BusiAna_6e_Part 4_Case Analyzing performance in the fashion industry - TN_Case Solutions.docx Part 4 Analyzing Financial and Non-Financial Performance in the Fashion Industry Teaching Note Version: May 2022 Introduction This case fits well with Chapter 5 Financial analysis. Depending on the desired focus, the case can help instructors discuss (1) the basics of financial analysis, (2) how the analysis of non-financial performance measures can support the financial analysis, (3) a useful approach in defining or selecting relevant financial and non-financial performance metrics, or (4) limitations of non-financial information. Questions for students Identify the (common) critical success factors that help the five international fashion retailers create value for their shareholders and other stakeholders. Define financial and non-financial metrics for each of the identified critical success dimensions. Using Exhibit 1, analyze and compare the five retailers’ financial and non-financial performance. Which retailers can be considered “leaders” or “laggards” in the areas identified above? Case analysis The instructor could start the class discussion by briefly explaining how the above questions describe a valuable framework for analyzing financial and non-financial performance. Following such a framework helps create focus in the analysis: The starting point of any analysis should be to develop a good understanding of what drives a firm’s value. These value drivers determine the firm’s critical success factors. (Note that, depending on the objective of the analysis, the ‘value concept’ that the analyst focuses on can be shareholder value, shared value, or stakeholder value.) Knowing the critical success factors helps the analyst define key performance metrics that are informative about how well the firm performs in its critical success areas. Such performance metrics can be financial or non-financial. The final step is to analyze and compare key performance metrics to evaluate firms relative to their peers. Question 1 – Critical success factors Critical success factors in the fashion industry include the following: Fast fashion. Retailers who respond quickly to changing consumer trends by frequently adjusting their assortment are more likely to succeed in creating customer loyalty, drawing customers to their stores, and optimizing store productivity. Successful fast-fashion retailers can also shield
themselves better from price competition. Supply chain. How a fashion retailer structures its supply chain affects how successful it can be in a fast-fashion strategy. For example, one reason why H&M; is less successful in fast fashion than Inditex is that H&M; outsources a larger part of its production, thus lengthening its production cycle. Digitization. Fast-fashion retailers benefit from digitization. Digitization facilitates monitoring consumer behavior and flexible production and logistics planning. Thus, digitization helps fashion retailers become more flexible and responsive. It also supports omnichannel sales (see next). Omnichannel success. As consumers increasingly shop online, success requires online presence. Physical stores and online platforms can serve complementary roles. For example, both may speak to different audiences, or physical stores could serve as pick-up points for online orders. Supplier financing. Given high inventory turnover, retailers finance a significant proportion of receivables and inventory with supplier credit, a comparatively cheap source of financing. Increased reliance on supplier financing can help lower borrowing costs and improve profitability. Sustainability and transparency. The increased focus of society on sustainable production and transparency about workers’ social conditions has also affected the fashion industry. ESG issues that are relevant in the fashion industry are (1) management of chemicals and wastewater, (2) environmental and social impact of sourced raw materials, and (3) labor conditions, especially in the supply chain (production workers). Question 2 – Key performance metrics After having identified critical success factors in the fashion industry, the instructor can invite students to propose key performance metrics that are informative about how successful a retailer is in each of the critical success areas. Some examples of such metrics follow: Question 3 – Analysis Exhibit TN-1 displays 2020, 2019, and average values of key performance metrics for the five fashion retailers. The ranked key performance metrics, and average ranks per performance dimension, help identify “leaders” or “laggards.” Inditex excels in its execution of a fast-fashion strategy. The retailer has high inventory turnover, a short cash conversion cycle, high store productivity, and above-average NOPAT margins. Inditex’s profitability further benefits from its efficient use of supplier financing. In contrast, The Foschini Group can be considered a “laggard,” given its low inventory turnover, low store productivity, and low margins. The Gap and Inditex qualify as leaders in omnichannel retailing, while Lojas Renner and The Foschini Group are omnichannel retailing laggards. Evaluating performance in sustainability and transparency is slightly more complicated. Fast Retailing seemingly outperformance its peers, except on CO2 Scope 3 emissions. In contrast, Lojas Renner surfaces as a leader in sustainability primarily because of its low CO2 Scope 3 emissions. This contrast illustrates one of the complexities of analyzing ESG performance: companies may use different definitions, especially when measuring CO2 Scope 3 emissions (see also below). Fast Retailing remains the ‘true’ leader in sustainability, ignoring these emissions. The Gap qualifies as a laggard in sustainability. While students may develop different performance metrics, leaders’ and laggards’ overall rankings and identification will likely be close to those shown in Exhibit TN-1. Conclusion
To conclude the discussion, the instructor can ask students to evaluate the usefulness of ESG information in business analysis. The above exercise may help stimulate such evaluation. For example, the observed effect of differences in retailers’ measurement of Scope 3 CO2 emissions on the above analysis highlights how a lack of standardization in ESG reporting (across firms and over time) may distort business analysis. Some other complexities of using ESG information in business analysis and valuation are: Transparency differences across firms. Because of a lack of detailed regulation, not all firms disclose the same ESG information. For example, we cannot evaluate recycling intensity or employee turnover for each fashion retailer. Much relevant information is qualitative. Qualitative information (such as the quality of formal procedures) can be difficult to quantify and use to prepare key performance metrics. Boundaries of the reporting unit may be unclear. Fashion retailers typically source part of their production. Consequently, part of their emissions or pollutive activities occurs lower in the supply chain. How retailers account for these emissions/activities varies (as illustrated by the Scope 3 CO2 emissions example). Exhibit TN-1 Key performance metrics in the Fast Fashion industry
BusiAna_6e_Part 4_Case Analyzing performance in the fashion industry_SOLUTION_Case Solutions.xlsx Sheet: Fast Retailing Fast Retailing - Uniqlo (Japan)
2020
2019
2018
Fiscal year end date
2020-08-31 00:00:00
2019-08-31 00:00:00
2018-08-31 00:00:00
Market capitalization ($ thousands)
60991.1
59775.4
47623.7
Net operating assets
7453.2
5840.1
5431.4
o/w Inventories
3941.5
3863
4187.7
o/w Trade Receivables
515.9
475.5
409.2
o/w (Payables)
-1423.2
-1197.1
-1455
Debt
9282.7
7662.7
7190.7
Shareholders' equity
9030
8832.4
7775.1
Revenue
18963.5
21554.1
19191.8
Cost of sales
-9751.5
-11019
-9731.9
Personnel expense
-2620.1
-2836.7
-2568.8
Net operating profit after tax
838.2
1712.6
1568.8
Group profit or loss
853.3
1675.4
1526.1
Financial information ($ mln)
Operating cash flow
2500.3
2827.7
1589.4
Number of stores
2252
2196
2068
Store space (sq.ft. thousands)
32802
31016
28757
Number of employees
128492
137281
124679
Employee turnover
NA
NA
NA
CO2 Equivalent Emissions – Scope 1 (Direct) (tonnes)
11174
11218
12419
CO2 Equivalent Emissions – Scope 2 (Indirect) (tonnes)
110471
117314
137857
CO2 Equivalent Emissions – Scope 3 (tonnes)
3971692
4185205
3120497
Total energy use (gigajoules)
1318050
1211497
1362045
o/w Renewable energy (gigajoules)
NA
NA
NA
Total water consumption (m3)
55637
53633
54752
Total waste (kg)
48067
43621
39727
o/w Recycled waste (kg)
NA
NA
NA
Gap (United States)
2020
2019
2018
Fiscal year end date
2021-01-30 00:00:00
2020-02-01 00:00:00
2019-02-02 00:00:00
Market capitalization ($ thousands)
7551.1
6559.3
9737.3
Net operating assets
8240.6
9873.9
8778.7
o/w Inventories
2451
2156
2131
o/w Trade Receivables
363
316
359
o/w (Payables)
-1743
-1174
-1126
Debt
7758.6
7675.8
6275.7
Shareholders' equity
2614
3316
3553
Revenue
13800
16383
16580
Cost of sales
-8588
-9722
-9680
Personnel expense
NA
NA
NA
Net operating profit after tax
-441.5
656.3
1257.7
Group profit or loss
-787
381
1036
Operating cash flow
237
1411
1381
Non-financial information
Sheet: The Gap
Financial information ($ mln)
Non-financial information Number of stores
3715
3919
3666
Store space (sq.ft. thousands)
34600
37000
36700
Number of employees
117000
129000
135000
Employee turnover
NA
NA
NA
CO2 Equivalent Emissions – Scope 1 (Direct) (tonnes)
27316
27818
26320
CO2 Equivalent Emissions – Scope 2 (Indirect) (tonnes)
336270
359825
379183
CO2 Equivalent Emissions – Scope 3 (tonnes)
564220
638418
651103
Total energy use (gigajoules)
3769200
3909600
3945600
o/w Renewable energy (gigajoules)
NA
NA
NA
Total water consumption (m3)
NA
NA
NA
Total waste (kg)
NA
NA
NA
o/w Recycled waste (kg)
NA
NA
NA
Inditex (Spain)
2020
2019
2018
Fiscal year end date
2021-01-31 00:00:00
2020-01-31 00:00:00
2019-01-31 00:00:00
Market capitalization ($ thousands)
92578.1
104981.5
86748.7
Net operating assets
17076.5
16624.1
15151.5
o/w Inventories
2816.7
2518.3
3107.5
o/w Trade Receivables
523.1
552.7
524
o/w (Payables)
-4169.9
-4422.9
-4284.9
Debt
7779.1
7830.2
5040.3
Shareholders' equity
17621.3
16551.6
16764.2
Revenue
24759.7
31394.1
29914.1
Cost of sales
-18194.1
-21644.9
-22703.6
Personnel expense
-4097.1
-4916.8
-4732.2
Net operating profit after tax
1450.8
4151.8
4108.4
Group profit or loss
1339.8
4047.7
3945.1
Operating cash flow
3661.4
7658.2
4609.8
Sheet: Inditex
Financial information ($ mln)
Non-financial information