As a market researcher, I have always been intrigued by what is known as the “observer effect,” whereby the mere observation of a phenomenon changes the phenomenon observed. I am keenly aware of it when I design a survey instrument. What’s measured takes on the utmost importance, but when the wrong variables are measured, no matter how accurate the measurement is, the whole study is pointless, even worse, it leads to the wrong conclusions.
It was the “observer effect,” and the damage that can be done by measuring the wrong things, that immediately came to mind when I studied a new report from Deloitte entitled The Future of Retail Metrics: Measuring success in a shifting marketplace. Its conclusion is that companies should make fundamental changes to how they define success and to what they measure.
The report goes on to explain, “Traditional retail metrics do not align with the configuration of the industry today and are not suited for the evolution we can expect in the future. If today’s metrics aren’t painting an accurate picture of the businesses we are trying to measure, then the logical move is to change our perspective.”
Traditional Retail Metrics Are Garbage-In, Garbage-Out
In other words, traditional retail metrics result in “garbage-in, garbage-out,” and no retailer can afford that anymore in an industry where customers have endless retail opportunities due to the proliferation of new retail business models.
The report goes on to break down what’s wrong with traditional retail metrics and why they don’t work today. One of the chief problems is that different metrics need to be applied to retail businesses at different stages of development and operating under different business models.
For example, startup companies are measured by customer/sales growth, funding and investments. Growth-phase companies are measured by sales/customer growth, but also digital sales growth, retention rates and margins.
Then for mature-phase retail businesses, some of those metrics are thrown out in favor of comp sales, sales per-square-foot, digital sales growth, margins, earnings-per-share, return-on-invested-capital and free cash flow.
However, the report argues: “If competing companies – no matter where they are in their growth cycle – are playing the same game and vying for the same share of wallet, then performance metrics should use the same set of rules and methodologies.”
Deloitte proposes a different metrics model that levels the playing field and measures consistently across all retail companies at every phase of development. It is one that looks at how companies leverage their customer base, deliver on their core businesses, create a sustainable profit model and deliver solid returns on capital.
Specifically, the new retail metrics model needs to be:
- Channel-agnostic to give a holistic view of the complete organization.
- Inclusive to address all retail formats (core physical and digital retail, membership and co-ops, stores within a store), channel approaches and fulfillment methods.
- Value-driven that identifies the parts of the business that drive value for the organization and investors.
- Operationally accurate to reflect the operations of the business, not simply financial ratios.
- Balanced so that the metrics place equal measure on growth and profitability and focus on recent performance.
New Retail Metrics Must Measure Value Across the Full Range of Business
In order to achieve those objectives, Deloitte has identified two key metrics that quantify value at the front end, specifically how the retailer creates value by acquiring customers and sustaining ongoing profitable customer relationships, and three that measure the back end, including data that reflects enterprise value and measures top- and bottom-line performance and investment. Taken together, these five measures give a broad-based framework that quantify the business.
The front-end, value-creation measures are defined by these two variables:
- Retail profit per transaction – This metric measures how profitable retail operations are for each transaction. It is channel agnostic and works for all methods of fulfillment. The report states, “This measurement allows for a like-to-like comparison across companies to see which organizations are most and least efficient in managing retail profitability in each customer interaction.”
- Sales per unique customer – This metric focuses on the lifetime value of a customer, measuring the total customer base and their purchases per year, or even less frequently for large-scale purchases.
The enterprise-value measures, which are described as a more traditional view of business performance and company evaluation, include:
- Revenue growth — This is a comprehensive top-line view across all retail operations and revenue streams, including both core retail and ancillary models.
- Return on invested capital (ROIC) – This measures how the organization is investing in modernizing its operations to keep pace with the industry and competitors.
- Free cash flow (FCF) – This provides insight into the retailer’s controllable cash flow and how it relates to current investments. It reveals how much money can be returned to stakeholders and invested in future operations.
With this comprehensive view across a retailer’s entire value chain, corporate executives will achieve perspectives on how well strategies are working – or not – to move each variable measured. And analysts and investors will be able to make direct comparisons of retailers at different development stages and across different business models and platforms.
For example, the Deloitte report compares three different retail businesses – traditional large format with 90 percent of sales derived in physical locations; a digital, vertically-integrated, direct-to-consumer at early growth stage; and an online-focused retailer with profits derived from financing, subscriptions, third-party sales, advertising revenue and consumer services. It then compared them using standard sales per square-foot and same-store sales metrics. They took data directly from publicly reported financials to make the comparisons. Obviously, these metrics only work for the traditional retailer.
By using the newly proposed metrics, reliable comparisons can be made across all three companies. The traditional format retailer leads in retail profit/transaction but is weakest in revenue growth. The digitally native DTC retailer takes the lead in sales/unique customer and revenue growth but is weak in retail profit/transaction and free-cash-flow. The online-focused retailer leads in free-cash-flow and is also strong in revenue growth and return on invested capital but is weak in retail profit/transaction.
New Retail Metrics Give Apples-to-Apples Comparisons
What is most important about these five metrics is they allow apples-to-apples comparison of different retailers at different stages of growth and using different business models, something that traditional metrics don’t allow.
Widespread implementation of this new retail metric model would answer a need that Deloitte identified in a survey with 25 retail CFOs and financial executives, where 88 percent said their companies are rethinking their metrics to more accurately align with cross-channel operations. Further, only about one-third said their internal metrics “really align” with how they measure themselves externally.
And only two of the retail CFOs/financial executives believe their organization’s traditional metrics properly position them to address changes in the retail market. I would venture to say those two retailers are either now or will soon be swept under in the retail apocalypse.
How a company measures its success is how it defines its goals. That is what the organization works towards, but that can mean ignoring other critically important variables that don’t factor into their scorecards. Measuring the right things in retail, not just the easy, convenient or traditional things, is critical now as retail is changing so rapidly and consumers have so many choices.
As Matthew Shay, president and CEO of the National Retail Federation says, “The current suite of metrics was built for a time that no longer exists. The lines between channels have blurred beyond recognition, making it challenging to properly attribute a sale with these outdated metrics.”
The Deloitte study presents a new set of retail metrics that is more comprehensive and measures a wider range of variables. They give a more insightful read on the state of the business now and into the future.
In closing, I can’t agree more with Deloitte’s final comments, “Companies should dig deeper into their numbers to better determine how and where they are generating revenue, who their customers are, and how they can drive additional income from customer acquisition and retention. Implementing and holding true to a new set of metrics should allow the entire industry to more effectively assess value creation and value capture.”