Benchmarks provide a powerful tool for assessing why a business is succeeding – or not

Benchmarks provide a powerful tool for assessing why a business is succeeding – or not

This is the first of a series of two in-depth articles focusing on how a fashion company can convince external stakeholders (investors or banks) and indeed itself (directors, management and staff) that the targets set out in budgets and range plans are both fair and achievable.

After many years looking at business plans, I am still surprised by how often the finance department uses an "it's like last year (season) but a little bit better" method to produce budgets and forecasts. I am also sometimes surprised at how bullish and optimistic budgets are. The over-optimistic ones are usually driven by the chief executive's hubris and belief that he/she can work a profitability miracle on what is often a sick patient.

This first article will outline the principles of benchmarking, which can be done from internal data, external inputs, or both. The second article will address mistaken hubris, which has led to business difficulties, and the need to make cuts. They can be read independently, but are better considered as a paired combination.

Inevitably, on a subject of this nature, some budgeting and planning mathematics is required. Also, it has to be said at the outset, there is no such thing as one set of benchmarks. Those for a budget value retailer (think Primark) will be completely different from those for a designer brand (think Prada). As always, you have to know your Prada from your Primark.

The imaginary, but realistic company I have chosen to profile and benchmark is what in the US would be called "better." That means that it sells merchandise in the second price quartile, below the designer labels and luxury brands, but above the mass market and fast fashion companies. It is a complex business, because, as with so many today, it is multi-channel.

  • It has its own brand, which it designs in house, has manufactured by third-party independent factories, and sells to 400 customer stockists across the world.
  • It has 100 own retail shops, which sell purely its ranges. They are in UK, Asia and US.
  • And it sells on its own website direct to consumers (a D2C, direct-to-consumer business). It does not sell on other people's websites, nor does it sell on social media.

Benchmarking methodology

It is known that benchmarking is measuring the causes or objectives of targets, not the outcomes. They are analogous to KPIs. Often, the two ideas are merged together.

Benchmarks will be set for sales. In this case set for the three different selling methods: retail shops, e-commerce to individuals, and wholesale to customer accounts. They will also be set for markdown losses, for margins, for overheads, and for warehousing and distribution. All of this will drive the ultimate end result of operating profit before interest and tax. Benchmarks are not set for either interest costs or for tax. The former is out of the hands of operating management, being determined by the capital structure and funding of the business. The latter is set by the government.

Sales benchmarks

There are three sets of sales benchmarks. They are shown in Tables 1-3 below.

Table 1: Sales benchmarks – Retail shops

Retail shops
Total shop sales£100,000,000
ShopsNumber100
Average sales per storeYear£1,000,000
Average sales per storeWeek£20,000
Average sales per storeDay£2,857.14
Average price per unit£75
Units sold per storeWeek267
Stock per storeUnits2667
Weeks of stock cover10
Sales densitySq Metre15
Average store sizeSq Metre178
Sales densityYear£5,625

Although our business is likely to have multiple store grades, for benchmarking purposes an average has been used.

  • An average store is benchmarked to sell GBP1m a year; approximately GBP20,000 a week. It is over-complex to set exact benchmarks. This is regardless of what season it is – autumn/winter or spring/summer – and what merchandise the stores are stocked with.
  • Using an estimated average retail price of GBP75 per garment derives benchmark unit sales of 267 garments per week.
  • Targeting stock of ten weeks cover, gives average stock-holding of 2667 garments.
  • Operating on a stock density of 15 garments per square metre, as recommended by our visual merchandisers for the best "look" of the store, means that the average store is 178 square metres.
  • And finally, dividing sales per year of GBP1m by the average store space of 178 square metres, means that our business is working to sell at a sales density per year of GBP5,625. This conforms to a reasonable target for "better" retailers.

Our shops now have benchmarks that create retail store sales of GBP100m.

Table 2: Sales benchmarks – E-commerce

E-commerce
SalesYear£10,000,000
SalesWeek£200,000
SalesDay£28,571.43
Average price per unit£75
Units sold on websiteWeek2667
Average units per transaction1.3333
Customers perWeek2000
Customers perDay286

Different benchmarks are needed for e-commerce sales, because:

  • There are no shops, and therefore neither space nor sales density.
  • Distribution is from the warehouse direct to individual consumers.

Those that have been chosen for e-commerce are:

  • Sales per year on the website of 10% of shop sales, giving a total of GBP10m for a year and GBP200,000 a week.
  • With the same average price as used for the physical shops (our company does not discount its web-sold merchandise) this generates sales of 2,667 units per week.
  • The historic units per customer transaction have been 1.333 for some time. Continuing to use this gives 2000 customer transactions per week. This will be important for warehouse benchmarks.

Finally in this section, benchmarks are set for wholesale sales.

Table 3: Sales benchmarks – Wholesale

Wholesale
Number of customer accounts400
Average sales per customerYear£15,000
Wholesale sales perYear£6,000,000
Average wholesale price£25
Units per account perYear600

The number of customer accounts is taken from the past performance at 400, with the average customer purchase (our wholesale sales) per year of GBP15,000. Using that figure:

  • There are wholesale sales of GBP6m.
  • The wholesale price is GBP25 (a mark-up of 3 to retail), and this gives a benchmark of 600 units per average account per year.

Markdowns and margins

Markdowns have simply been taken at last year's percentage of 4.16% on this budget year's sales.

Table 4: Markdown losses

Markdown losses
Mark down loss perYear£4,830,000
Mark down loss%4.16%

Table 5: Margin benchmarks

Margin benchmarks
Total company sales£116,000,000
Company sales exc VAT£96,666,667
Sales ex VAT less markdowns£91,836,667
Total company margin£55,756,667
Margin % on ex VAT sales%57.7%
Mark upNumber3.0398
Cost of purchases£36,080,000
Units purchasedYear1,700,666

Margins are a bit more complex. A separate calculation has been made of the:

  • Retail GBPs money margin for both stores and e-commerce based on 65% (a mark-up of 3.4286).
  • Wholesale margin of 20%, based on the average wholesale selling price of GBP25 and the average merchandise purchase price of GBP20.
  • This allows the derivation of certain benchmark outcomes that will be needed for overheads and the warehouse, namely sales at full retail price, sales exclusive of VAT (we only sell adult clothing), markdowns and total company purchases – thus deriving achieved margin after markdowns.
  • The weighted average achieved margin of 57.7% (an average mark-up of 3.0398).

Overheads

Table 6: Overheads

OverheadsEstimated at
Retail space cost% retail sales16%
Retail staff cost% retail sales24%
Head Office staff cost% all sales10%
Head office other costs% all sales5%

These are much simpler. Each is a simple % of sales, as shown in Table 6. The sum of the four elements adds up to a bit less than the company margin target, hence leaving some operating profit.

Warehousing and distribution

The final element of the benchmarks is the warehouse.

Table 7: Warehouse and distribution

Warehouse and distributionUnits
Receipts perYear1,700,666
Receipts perWeek34013.32
Sent to retail storesWeek26667
Sent to e-commerce customersWeek2667
Sent to wholesale customersWeek4800

For this article we are only using receipts and despatches benchmarks for eventual staff number purposes. In fact, these calculations can be used to plan new warehouse configurations and the required square metres of space.

The units received in a year and the average for a week are taken directly from the last margin benchmark in Table 5. The units despatched are an average derived from each of the three selling methods.

The budget for a year

The benchmarks in Tables 1-7 have been exploded into an annual budget. To make it look more realistic, it has been split into two seasons and presumed to be for autumn/winter and spring/summer.

Table 8: Next year's budget using benchmarks

AW budget (GBP millions)SS budget (GBP millions)Yearly budget (GBP millions)
Sales at full price, retail52.0048.00100.00
Sales at wholesale prices3.202.806.00
Sales through retail e-commerce5.005.0010.00
Total sales at full price60.2055.80116.00
Sales excluding VAT50.1746.5096.67
Markdown losses2.512.334.83
Net sales after markdowns47.6644.1891.83
Cost of sales (purchases)18.7617.3336.09
Achieved gross margin28.9026.8555.74
Overhead costs
>>Retail space cost8.108.1516.25
>>Retail staff cost12.4012.1024.50
>>Head office staff cost4.854.859.70
>>Head office other costs2.402.404.80
Total overhead costs27.7527.5055.25
Operating profit before interest and tax1.15-0.650.50

Our company's seasonality is skewed in favour of autumn/winter, which consequently has a better operating profit. This is in spite of reductions in markdown loss and total overhead costs in spring/summer. The yearly budget is based entirely on the benchmarks from Tables 1-7, and shows a small operating profit.

The organisation chart

A mixture of staff calculations from the benchmarks and our company's current staff position allows a calculation to be made of staffing numbers required for the delivery of the budget. The staff numbers are shown in the organisation chart below.

The budget requires a staffing level of 999, split (mostly according to historical reasons) into:
– 4 directors
– 2 heads of (brand and wholesale)
– 31 senior management
– 129 junior management
– 782 clerical workers
– 51 hourly paid staff

Of this total:
– 850 are shop staff
– 52 are warehouse staff
– and 96 are head office staff

These numbers will assume extra importance in the second article.

The effect of small improvements on the benchmarks

Small improvements in benchmarks have a dramatic impact on the resultant operating profit. I am assuming only 1-2% improvement on certain key benchmarks:

  • If sales density improves by 1% from GBP5,625 per square metre per year to GBP5681, then operating profit would rise to GBP0.98m from GBP0.50, effectively doubling.
  • If in addition, e-commerce prices improve by 2% from GBP75 to GBP76.50, by charging for delivery, then operating profit would rise to GBP1.07m.
  • If in addition, wholesale prices improve by 2% from GBP25 to GBP25.50, then operating profit would rise to GBP1.13m.
  • If in addition, markdown loss reduces by 2% from 4.16% to 4.08%, then operating profit would rise to GBP1.23m.
  • If in addition, gross margins improve by 2% from 57.7% to 58.85%, then operating profit would double again to GBP2.36m.
  • If in addition, retail staff costs were cut by just 1%, then operating profit would rise to GBP2.60m.
  • If in addition, head office staff cost were reduced by 2%, then operating profit would rise to GBP2.80m.
  • Finally, if in addition warehouse costs were reduced by 2%, then operating profit would rise to GBP2.89m.

GBP2.89m on sales of GBP117.32m is a return on sales of 2.5%, which is respectable in the circumstances, and would be deemed by most to be an achievement.

Conclusion

Benchmarks provide a powerful tool for assessing why your business is succeeding and, more importantly, why it is not.