How will high aussie dollar hit retailers

JBH’s relentless growth has managed to bulldoze any apparent effect from the fluctuating AUD. However, now that there are signs that JBH’s business model might be maturing, and that growth might be slowing, the question is how JBH might be affected.

To isolate the (AUD) effect, and neutralise the effect of JBH’s growth, the margins can be analysed. The rising dollar has two competing effects.  JBH‘s COGS, denominated predominantly in foreign currencies, becomes cheaper, which should fatten GPMs. Without the jargon this means that the goods that JBH buy overseas to sell in Australia beome cheaper for them. If they sell them in Australia at the same price they make larger profits. However overseas goods become cheaper not just for JBH to purchase for resale, but also for Australians to purchase directly from overseas. Overseas businesses selling into Australia have two options. They can raise prices to increase their own margins, keeping prices constant for Australians, but in these markets with low barriers to entry this will entice new firms to enter the market, driving down prices until all but a "normal" profit (just say "low" if your not an economist) erodes. More likely, online retailers exporting to Australia will cut prices to gain market share, and without the fixed costs of a bricks and mortar retailer, they can operate with razor thin margins, and will be much more effective at passing on the savings to Australian customers. The resulting deflation as prices fall around JBH puts downward pressure on gross profit margins.

The question is which one of these competing forces is stronger, resulting in a net benefit or loss.

JBH’s GPM has been negatively correlated with the exchange rate over the last seven years. Admittedly to increase the strength of the model one has to omit an outlier in the data. In the 2008/2009 financial year, even though the aussie dollar was low (which should have made it easier to compete with overseas retailers) JBH’s GPM was still low shedding yet more doubt on the ability of the retailer to cope with competition (during this time the AUD plunged and then climbed very rapidly, pushing the average down even though people perhaps didn’t have time to adjust their purchasing behaviours, however this is purely speculation). The following graph plots the average value of the AUD TWI in each financial year against the GPM resulting that year.

The graph strongly suggests that the net effect of a rising AUD is negative for JBH. 81.08% of the variance in GPM is explained by variance in the TWI. The model predicts (assuming the exchange rate remains at current levels) a GPM of 20.98% in 2011 (this research was conducted at the beginning of the year and the exchange rate rate input hasnt been updated since then).

More concerning than the competition from online retailers is JBH’s push to become an online retailer itself. In the twentieth century being a good retailer was about being able to most effectively get products from manufacturers to consumers at the least cost so as to be able to price competitively. The competitive advantage of these retailers has been their state of the art distribution systems within business models which are otherwise not hard to replicate. If they become predominantly online retailers mailing products out to customers, these distribution systems could become less relevant, and they run the risk of losing this competitive advantage. If one pictures a retailing environment as a purely online affair, it is a fiercely competitive market with low barriers to entry, small firms relative to the now global market, with consumers who can easily compare prices. It’s unlikely that even large retailers would have the scale to exert sufficient bargaining power over suppliers to dig out any sustainable competitive advantage over other firms. The ability to try on clothes, the appeal of instant gratification, and the intrinsic enjoyment people derive from the shopping experience itself will obviously provide friction to such a complete transition, but the more the line is blurred between online and physical retailers the more the market will resemble "perfect competition" (just say "price to earnings ratio of nine" if your not an economist).

What’s more Australian retailers have more to lose than those in other parts if the world. In general they have enjoyed margins much thicker than their overseas counterparts. Costco, which has relatively recently entered the Australian market, had only 1.67% of its revenue fall to the bottom line in 2010, whereas Woolworths saw a net profit margin of 3.91%. Wal-Mart operates on a similar margin of 3.89%, but JB Hi Fi enjoys a royal 4.34%. If JB Hi Fi was to operate at Costco’s margins, it would have to earn revenues of $7 104 910.18, 160% higher than they currently are, to maintain current profit levels. Woolworths’ revenues would have to grow by 134%.

Anyone who tells you they know what is going to happen is lying, but there is no doubt things are going get tougher for retailers in Australia, and it’s very tough to see who the winners will be. This trend is certainly one to watch as the next decade unfolds. Myer has taken the first step down a dangerous path for retailers, which could render them just another online agent, right when they should be diversifying the shopping experience they offer.  They run the risk of becoming more like brokers between manufacturers and consumers, collecting fees along the way.