Billabong chairman on retail integration, evolution of strategy

Billabong held its annual shareholder meeting in Australia yesterday and executives shared some interesting details about the reasons behind its retail strategy, how retail is performing and how business is going in general since the company’s fiscal year ended at the end of June.

Below are some highlights from the address by Chairman Ted Kunkel. This information comes from a transcription of the address provided by Billabong. I added headings to break up the text.

Click here to read highlights from CEO Derek O’Neill’s address, where he gives an update on Billabong’s current business performance.

Chairman Ted Kunkel discusses structural changes in industry

When discussing structural change it is important to understand the evolution of the boardsports industry. There are two key groups in the industry, being the brand owners and the specialty retailers.

The brand owners are the product innovators, the supporters of the athletes and events and the providers of the merchandise, while the retailers are the important interface through which the brands connect with the consumer.

Historically, these retailers have predominantly been independent operators of small businesses and, while servicing their local communities well, their capacity to reinvest into their businesses, particularly through an extended downturn in consumer sentiment, has been limited. Many of these retailers were the first generation of boardsport retailers and, given they had been operating their stores for most of their working lives, were looking at opportunities to exit their businesses.

Over the same period, there was also the emergence of several large chain retailers specializing in the boardsports sector. One particular trend among the larger mall-based retailers has been a transition to vertical product, thereby reducing the floor space available to authentic boardsport brands and, in many instances, watering down the appeal of the stores to the core boardsports consumer demographic.

This vertical product trend, where the retailer creates an own brand and sources goods directly from offshore, is more attractive when the purchasing currency is strong, as the AUD has been for some time. The historical model of the boardsports retail structure has therefore been undergoing rapid change and with it the traditional long lead-time indent system. Retailers, generally, were indenting less, ordering much later and preferring to rely on in-season buying.

Billabong develops a strategy 

The Billabong Group had observed these trends over several years, primarily in North America and parts of Australasia, but noted a sharp acceleration in recent years principally driven by the economic forces resulting from the global financial crisis. Left unchallenged these trends had the capacity to undermine the future growth prospects of the Billabong Group.

Following extensive market analysis, it was determined that the Billabong Group would, in some regions, look to gain greater control of its route to market. This led to a series of small retail acquisitions and, in the past year, the acquisitions of larger retailers including Canada’s West 49 and Australian retailers Surf Dive ‘n’ Ski, Jetty Surf, Rush Surf and Surfection.

While there were sound commercial considerations supporting each of the acquisitions, there was also an acknowledgment by the Group that there would be a year of transition when margins and profitability would be adversely impacted as the Group evolved from wholesale supplier to the stores to the owner of the stores.

At the time of the acquisitions, management stressed that the benefits of the retail acquisitions, primarily the capture of the vertical margins, would only start to flow from the second year of ownership. To the close of the 2010-11 financial year, the Group had owned the major Australian retail acquisitions for approximately seven months and the West 49 business for just 10 months. So, the message here is that the Group is now through its previously foreshadowed transition year and expects the benefits from the retail acquisitions to start flowing in the 2011-12 financial year.

It is worthwhile pointing out that the above dynamics are only apparent in markets that have been established for many years. In destinations such as Asia there is no wholesale channel and therefore the route to market is to build retail, which the Group has done very successfully and profitably to date and continues to do so. Markets such as South America and most of Europe, on the other hand, still have a developing wholesale account base so there is likely to be lower retail investment into those regions.

See Page 2 for an online update, and how West 49 integration is going

Online update 

Another major retail trend that emerged in the past year is the migration of consumers to online sales platforms. This has been an area in which the Billabong Group has invested in recent years.

Online sales, primarily through the Swell.com and SurfStitch.com businesses, accounted for approximately 3% of Group sales in the 2010-11 financial year and their contribution to Group sales should rise by in excess of 50% in the current financial year.

This remains a very fast growing business unit and is considered complementary to the Group’s bricks-and-mortar retail assets. To give you a feel for the success of the Group’s online operations, in the past month alone SurfStitch was awarded the Online Fashion Retailer of the Year by the Australian Interactive Media Industry Association and the Best Online Pure Play and Best Use of Technology awards at the annual Australian Online Retail Industry Awards.

Of course, the overall re-balancing between the wholesale and retail operations has been reflected in some internal restructuring within the Billabong Group. The Group already had its own retail operations and these have been expanded and, where appropriate, duplication within the acquired businesses has been removed. So, when the acquired assets are fully integrated into the Group there will be ongoing synergies in areas such as warehousing, IT and back-end services that should further benefit the business into the future.

Where the retail integration stands

Just to give shareholders a feel for where the Billabong Group is at in the retail integration process, the Group has:

– Installed new management at West 49 in Canada, closed its loss-making Off The Wall banner and is now beginning to generate a healthier level of profit. As an example, let me describe for all shareholders the progress the Group is making with West 49 in what is a somewhat depressed Canadian market. Prior to the acquisition, which cost $99 million, the annual EBITDA contribution to the Billabong Group on previous wholesale sales made to West 49 was approximately $5 million, with a store penetration level of 15% company owned product.

For the year ending 30 June 2012, Billabong anticipates an EBITDA contribution in excess of $15 million with approximately 35% penetration of company owned brands. This EBITDA contribution is expected to rise further in the 2012-13 financial year as company owned brand penetration increases and additional operational synergies are realized.

– In Australia, the Billabong Group is now in the final phase of the migration of all retail businesses across to a common IT platform, the consolidation of multiple warehouses into a single warehouse, the wrapping of all back-office support and systems into the Billabong Group’s existing structure and the elevation of the Group’s in-store brand presence.

– Currently, the Group’s direct-to-consumer sales (company owned retail and online businesses) account for approximately 40% of the Group’s global sales.

Going forward, the wholesale account base appears to be stabilizing in the US, remains volatile in Australia and Europe and continues to grow in emerging markets including South and Central America. Online sales are expected to grow strongly, while in company owned retail a concentration on family brand penetration and innovation will help lift sales, profit and returns.