earned $3.0 million, or 3 cents per share, compared with $25.1 million, or 28 cents per share, a year earlier.


In Q1, ANF was holding 56 days of sales in inventory (the actual number is higher considering that I use cost of inventory and price of sales). Its gross margin has reduced to 62.5% (down from 66% 3 years ago)...but still significantly high compared to industry average.


According to this AP report:
Abercrombie & Fitch announced in June that it was closing 180 U.S. stores over the next few years. The chain had already closed 135 under-performing U.S. stores in two years. The closure will primarily be among its namesake and kids brands but it also plans to close a few Hollister stores as well. 

I will be watching their Q2 results on Wednesday to see how this story develops.

Customized database marketing for Indian e-commerce

Most of the players in the Indian e-commerce market are losing money.

My friend, Sanjay Dattatri has blogged about the challenges facing Indian e-commerce (click here). As he points out, Indian consumers are price-sensitive, dis-loyal and ill-behaved. I tend to agree with him.

As Sanjay points in another blog post, pricing sanity needs to prevail (click here). I agree with him on this one as well.

I do think that e-commerce vendors in India need to adopt a more customized approach to marketing and pricing. After all, aren't online marketers supposed to know all about their customers' buying behavior, browsing, email response (and customer care calls).

Why give the discount to all your customers when the reality is that some customers value your brand and superior delivery performance (and couldn't care less about the few rupees extra for that). The vendor can give a golden treatment to these price-insensitive customers by giving differential free shipping terms, and loyalty points. Some players like indiaplaza and healthkart do have a loyalty program.

On the other hand, one cannot lose out on selling to the price-sensitive customers, who will switch on a better deal available somewhere else.

The only way out is customized database marketing.

In my opinion, e-commerce vendors need to stick to the following rules of customized database marketing:

1) Target your discounts at customers who are likely to shift their purchases from your competition to your website, when given a discount. Examples of these customers include:

• Customers who bought a regular purchase like clothes, or diapers, or books, or groceries or nutritional products many months back and have not purchased since. I was delighted to see that healthkart sent me a  customized coupon code for whey protein 6 months after my first purchase. They avoided giving the discount to everyone as they know they have targeted a potential buyer. The key is to send out a customized coupon code which works only with the specific customer's login.

• Customers who have browsed a particular product or a category for a long time and not bought that product/ category. This can be done only when the customer is browsing with his cookie activated, and the e-commerce vendor is smart about tracking browsing behavior. A classic example would be a books-buyer browsing a mobile phone product page, getting a customized offer. My recommended approach would be to price the product at slightly higher than competition for the masses, and to give a discount coupon to customers who browsed and did not buy. (Quick programming note to vendors: Please don't send discount coupons for lingerie to men who are just browsing. But for that you've got to read the next point.)

2) Get to know more about the customer (even though you may know nothing to begin with). I get shocked when online retailers say that they deliberately have no information about their customer other than their user ID, name and shipping address. As a trusted seller you should try to get more information about the customer. Incentivize customers to update their profile online (such as gender, date of birth, marital status, interests, etc). The Payback program (called imint earlier) did that when they transitioned. When you know that you are dealing with a single guy who has never bought women wear before, you can stop sending him lingerie ads and coupons. Also some interesting things you can do with demographic data:

• Promote Gudi Padva to Maharastrians, and Onam to the Keralites and Eid to Muslims (irrespective of where they live)! -- if you can classify names by mother tongue and religion
• Promote kids items to families with kids

3) Send personalized recommendations/ suggestions, by putting yourself in the customer's shoes. Most e-commerce vendors are using formulaic recommendation engines which give recommendations based on the customer's last purchase. Ideally the recommendation engine should be based on the basket of goods purchased by the customer in the last 6 months.

Also, the recommendation logic needs to be altered for capital goods purchases (mobiles, electronics) vs. regular purchases (books). A mobile phone buyer does not need recommendations on what other similar mobile phones to buy! However a book buyer may appreciate recommendations on which other similar books to buy. For the mobile phone buyer, a list of accessories which go with his/her phone may be useful, but a formulaic recommendation engine may not capture that.

More later...let me know what you think!