This universally forgettable year is leaving an enduring lesson behind for retail. But for an industry that hasn’t entirely caught its breath from the knockout punch of an abrupt stop to all operations in March, this revelation may be yet to arrive. When retail patched up its processes to safely get product to customers despite the largest channel of in-person sales being down to a trickle, it developed a whole new hidden crack in the system. This problem—of dwindling profit and free cashflow—must be fixed before it causes lasting damage.

The mountain of difficulties this year came without giving retailers any time to plan or prepare. The leap from overseas manufacturing delays and factory work stoppages in January to shelter-in-place orders and store closures in a majority of the global markets in March was not long. And with customers staying home through most of spring and summer and uncertainty abounding, many retailers were incapacitated by the disruption. There have been 29 reported retail bankruptcies year-to-date, and 25,000 stores are expected to permanently shut down in the US this year. It won’t be too much of a stretch to say that this has been the toughest year for our business.

When stores first shut down, much of retail understandably went into panic mode and focused on preserving cash and keeping revenue flowing. To achieve the first goal, it tightened costs. Per AlixPartners analysis, 91 of the top retailers have announced reductions in force, furloughs, or pay cuts in corporate offices and stores this year. Many have accelerated store closures or delayed planned investments. To achieve the second, it pulled out all stops to drive sales online.

After aggressively marking down inventory online throughout the summer, retailers also started holiday sales earlier this year—stretching out the start of this usually lucrative period to early October. Many are in the middle of months-long Black Friday-like deals, which can drive a lot of traffic. Even so, only a handful of retailers have seen sales grow over the last nine months. Exceptions are those whose key categories are grocery and home and electronics, or those that have benefitted from their scale and prior investments in omnichannel infrastructure, including Amazon, Walmart, and Target.

But there is a whole layer of retailers that have historically relied on foot traffic—those that primarily sell apparel, mid-tier retailers, department stores, mall-based retailers—that have lost touch with their customers. And then there is the tier of retailers that have moved most of their operations and inventory online but are now embedded in the deep costs of doing so with little to no preparation. These retailers hurriedly added a multitude of buying options over the last few months, including expanding delivery models such as curbside pickup and newer last-mile delivery partnerships, such as Instacart or DoorDash. This wasn’t cheap to do. And expenses have also gone up for anyone doing business at the moment because of new cleaning and sanitization processes.

This means that retailers are earning lower profit margins on any sales generated: either because of growing costs, sales and promotions hurting gross margins, or, in most cases, a combination of both.

As a result, retailers’ free cashflow has fallen off a cliff (Figure 1). Some of it is cyclical and driven by the pandemic. But a lot of it is structural and here to stay.

figure 1 december 2020 retail viewpoint chart v02 002

All this should make one thing crystal clear: these days there is an increasing cost of doing business in retail. The more you do to drive sales and the more product you sell, the more likely it is that you will lose cash.

Retailers must put away the blinders that helped them focus on selling over the last nine months. It’s time to take a clear-eyed look at the state of the business, especially as lockdowns and restrictions return around the globe. It is looking more likely that retail will have to go through another period of closed stores, which will cause this profit hole to get even bigger. Moreover, the consumer shift to digital channels is likely to stick beyond the pandemic. A permanently higher ecommerce penetration means retailers need to stop looking at stop-gap options and patch-up solutions. In the long run, it will be smarter to make investments that will sustain into the future. Retailers need to acknowledge that they will have less free cashflow than they were planning and must work aggressively to fix the gap.

With so much on their minds, it isn’t entirely surprising that retailers have not paid attention to this problem that has been bubbling just under the surface. Safe operations and keeping sales churning were the priority. It would be a mistake to ignore this any longer, however. The focus must move to P&L and free cashflow urgently. Here’s how to start:

  • Maximize use of fixed costs: You have invested in newer fulfillment and delivery options to accommodate consumer shopping behavior shifts. Now you must ensure that you are getting the most out of these. Even as you offer consumers various increased convenience options, push them toward the lower cost channels. For example, encourage consumers to buy online and pick up curbside instead of defaulting to fast home delivery by offering a future redemption or discount on the former.
  • Make smart use of available cash: It’s key to understand and identify which liquidity levers can be pulled in your business urgently and rank them in terms of ease to implement. This is the time to reinvest cash back into your business, so consider cutting cash dividend and share buybacks as one example.
  • Prioritize improvements and investments: Prioritize initiatives that enhance the customer experience. Include your finance operation in any modeling of the financial impact of these initiatives to facilitate companywide prioritization.

While 2020 has been dramatic in its changes, retail cannot afford to shrug it off as one bad year. The pandemic will eventually go away, but consumer behavior has changed forever. And any additional damage to profit and cashflow will be catastrophic. Retailers that do not act now to make sustainable changes in their attitude and anticipate oncoming challenges will have a hard time getting through our disruptive, changed world.