Retail model v/s distribution model in Footwear

There are two offline sales models prevailing in the Footwear industry:

a) the retail model – Exclusive Brand Outlet (EBO), and

b) the distribution model.

Typically, lower ASP products are largely sold through the conventional distributor model in order to cover the wide depth of small retailers which constitute nearly two-third of the market. The higher ASP products – premium brands are predominantly run on EBO networks to display their complete range and maintain brand positioning.

High gross margin: An EBO has better brand recall and is able to sell premium products, which gives it a higher pricing power (as reflected in the higher ASP of BATA, METRO, and Sportswear brands). This translates into a higher gross margin. Typically, distributors cater to the unorganized smaller players selling low-ASP products with lower brand recall and pricing power. However, Campus and Relaxo both through their in-house facilities have created cost efficiency and thus healthy margin and yet attained strong product quality to drive scale.

Neutral EBITDA margin advantage: While an EBO garners higher gross margin, the high cost of retailing largely offsets gross margin benefits. The distributor model entails a lower cost of retailing and caters to a wider network, thereby generating higher volumes and improving the ability to leverage fixed costs. This leaves both models with similar EBITDA margin levels.

Asset heavy model: The EBO model requires greater investments on stores, making it a high investment model. This creates a barrier for new premium brands and makes it hard to scale. Further, it becomes key to drive store productivity and achieve healthy asset turns and profitability. The conventional distributor model does not require capital investments, but focuses on production to drive cost competency.

Brand creation: Distributors and local footwear retailers are flooded with brands and have a low incentive to stock inventory of new brands, unless it is a recognized brand, or there is a pull factor from customers, or are offered higher distribution margins. Thus making it difficult to create a D2C brand. Alternatively, companies develop own retail chain to create a recognized brand in the market. However, given the localized nature of the business, it increases the customization and store profitability.

Working capital: Investment in working capital remains largely the same for both the retail as well as the distribution model, with the key difference being that a retailer may have to stock higher store inventory, while the distribution model operates on receivables as channel credit. The only difference is if the brand has a pull, then it could limit the receivable days as evident in the case of Campus, thereby shifting the burden of working capital onto the distributor.

Return ratios: Despite operating an asset heavy model, BATA and METRO (retailer) have been able to maintain a healthy return profile, with its average ROCE/RoIC at ~20%, which is a difficult ask. Campus and Relaxo have invested in in-house facility but yet garner healthy return profile thanks to the cost efficiency and high asset turns.

Growth: The biggest advantage of operating a distributor model is the acceleration in growth due to the low investment requirement in retail and ability to penetrate the market faster. This can also be partly achieved through the asset light franchisee route. But with in-house production, it increases the reach.

Entry barriers: A low-ASP product has a lower entry barrier as a distributor could flood the market. Less brand conscious customers can impact pricing. High ASP products sold through the EBO channel may create brand loyalty and customer stickiness, which allows it to compete better and garner higher return ratios.

Comparison of store economics in Footwear

Typically, premium retailers, who command higher ASP and margins, have to invest heavily on the look and feel of their store and inventory. Due to their higher ASPs, margins too are higher.

In order to analyze store economics across the Footwear categories, we have included various parameters such as sales, investment, area, and cost of retailing at the store level. METRO’s overall business economics is dominated by a healthy gross margin, lesser retailing costs, and lower store investments (capex and working capital), which allows it to garner healthy asset turns. Its ability to achieve good store economics is derived from healthy scale.

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