Guest Article

The Secret to Success in Retail

PE firms can maximize returns by focusing on the customer experience of retail chains, says CBX's Todd Maute (pictured)

Some observers apparently think that brick-and-mortar retail businesses are a bad bet for private equity.

But by paying close attention to the customer-facing side of the chains they invest in, private equity firms stand a much greater chance of maximizing returns - even in the face of the admittedly daunting challenges arising from e-commerce. After all, high-definition broadcasts haven't killed live sporting events, and TV evangelists haven't stopped people from going to church.

When retailers emphasize the point of differentiation their brand offers, and enhance the customer experience and relationship, they give people a reason to come to their stores in precisely the same way. Brand loyalty is a huge factor in the value of any retailer, and Forrester Research has found that the customer experience is the driving factor in determining brand loyalty. "This means companies can't expect to outperform competition on price while ignoring their customers' experience," wrote senior analyst Maxie Schmidt-Subramanian in a May 2013 report.

A report from earlier this year highlighted the particular struggles of specialty retail "category killers" like Toys "R" Us, Sports Authority, Petco, Burlington Coat Factory and Guitar Center, arguing that the private equity heavy hitters that had invested in these chains had, to date, come up short. With the likes of Amazon on a veritable tear, it is certainly valid to question investments in certain specialty retail formats. But because the $10 trillion U.S. economy is consumer-driven to a remarkable extent, retail is too huge a sector for private equity firms to ignore altogether.

Clearly, these firms will continue to sink billions of dollars into retail investments of various kinds. So asking whether retail amounts to a bad bet might be the wrong question. It is more productive to ask if private equity firms are playing their hand correctly in this arena, and if they are doing all they can to maximize retail returns. Many private equity firms have yet to focus on the creative, customer-facing side of retail. Are some brick-and-mortar chains too vulnerable to Amazon and its ilk? Certainly. But this hardly means all of retail amounts to a bad bet. Risk can never be eliminated, but by taking a holistic approach that includes the brand and its customers, private equity firms can boost their odds of walking away from the table as big winners.

Consider another, very different, analysis: "Vindicated," runs the headline of Mergers & Acquisitions magazine's March 2011 cover story. "Oak Hill Capital's sale of Duane Reade - the 2010 'Deal of the Year'- highlights the perseverance of the PE model." Here the reporter focuses on Walgreen Co.'s 2010 acquisition of New York's largest drugstore chain, which gave Oak Hill a return of about 1.5 times its approximately $400 million investment in Duane Reade. In the context of the challenges Duane Reade had faced prior to Oak Hill's stewardship, this was an impressive result. CBX worked with Duane Reade on its private label, store design and other branding initiatives.

It was a move that took some courage. Oak Hill had initially invested $239.5 million in Duane Reade, followed by an additional $39.5 million. But it was in the late summer of 2009 when, heartened by a new strategy, Oak Hill risked another $125 million.

What was so different about this new approach? It was customer-facing.

To back up for a moment, when most private equity firms invest in retailers, they typically focus on ramping up efficiencies and reaping the benefits of scale. These back-end changes, which are mostly invisible to the customer, hinge on taking a hard look at headcount, systems, real estate, warehouses, the supply chain - just about any process improvements that could make the company more profitable. This is part of the standard playbook because it mostly works.