Dick Smith’s Nick Abboud ignored the golden rule of retail

STEPHEN BARTHOLOMEUSZ
September 9, 2016
The Australian
After the first week of public examinations of former Dick Smith executives and non-executives, the key flaw in the group’s business model that led to its collapse early this year appears to have been identified. It was unwittingly running something analogous to a retailing version of a Ponzi scheme.
In a Ponzi scheme, apparent (and usually high) returns to investors are paid, initially from their own capital and then from the funds contributed by subsequent investors in an ever-expanding cycle — until it collapses when the flow of new capital dries up.
In Dick Smith, there wasn’t the fraud associated with Ponzi schemes, but apparent incompetence. An inexperienced chief executive took some perhaps half-understood advice from a vastly experienced mentor and pushed it beyond its limits and drove Dick Smith into the corporate graveyard.
In evidence to the hearing in the NSW Supreme Court, former Woolworths senior executive, Myer chairman and Dick Smith director Bill Wavish said he had encouraged Dick Smith CEO Nick Abboud to maximise the group’s rebates from suppliers.
“There seems to be a view that rebates are bad. Rebates are good. Retailers cannot survive without rebates and, for most companies like Dick Smith and Woolworths, rebates exceed profit. You don’t try to avoid maximising rebates,” he said.
“Everybody knew. It was the whole business strategy.”
That’s true, to a point. Every good retailer tries to get their suppliers to provide their working capital to reduce their need for bank funding. Extended terms from suppliers, promotional support and incentives creates an opportunity to sell products and generate cash before they are actually paid for.
While Wavish, who left the Dick Smith board in March last year, said the issue was how rebates were accounted for and whether the auditors were happy about it, he left out the major dimension to the rebate issue, the stock they are associated with.
One of the startling insights into the blowout in inventories on which Dick Smith ultimately choked was in October last year, three months before the collapse, the company secretary emailed Abboud asking why the group was holding nearly 12 years’ worth of home brand batteries. The answer involved stocking up for planned marketing activities in the lead-up to Christmas.
Another bizarre insight from the former company secretary, David Cooke, came when he was questioned by the counsel for the receivers, Ferrier Hodgson, about a document outlining a strategy for improving cash conversion.
“Sell private label products bought at 98 cents back to supplier at 78 cents and rebuy it at 78 cents, or even 77 cents, with a risk-related adjustment to overs and aboves (rebates and other supplier support) … it would generate cash and make a profit,” it read.
Not surprisingly, Cooke said he didn’t understand what that meant, or how such a strategy might generate cash and profit.
As Dick Smith delved deeper into the marvellous and seductive world of rebates its inventory levels were climbing and its cashflows were declining.
Wavish said that until December 2014 the company’s inventory levels were around $250 million, rising by about $100m as the peak Christmas sales season approached, and then subsiding by February. By January and February of 2015, however, inventories were $100m too high and provided his “first orange light.”
Former non-executive, and Lion chief financial officer, James Tomlinson, who only joined the board last April, said he was concerned about the company’s expansion of its private label products and the booking of rebates against those products and had raised a “red flag” in an email to board members about a spike in inventories and $65m to $75m of negative cash flows.
“We’re attributing this to a private label inventory build-up. Seems like a lot of private label to me,” he wrote.
Tomlinson, who said he was ready to resign by December because of the company’s positions with suppliers, inventory and cash flows, said Abboud was a good retailer but out of his depth as a CEO.
“It was an issue of competency, not one of dishonesty or deceit,” he said.
“Dick Smith failed because of a poor strategy, leadership from the top and a breach of trust.”
He had been concerned about the push into private label products because it had no competitive advantage. He wouldn’t buy a Dick Smith-branded television and he doubted anyone else would.
Dick Smith, post-listing, was expanding both its store network and product range rapidly even though same-store sales were shrinking and inventory levels were climbing.
Last May, Abboud told an investor conference that the group had invested in inventory “ahead of the sales growth curve” to take advantage of the strength of the Australian dollar. The excess inventory position would be unwound in the December half. Instead, last November, Dick Smith shocked the market with a $60m impairment of those inventories.
It appears Wavish, in advising Abboud that pursuing rebates was the key Dick Smith strategy, either didn’t qualify that advice or else Abboud didn’t understand that it had limitations.
A retailer only survives, let alone prospers, if it stocks products consumers actually want to buy. They don’t know or care about supplier rebates.
It would appear Abboud became fixated with the level of rebates he could extract, and the prices at which he could acquire private label, rather than the saleability of the product his stores and warehouses were filled with.
Tomlinson said he was concerned that the company was booking rebates for private label stock, which he considered to be highly unusual, given that private label products were normally specified by the retailer rather than pushed by the supplier.
It would seem logical that the biggest rebates would come from suppliers with the least saleable stock, so an increasing addiction to rebates and private label stock would create an increasingly destructive cycle and inevitably end badly, as it did when the weight of the unsaleable inventory overpowered the ability of the group to generate rebates and book them as apparent earnings.
No doubt, as the hearing continues, there will be further insights into the reasons for the collapse.
There will be considerable interest in the contribution from Anchorage Capital, which bought Dick Smith from Woolworths for about $115m (in what turned out to be a self-funding acquisition) and then floated it with a value of $520m a year later.
The initial week of hearings, however, would suggest that an inexperienced and overconfident CEO (Abboud was plucked by Anchorage from the second tier of Myer’s executive ranks) saw rebates as a golden and bottomless pool of potential earnings and private label as a source of expanded margins.
In pursuing them to the point where they distorted Dick Smith’s buying decisions, steadily diluted the quality of its earnings and cash flows and undermined its viability, he lost track of the most fundamental aspect of retailing. Stock what sells.