Asset-based lenders can place themselves in a stronger position to realize incremental opportunities in the e-commerce sector by understanding some basic “rules of the road.” In this article, we provide a high-level overview of the unique elements of the e-commerce model that contribute most decisively to the value an online retailer and its lenders will realize in an inventory liquidation process. We then consider specific metrics and best practices that can enable asset-based lenders to plan ahead for potential dispositions in this sector and develop a clearer picture of a given inventory’s value as collateral.
E-Commerce Disposition Processes: Key Drivers
There are a number of similarities between traditional brick and mortar going-out-of-business (GOB) events and their online counterparts. The success of each type of event hinges upon a number of critical determinants including brand awareness; recent sales and traffic trends; the assortment, age and seasonality of the inventory; the capabilities of the company’s systems; retail pricing and promotional activity; and the company’s ability to retain essential staff, especially technical and other highly-trained personnel.
Despite these similarities, however, there are also unique and differentiating factors of a successful online liquidation. In order to optimize the outcome of an online GOB event, retailers and their lenders should be prepared to take advantage of the unique benefits of the e-commerce channel while guarding against its potential drawbacks. For the purposes of this discussion, we have simplified the key drivers in this process into the following two categories:
E-commerce sales and inventory reporting
Detailed sales and inventory data can provide a granular and highly accurate view of an e-tailer’s sales prospects in a liquidation scenario. At the commencement of the sale, the process of identifying slow-moving, aged and other inventory that may be difficult to sell is critical. An in-depth review and analysis of the retailer’s sales and inventory data will expose problem SKUs and allow for a more aggressive discounting approach from the start on those items. By taking a pro-active approach to targeting this problem merchandise, retailers can increase overall sell-through expectations and decrease the quantity of inventory to be sold through wholesale channels at the end of the event at a low recovery.
Key e-commerce sales and inventory metrics to focus on in this area include:
- Website traffic, including page views, unique visitors, number of referring websites and search engine rankings
- Sales transaction metrics, including average order size, orders per month, and units per order
- Drop-ship (consignment inventory) sales to owned inventory sales ratio
- Inventory turnover and weeks of supply analysis by SKU
- Return and chargeback rates; high chargeback rates can indicate negative customer reviews and/or systemic customer service problems. Unusually high return rates may indicate weaknesses in systems capabilities or product quality issues.
- Fulfillment rates; low fill rates could indicate issues with buying and replenishment, as well as high system lag times and error rates.
Online Brand Equity and Marketing Practices
An e-tailer’s reputation for delivering quality products accurately and on time helps to build a loyal customer base and establish the e-tailer’s online brand equity. When a company finds itself approaching insolvency, sometimes these principles are sacrificed due to cash constraints, making it important to take action quickly to preserve brand equity so as not to hamper the results of a GOB sale event.
Online retailers can achieve this goal through targeted and efficient use of digital marketing tools such as Facebook, Twitter and daily emails to communicate with customers in real time. This allows for greater flexibility in adjusting sales tactics to optimize the outcome of the GOB event by communicating changes in pricing and incentives to customers immediately. Further, companies with strong and effective online advertising practices (including email marketing, ad retargeting and customer loyalty programs, among others) will be well-positioned to optimize value in a liquidation event.
Key metrics/factors that can help an ABL determine an e-tailer’s strength in this arena include:
- Website functionality. The functionality, user-friendliness and security of the e-tailer’s website are crucial to driving sales while maintaining customer trust both prior to and during a GOB event.
- Strength of the retailer’s email list. Customer email lists — and a company’s ability to leverage them to drive sales — can provide a key indicator of customer loyalty and help e-tailers project sales results from their “core” customers in a GOB event. ABLs should focus in particular on subscribe rates versus unsubscribe rates in order to assess whether the number of core customers is growing or shrinking.
- Strength of social media presence. Large followings on Facebook, Twitter and other social media channels can be a strong indicator of a retailer’s strength in the marketplace.
- Sales generated through referral networks and attendant economics. Online retailers that generate a high percentage of sales through affiliated referral channels should factor in the impact of commissions and expenses in a liquidation event, including potentially reduced margins.
- Overall reputation in the marketplace. A borrower’s reputation among customers, while somewhat subjective and fluid, nonetheless represents a key indicator of a GOB event’s prospective outcome. ABLs can monitor an e-tailer’s reputation by following online reviews, comments from and relationships with key bloggers, and the strength of the company’s affiliate relationships.
Positioning ABLs & Borrowers to Maximize Inventory Values
In order to prepare for an online liquidation process and develop a clearer picture of the appraised value of an e-tailer’s inventory, asset-based lenders should consider the following measures:
- Conduct an SKU-level inventory analysis during the appraisal process. While most ABLs that work with brick-and-mortar retailers are familiar with department-level inventory analyses that gauge stock-to-sale ratios and other metrics, e-commerce companies’ more sophisticated systems offer a greater level of depth and provide opportunities to develop more precise predictive analytics that can guide lenders and borrowers in a GOB event.
For asset-based lenders, developing an understanding of an online retailer’s inventory at the individual SKU level as early as possible can help to identify potential problems (such as small quantities, broken size runs or slow-moving goods) that may crop up in a liquidation scenario. Lenders and e-tailers can then plan accordingly by, for example, adjusting initial discount levels or initiating other promotions on a strategic basis. Borrowers and lenders should also work together to determine appropriate guidelines on when to take down remnant SKUs (i.e., those for which only one or two items remain in inventory) that will be wholesaled at the conclusion of the sale.
- Factor in the potential impacts of ongoing returns during the disposition process. In a traditional brick-and-mortar GOB event, a “No Returns”/“All Sales Final” policy is commonplace or expected. This policy does not always work in the e-commerce sector, however, as customers may expect to have the option to return goods purchased online despite the GOB nature of the event. This is especially prevalent in the apparel, footwear and jewelry sectors, where a customer’s need to touch, feel and try on the item is crucial. The strategy for accepting returns will vary depending upon the product classification. In our experience a certain level of discounting will ultimately outweigh the customer’s hesitation to buy, regardless of the “All Sales Final” policy. By anticipating the impact of this dynamic — and making effective use of sales and inventory data to minimize the total sale term — asset-based lenders can position themselves for better outcomes in liquidation scenarios.
- Understand the potential effects of promotional pricing and incentives on final value. ABLs and borrowers should work to develop a clear understanding of the incentives needed to drive sales, but should remain mindful of the potential impacts of various discounting options. Free shipping promotions, for example, may draw in consumers and speed up the term of the disposition process, but they may also increase the expense burden the company bears if shipping is typically paid for by the customer.
- Customer service functions should be “business as usual.” Maintaining consistent customer service functions, including call center and live chat operations, is crucial. ABLs should understand that an e-tailer’s ability to draw on its email lists and existing marketing data to drive sales in a GOB event is contingent on the company’s ability to continue to deliver on its customers’ expectations. Throughout the process, e-tailers should adhere to the same standards of authenticity, transparency and consistency that they would use in normal course operations.
- Double-check all relevant legal agreements. In cases where a third party manages e-commerce functions, lenders should examine all related legal agreements to ensure they have the ability to sell the inventory through all channels (online, retail store or wholesale). Additionally, maintaining the ability to utilize certain third-party services to maintain normal course sales and fulfillment operations is essential. Lenders should also work in advance to develop a clear understanding of any terms governing ownership of URLs and other critical intellectual property in a GOB scenario.
By bearing in mind the best practices and key metrics mentioned above, ABLs can leverage the strengths of the e-commerce model to anticipate possible liquidation scenarios in the sector, develop a clearer sense of the value of e-tailers’ inventories and maximize the odds of success as they deploy capital in this segment. Asset-based lenders can also position themselves to realize strong returns in the e-commerce sector by partnering with third-party advisors that have both significant resources and hands-on experience in this market in order to best assess and execute on their options in this arena.
Ann Merrill is co-president of the Appraisal & Valuation Division of Gordon Brothers Group. She can be reached at amerrill [at] gordonbrothers [dot] com.
Rick Edwards is a principal & managing director in the Retail Division of Gordon Brothers Group. He can be reached at redwards [at] gordonbrothers [dot] com.