Challenges And Pressures On The Australian Retail Industry

Real Pressures on the Australian Retail Industry

The pressures on the Australian retail industry are building. A number of forces are constraining top-line sales growth for many leading brands. Some high profile brands have even failed. The remainder are looking at the only other way to maintain profits – cost reduction.

The decisions that the leaders of these businesses make in response to these pressures will be scrutinised closely; after all, the major retailers are household-names. Commercial skills will be tested. But the ethics of these decisions will also be examined. The criteria of success have arguably become multidimensional. Management will not only be judged on what profit they make but the manner in which they achieve it. And, accountants are uniquely placed to have a major impact on how these decisions will be made, how outcomes will be measured, and, how they are reported.

A current analysis of the Australian retail industry shows just how real the pressures are on the key decision makers within the major retailers in Australia and why action is required.

                                                                         Figure 1 Australian consumer prices 

                                              

 At  a  macroeconomic  level,  the Reserve Bank of Australia (RBA) has  recently  detailed  the lack of price growth in the economy see  Figure 1 (RBA 2016). Retailers prefer inflationary to deflationary worlds, the latter having a  natural downward impact on sales growth. Consumers can’t easily be talked into price rises unlike in previous times. In fact consumers are expecting  price reductions.  But, macroeconomic conditions are not the only problem.

                                                                              Figure 2 Aldi Sales and Store growth

                                                                 

                                                                                                      (source: Low 2016)

International Retailers and New Business Models

International retailers are starting to see the opportunities in some of the more highly concentrated parts of the Australian  industry. Brands  like H&M, Zara and Uniqlo have entered various industry segments.  In the supermarkets space,  the  giant  German  group, Aldi, has been experiencing significant growth since its arrival in 2001 see  Figure  2. This  success has  been a major contributor to falling prices at its main  rivals.  Some  analysts  have estimated that prices at Coles and  Woolworths have dropped by between 1.5 and 2%  during 2015/16 due to Aldi (Low 2016).                                     

Woolworths,  in  fact,  recently  announced  a  $1billion  restructure  including:  the  closing  of  poor  performing stores; 500 job losses within its head office and supply chain; and, as noted, a major “investment” in sell price reductions (Woolworths 2016a).

And it’s not only competitors in the traditional “bricks and mortar” space causing concern. Woolworths and other retailers are also experiencing intense competition from disruptive on-line retail models. It is this development that shows that the retail industry is being confronted by both operating challenges and also the strategic challenge of entirely new business models

These  new  models  are  stripping  costs  out  of  the  business,  particularly  the  customer  facing  infrastructure required by the “high street” retailers. Figures vary but some have estimated that on-line sales have increased by over 12% during the previous year (NAB 2016). Not bad in a disinflationary environment.

The industry dynamics facing the major established retailers have, therefore, rarely been more challenging. And while some have tried to differentiate themselves from the competition, cost control remains the major objective to maintain profit levels in the face of headwinds in sales growth. But what types of decisions are being made to reduce cost bases or to otherwise squeeze out incremental return on investment increases? Are there any ethical implications or behavioural issues arising from these decisions?

There are a number of options for retailers in their drive to reduce costs. The two main areas targeted are represented by the Cost of Goods Sold (COGS) and the Cost of Doing Business (CODB). These components in relation to total profits are shown in Figure 3.

                                                                      Figure 3 The retailer’s profit components

Reducing Costs to Improve Profits

                     
                                                                                 (Source: Productivity Commission 2014)

Particularly due to the emergence of internet retailing and the disruptive way it has changed the cost structure of retail, a focus on CODB has grown in importance in recent years. These costs, as the name suggests, are those required to service the infrastructure of a retailer and include staff costs, occupancy costs such as rent, utilities, distribution and selling costs amongst others. 

A number of companies “outsource” elements of these costs particularly in the areas of distribution and information technology services. However, a major focus of retailers has always been on Gross Profits (or margins). And there are only two ways that unit gross profits can be improved: either through increasing the sell price of the product or decreasing its cost. Given the pressures on the top line sales numbers and therefore sell prices, there is really only one way retailers can go in this environment: how to reduce COGS?

For many retailers, cost reduction strategies have been to source product from overseas suppliers. This has very much been the case in the garment industry. Over 60 million people work in the garment industry and over 15 million of these work in Asia who supply 90% of the garments imported into Australia (Oxfam Australia 2016). Given the low wage environment operating in Asia it is natural that garment retailers are increasing their sourcing from these countries.

Make no mistake, this is not high-end fashion. Garments obtained from these countries are specifically to service the demand for increasingly lower cost items. As some countries wage rates gradually increase, so buyers move to other, lower wage countries to “chase” the margin improvement. If they don’t do this, competitors will and the cost advantage will vanish. This is what happened in Bangladesh and, in one supplier circumstance, with tragic consequences.

The RANA Plaza disaster made world-wide news in April of 2013. An 8 storey building in Dhaka in which thousands  of  people,  mostly  women,  worked  long  hours  each  day  collapsed  due  to  poor  construction  and maintenance  standards.  The  working  conditions  in  these  types  of  factories  are  appalling  with  insufficient space, light and drinking water: “[they] are literally ‘death traps’ with workers locked inside to prevent theft, leaving no way to escape disasters such as fire” (As-Saber 2013).

Sourcing Products from Overseas Suppliers

The official death toll has been put at 1,134 (Hoskins 2015). And, it is not the only example of its type. Due to the  pressures  from  international  retailers,  poor  building  and  worker  regulation,  and,  managers  driving relentless  volume  performance,  thousands  of  people  at  RANA  and  elsewhere  in  Asia  have  been  and  are continuing to be exploited to produce garments at a cost that is a faction of that which would be incurred if big retailers produced in their home markets.

The international supply chain for the garment industry is big business. At the time of the disaster, Bangladesh was  earning  US$20billion  annually  and  was  the  second  largest  supplier  behind  China.  Other  countries involved include Pakistan, India, Vietnam and Indonesia. In Bangladesh, 3.6 million garment workers often work 14-16 hours per day at a minimum wage of A$20 per week (Oxfam Australia 2016). International retailers buy  direct  from  manufacturers  but  these  suppliers  can  also  sub-contract  out  their  production  to  other manufacturers.  These  arrangements  can  be  so  complex  that  at  the  time  of  the  RANA  plaza  disaster  many retailers did not in fact know if they used this supplier (OxFam Australia 2016).

This lack of transparency is just one reason why groups such as Oxfam regularly compile scorecards of how the major  retailers  are  performing  when  it  comes  to  monitoring  its  supply  chain  to  ensure  against  worker exploitation (Oxfam Australia 2016).    Another charity, Baptist World Aid Australia, monitors suppliers on a range of measures such as: the existence of polices relating to supplier arrangements; “knowing your supplier”; worker empowerment; and, similar measures. (Baptist World Aid Australia 2016). An example of how one Australian company, Cotton On, has developed a policy framework surrounding its supply chain can be found here: 

Many retailers take an active stance in managing its supply chain. Wesfarmers, for example, acknowledges that it has an obligation to monitor the way it sources its products from developing countries and that it had done this in a number of ways including through the use of auditing programs. The audit program had the following findings for 2016 (Figure 4): 

                                                                         Figure 4 Wesfarmers Ethical Sourcing Audit Findings

                                                                         

Ethical Implications of Overseas Sourcing

                                                                                           (Source: Wesfarmers 2016c)

Oxfam  highlights  however  that  whilst  some retailers  may  have  good  intentions  when  it comes   to   auditing,   the   practice   of   “audit fraud” is widespread – that is, workers being coached  by  managers  to  say  the  right  thing when    independent    auditors    are    around (Oxfam  Australia  2016).  It  is  not  difficult  to imagine a situation where workers may be too fearful to raise concerns for fear of losing their livelihoods. 

At the time of the RANA Plaza disaster, Simon McRay, of Ethical Clothing Australia, made it clear where the international supply chain for the garment industry is placed. He said that while responsibility for sourcing clothes ethically lies with retailers, it is consumers who must also realise that there is a reason why clothing seems so cheap. “If you’re going to buy cheap fashion”, McRay says, “you’re buying   exploitation   there’s   no   two   ways around it” (Michael 2013).  The international charity OxFam in fact believes that consumers are willing to pay more for their garments. In a recent    survey, they found that 89% of people said that they “were  willing  to  pay  a  little  more  for  clothes  to  ensure  garment  workers  had  safe  and  decent  working conditions” (Oxfam Australia 2016).

In their race to lower and lower costs, are retailers ignoring the goodwill of consumers? Or is it a matter of consumers saying one thing but actually doing another when it comes to parting with actual cash?

Whatever the situation on the consumer’s side, it seems that the international garment manufacturing industry is still potential prey to the big retailers. Why? Simply, the big buyers have the power. This is what market power is all about; whatever the industry, whatever the country. The same “rules” apply even in a developed country market like Australia.

Strategic theory suggests that having power is a desirable thing. Not having power is to be avoided. Competitive strategy is about using power to achieve desired objectives. But when is using your power legitimate?

The big retailers in Australia’s oligopolistic supermarket industry certainly have plenty of power simply because of its concentrated nature (see Figure 5). While there are differing views of how this concentration translates to power over consumers, there is plenty of evidence that it does put local Australian suppliers at a distinct disadvantage when it comes to negotiations.

Monitoring Supply Chains to Avoid Worker Exploitation

                                                        Figure 5 Market shares within the Australian Supermarket Industry

                   

                                                                              (Source: Roy Morgan Research 2016)

In  fact,  the  Australian  Competition  and  Consumer  Commission  (ACCC)  successfully  brought  legal  action against the giant Wesfarmers corporation, owner of Coles, in respect to a number of matters relating to the treatment of the supermarket’s suppliers. The Federal Court Judge, who found against Coles, was scathing. “Coles  misconduct  was  serious,  deliberate  and  repeated”,  Justice  Gordon  said  in  her  judgement.  “Coles misused its bargaining power. Its conduct was not done in good conscience” (quoted in ACCC 2014).

It  was  found  that  Coles  demanded  continuing  payments  from  suppliers  “based  on  purported  benefits  to suppliers that Coles asserted had resulted from changes Coles had made to its supply chain” (ACCC 2014). The scheme was called the Active Retail Collaboration (ARC) program. And, if the suppler refused to make the payments, it was found that Coles would threaten the supplier with downgrading the suppliers’ products within the supermarket’s range, cease promoting the product, or, ultimately, no longer buy the supplier’s products at all.

In   a   further   proceeding,   Coles   was   also   found   to   have:   demanded   payments   for   “profit   gaps”   for underperforming   products;   sought   compensation   retrospectively   for   wastage;   and,   demanded   penalty payments for late deliveries when this had not been part of the supply agreement (ACCC 2014).

Wesfarmers moved to rectify all of these matters. A former Victorian Premier, Jeff Kennett was appointed as an  independent  arbiter  to  review  supplier  arrangements  at  Coles,  and  if  required,  recommend  financial compensation. He ended up ordering Coles to repay more than $12 million to small food and grocer suppliers and stated: “[the] ACCC’s involvement in this has been good for the suppliers but the biggest winner is Coles, because it’s been forced to move to a more modern way of dealing with those they need most – the suppliers” (quoted in Mitchell 2015a)

Wesfarmers and the industry generally, including Coles biggest competitor Woolworths (also the target of supplier complaints) have moved to the creation of a voluntary “Food and Grocery Code of Conduct”. The code, which is administered by the ACCC: 

• “sets out minimum obligations for retailers and wholesalers relating to the making of grocery supply agreements
• requires retailers and wholesalers to act lawfully and in good faith
• prohibits retailers from threatening suppliers with business disruption or termination without reasonable grounds
• establishes minimum standards of conduct by a retailer when dealing with suppliers, such as

Active Stance on Managing Supply Chain

payment, de-listing, standards and specifications for fresh produce, and the allocation of shelf space

• requires retailers and wholesalers to provide annual training to employees whose role includes direct involvement in buying grocery products, and their managers, on the requirements of the Code”. 

It is early days in the operation of this code but it’s not going to be the only thing that the big supermarket retailers need to look out for. There are other ways retailers can push the boundaries of appropriate behaviour in the pursuit of cost advantage.

Australian supermarkets are not alone in using their power over suppliers. For example, the giant British supermarket company, Tesco PLC, has also been found to be using its muscle not only in negotiating tough deals with suppliers but being creative in the way that these are being accounted for as well.

Through  a  number  of  scenarios,  Tesco  was  found  by  an  independent  enquiry  to  have  “knowingly  delayed paying money to suppliers in order to improve its own financial  position” and that “even in circumstances where a debt had been acknowledged by Tesco, on occasions the money was not repaid until over 12 months later with some amounts taking up to 24 months to be repaid”. (Groceries Code Adjudicator 2016).

The enquiry found this to be unreasonable behaviour. It was recommended that finance and buying teams at Tesco would be trained in the findings from the investigation – a pointed reminder that Tesco management needed to improve its administrative and ethical standards.

Both in the UK and in Australia, and in addition to the simple (if unfair) tactic of delaying supplier payments, another area that is notorious in retail as being open to commercial and accounting manipulation is the area of supplier rebates. These are the supplier payments made to retailers based on things like:

• volume purchases (dollar or percentage discounts either paid at the point of purchase from the supplier or from register “scan data” of sales to customers); and,
• Promotional rebates (also known as “over and above” or “Co-op” rebates) negotiated with suppliers for any number of scenarios but typically for things like: favourable placement of the supplier’s product on shelves; to share advertising costs; or, in return for other promotional expenditures incurred by the retailer.

Accounting for so-called “volume rebates” is guided by the standard AASB 102 Inventories, as reductions in the cost of inventory and hence Cost of Goods Sold while promotional type rebates tend to be accounted for as reductions or reimbursements of a retailer’s selling expenses and hence of Cost of Doing Business. On the face of it, the accounting treatment required seems relatively straightforward. But this has not stopped the senior managers  and  financial  officers  at  some  major  Australian  retailers  from  getting  into  some  very  difficult situations.

The management of the Wesfarmers operated Target  chain of stores, for example,  has been shaken up for allowing  some  questionable  rebate  deals  to  significantly  impact  its  2016  half  year  results.  In  a  company announcement to the ASX (Wesfarmers 2016a), the company said that it had been brought to its attention that previous management had negotiated increased rebate deals for the first half of 2016 in exchange for future supplier cost increases - in effect, bringing forward cost reductions (through rebates) in exchange for future invoice cost increases.  As at the December 31 reporting date, reported profit was $74m; it should have been $53m. Not material for the Wesfarmers corporation as a whole, but deeply embarrassing.

Audit Fraud and Ethical Sourcing

The   announcement   stated   that:   “Wesfarmers   Managing   Director,   Richard   Goyder,   expressed   his disappointment with the actions of those involved”. But, in the press conference announcing the issue, he was a  little  more  candid:  he  described  the  actions  taken  by  previous  management  as  “mind-blowingly  stupid” particularly given that any benefit would have been reversed in subsequent periods (quoted in Mitchell 2016).

Further, he said that up to 10 people had been involved in the arrangements with suppliers and that “there is no excuse for this conduct. We set very clear directions and expectations at Wesfarmers crystallised in our code of conduct and supported by detailed group policies, divisionally specific accounting policies and regular staff training”. And further, he said, “we encourage and expect adherence to a strong culture of managing for long- term sustainable growth over short term gain which is regularly reinforced by the Wesfarmers board and which should have guided behaviour” (quoted in Beattie 2016).

The fall-out for Target’s management has been significant. As noted in the Wesfarmers announcement, while “Target Managing Director Stuart Machin has stated he was not aware of the accounting issues in the first half”, he “has accepted his share of the responsibility given his leadership role and has chosen to resign from the Wesfarmers Group” (Wesfarmers 2016a).

And, even though the previous Target Chief Financial Officer had resigned in December 2015 to take up a role in  the  UK,  events  in  Australia  caught  up:  his  new  UK  employer  advised  when  the  news  broke  that  his appointment would be “postponed” following “recent media reports of an investigation into supplier payments at  Target”  (Pets  at  Home  Media  Release  2016a).  Ten  days  later,  the  company  announced  that  by  “mutual agreement” he, in fact, would not be taking up the role of CFO. (Pets at Home Media Release 2016b)

Tough treatment? Well according to Wesfarmers boss Goyder, himself an experienced CFO: “[if the former CFO] wasn’t aware of the questionable transactions, he should have been aware” (quoted in Mitchell 2016). This is a reminder that CFOs need to uphold the highest of standards. Difficult, particularly when non-financial managers are carrying out commercial negotiations, often poorly documented  (sometimes over the phone), desperate to get the right profit results by balance date. CFOs in any retailer need to watch out for requests for balance date adjustments concerning accrued revenue and the creation of debtor balances at these times based on these apparent negotiations.

Yet another recent instance where the issue of rebates has been a primary focus is in the disastrous outcome for  the  iconic  electrical  retailer,  Dick  Smith  Group  (DSG).  Its  road  to  failure  started  with  previous  owner, Woolworths, selling DSG to a private equity firm, Anchorage Capital, for $93m in November, 2012 – a year later it was floated on the ASX with a market capitalisation of over $500m. But within 2 years, administrators McGrathNichol had been called in.

Explanations of how a seemingly successfully turned around company could have so spectacularly sunk into failure are continuing. However, the processes of administration will take their course and one of those is a report to creditors by the administrators (McGrathNichol 2016).

One of the key emphases of this report was DSG’s reliance on rebate income. In the year ended June 30, 2015, DSG’s reported Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) was $72m. If rebate income was excluded, EDITDA would  have been a loss of ($119m).   This demonstrates just how important rebates were to DSG.                                                          

                                                                  Figure 6 Rebates compared to EBITDA - FY15

    
                                                                                        (Source: McGrathNichol 2016 p48) 

The break-up of the types of rebate is shown in Figure 6 where the main types of rebate were scan (volume purchase) rebate and the previously described “over and above” type rebates for things like reimbursement of promotional  expenses.  The  administrators  have  stated  that  a  large  proportion  of  these  rebates  were appropriately  applied  (e.g.  to  COGS  at  time  of  sale)  and  were  regularly  tested  by  the  external  auditors (McGrathNichol 2016 p48). Nevertheless, it seems there was at least some not appropriately accounted for.

The administrator’s report made a number of telling observations concerning this point and other issues:

• “Poor and declining performance appear to have led to Management making decisions on what stock to buy (and at what volumes) based on the rebate attached to the stock, rather than customer demand;
• Rebate-driven buying contributed to a build-up in inventory and encouraged poor product mix decisions;
• In periods of low profitability, some rebates provided a short-term incentive for Management to prefer a certain supplier and product, because the rebate increased profit in the month of purchase, rather than when the product was sold (as ordinarily would be the case);
• Purchasing decisions increasingly based on rebates ultimately leads to a slowing of inventory turnover rates, as the products are generally less popular with Eventually, in the case of DSG, heavy discounts were needed to sell the rebated stock, destroying the margin uplift that the rebate sought to achieve; and,
• In some cases, the stock could not be sold at all and became obsolete” (McGrathNichol 2016 p48).

It seems that things started to go horribly wrong in  Christmas 2014. Trading did not meet expectations. In subsequent months, management made a provision for aged and inactive stock of $20m. In October, 2015, an independent consultant identified that, in fact, $60m of stock should be written off.

The Board ultimately accepted this with a consequent, dramatic impact on profit guidance. In addition, sale activity   to   clear   this   aged,   low   margin   stock   only   cannibalised   sales   of   active,   high   margin   stock (McGrathNichol 2016 p50). The reasons why DSG board and senior management didn’t get onto this situation earlier  is unclear.  But, the  end was now not  far off. Poor merchandising and  ranging, and, poor  inventory management were sinking this famous retail brand.

From a supplier’s point of view, rebates are offered to retailers to move stock. It’s no surprise that in some instances, suppliers adjust their margins downwards for stock that they think may be becoming aged. A lack of astuteness from merchandise buyers, a desire to make buying decisions that appear will lower COGS, and, maybe even greed, will eventually impact profit as it did at DSG if the stock can’t be sold. What appears to be a good deal, may end up being a weight.

There was no separate internal audit function at DSG. Even if there was, would this have made a difference? Would an internal auditor have questioned what was basically a commercial, merchandising practice? One could at least expect that they would get involved with questions of compliance with accounting standards concerning the recognition of rebate income and the valuation of stock, but further complications can arise depending on the reporting structures of internal audit functions.

Some report to Chief Financial Officers (CFO), some to Chief Executive Officers (CEO) while some even directly to the board. Potential conflicts of interest arise if reporting to CFOs (questioning your boss), while there is potentially a loss of focus and sometimes skills if CEOs are charged with the responsibility of internal audit (CEOs tend to have their minds on profit). Likewise, a lack of time and supervision may arise if internal auditors report directly to boards.

While an internal audit function can be a useful part of a governance function generally, it may not represent a complete solution to questionable management and financial business practices. Other controls need to be considered as well.

The discussion so far concerning the apparent use of buying power by big retailers to take advantage of either an international or domestic supplier base (and the backlash against these actions), and, the cases described above where commercial rebate negotiations were undertaken to achieve illusory financial benefits, points to one of the great temptations of organisational life:

Management decision making that may bring short term benefits but which may negatively impact the performance of the company in the longer term. What’s driving this and how may this behaviour be controlled?

Attempts to resolve these questions have generally been included within discussions concerning the “agency dilemma”. Put simply, this theory suggests that the separation of the owners of the company (the shareholders) from the managers (and directors) of the company as part of the development of the modern corporation, has caused a problem because management will act out of self-interest not necessarily in the interests of the company. It suggests that this needs to be mitigated by “artificially” aligning each party’s interests in some way.

In recent times, the mechanism through which this has been attempted has been the design of senior management’s remuneration. The way that this has been done in practice has been to reward senior management based on measures such as Total Shareholder Return (TSR). Rewards also include amounts paid in equity, and, importantly, that a proportion of total remuneration is “at risk” – that is, management will gain only if shareholders gain.

A Productivity Commission study into company remuneration practices called by the federal government in 2009 after what was seen as the excesses of the period leading up to the Global Financial Crisis (GFC) identified the structure of CEO remuneration  (Productivity Commission 2009). Structures are typically defined by: a fixed element; a short-term incentive payment (STIP) - paid as cash bonuses typically paid in the current year; and, a long-term incentive payment (LTIP) - typically paid by the issuing of shares based on performance over a longer timeframe.

Figure 7 shows that the bigger the company, the greater the “at risk” component is (that is, the STIP and LTIP elements). Presumably, agency issues are greatest the larger the company?                                                         

                                                                                   Figure 7 CEO Remuneration Structure                                                                   

                                
                                                                                                (Productivity Commission 2009)  

At Dick Smith Group, the remuneration structure for Key Management Personnel (KMP) in 2015 is shown in Table 1.

Table 1 – Remuneration Structure for Key Management Personnel at DSG - 2015 

	Fixed (i.e. Base salary)	STIP (cash)	LTIP (shares)
CEO	44	34	22
Other KMP (incl.CFO)	51	27	22

                                                                    (Source: Dick Smith Group 2015) 

The STIP element was  paid as cash bonuses and  based on measures such as: sales, cost  of doing business (CODB) and EBITDA. Financial measures made up to 60-70% of the required measures; the remainder were based  on  operational  measures.  In  respect  to  the  LTIP  element  these  were  based  on  the  measures  Total Shareholder Return (TSR) and Earnings per Share (EPS) growth. “Long term” performance was measured over a 3 - 4 year time period (DSG 2015)

For the sake of comparison, Woolworths KMP remuneration structure for the 2015 year is shown in Figure 8.                                                    

                                       Figure 8 Remuneration structure for Woolworths Key Management Personnel (KMP) 2015

            

                                                                                            (Source: Woolworths 2015)

Woolworths STIP payments were based mostly on financial measures including Net Profit After Tax (NPAT), other  profit  measures  such  as  EBITDA,  Gross  profit,  or,  controllable  profit  (depending  on  the  manager’s position), Sales, and, Return on Funds Employed (ROFE) and CODB. Some other operational measures were apparently used but these were not identified by the company in its remuneration report. And, further, NPAT was defined as a “gateway” measure: if this was not achieved, no STIP would be awarded at all. The company’s LTIP rewards were, in a similar way to DSG, based equally on TSR and EPS outcomes (Woolworths 2015).

While Woolworths continues to be a successful company, some analysts have criticised its relentless pursuit of profit. A well known stock analyst David Errington from Merrill Lynch speaking at a results presentation said:

"The elephant in the room is Woolworths in the last five years has taken its eyes off the ball in focusing  on  customers  because  it's  been  focusing  on  the  (profit  and  loss)  –  you  have  taken margins up to record levels and this is fertile territory for Aldi" (quoted in Mitchell 2015b). 

Woolworths’ emphasis on gross margins has been quite clear as shown in Figure 9. 

                                                                    Figure 9 – Woolworths Gross Margin performance 2008- 2015

                                                               

                                                                                                (Source: Mitchell 2015b)

It’s the retailer’s dilemma: should you pursue profit or should you pursue market share promising greater profits but only in the longer term?

This  raises  issues  concerning  non-financial measures generally. Market share is a classic retail non-financial measure; there are others. Woolworths   new   CEO   Brad   Banducci   has recently reviewed the key measures he wants to   use   in   the   business   to   drive   business transformation (Woolworths 2016a) 

A key change has been the elevation of “sales per square metre” - this will now be included as part of the LTIP reward scheme. Short term measures will also now include a renewed focus on customers and team performance. How this will be implemented has not been communicated in detail  but the fact  that  the

CEO elevated the discussion of these new and revised  measures  in  the  latest  earnings  announcement  indicates  a  re-focus  of  measurement  priorities (Woolworths 2016b p3).

The use of non-financial measures in any performance management system is not new. Management accountants advocate their use particularly given their ability to be a “leading” indicator of future performance. A reliance on financial measures only, may actually create adverse consequences. Non-financial measures can be more targeted, measuring the performance that is important to delivering on chosen strategic drivers. And, it’s the acknowledgement of the legitimate importance of the stakeholders of organisations that is proving to be the catalyst for a more extensive view of what performance management is all about.

To be sure, the capitalist system is built on the profit motive and the remuneration structures described for DSG and Woolworths are in fact typical of most major companies. Indeed the big companies often use the same remuneration consultants to design these systems.

Indeed, the structure of remuneration systems has become a major point of contention particularly for ASX listed companies. Institutional shareholders and their proxy advisors have significant power to bring about change in remuneration structures given the ability for shareholders to vote against company remuneration reports and consequently to force elections for new directors. Some of these proxy advisors believe that performance targets should, in fact, remain focused on financial targets. Amongst other reasons, it is argued that they are easily measurable and objective.

But a recent example of where this idea was not necessarily fully accepted by a major company was the Commonwealths Bank’s (CBA) intention to base senior pay on customer, community, and, people metrics as well as financial measures. CBA chairman David Turner maintains that the bank was doing the right thing on this issue saying that

“…we  need  a  balanced  set  of  measures  between  financial,  people  and  community  to  set  even standards for our business, and position us for a successful future" (quoted in Yeates 2016).

But, after some major fund managers and advisors flagged that that they would vote against this, CBA backed down. Turner defended the original move. “Sustainable success” he said on the day of the AGM,

“is not a binary issue of whether you make X profit or Y profit on a particular day of the week because that  doesn’t  encompass  how  behaviours change and  how an organisation will evolve” (quoted in Bennet and Garvey 2016)

Maybe from a company perspective, at a board level, it seems there is an increasing recognition that business models need to be sustainable. And for this to happen, the expectations of stakeholders, other than just simply shareholders, are increasingly being acknowledged.

Wesfarmers for example, extensively report on sustainability activities. The company’s experiences with the RANA   Plaza   tragedy   has   only   heightened   this   awareness.   In   Wesfarmers   2016   results   presentation (Wesfarmers 2016b), CEO Richard Goyder, made it quite clear the place the company has in Australian society by showing the total value created for stakeholders (see Figure 10)                                                           

                                                                    Figure 10 Wesfarmers Stakeholder Value Creation

                     

                                                                                         (Source: Wesfarmers 2016b)

True, it is expressed in dollar terms but it is clearly demonstrating that in terms of “stakes” in a company, shareholders comprise, in fact, a relatively small part. This type of reporting, along with the major international moves to concepts such as Integrated Reporting , may be signalling that the emphasis on financial performance measurement and its reporting is undergoing significant change – a change that is being driven by arguments based on the need to take a more holistic view of strategic performance management.

Conclusion: What role for the accountant?

The big retailers in Australia need to act on this change. They are high profile. With the ability of customers, and others, to take to social media they are constantly in the public eye. It is therefore even more important to think about all parties who have a legitimate “stake” in the company.

The  example  of  7Eleven  in  Australia  is  a  case  in  point.  The  recent  extensive  publicity  concerning  its questionable  employment  practices  particularly  in  respect  to  the  underpayment  of  a  mostly  international student workface  - a  workforce vulnerable because  of its relatively weak bargaining  position  - is a striking example of how a major retail brand can be exposed (Chung 2016). It may be the ultimate demonstration of how the employment relationship should not represent simply an expense line item in an income statement for a company but a vitally important stakeholder that needs to be managed for the long term.  The ease with which whistle-blowers can  take to social  media now,  possibly makes this relationship more fundamentally important than it has ever been.

The other instances highlighted in this case have explored the idea that commercial decision making can no longer be thought of as being driven by profit criteria alone. The justifiable concern for suppliers in less developed countries and the use of power by big retail buyers generally show that supply chain analysis can’t just be about “COGS” and “CODB” reductions.

Likewise, the short-termism demonstrated in the discussion concerning supplier negotiation over rebates and other allowances in the pursuit of cost reduction, indicates that the emphasis on profit and the behavioural consequences arising from this need to be considered. How accountants approach this decision making as part of the senior management group, and, what advice they provide to key personnel, will have a major bearing on how the strategies of the big organisations will be viewed by all of its stakeholders.

Accountants have always been in a critical position within the organisation when it comes to control. They are also now in a pivotal position to help to define, promote, and, implement performance measurement and reporting which can be the drivers of not only profit driven decision making but also decision making that is viewed by society as being ethical. This is the challenge now confronting the accountant.                                                     

Questions for Ethics Case Study

After reading the above case, please answer the following questions: 

1. The Food and Grocery Code of Conduct which provides guidelines to the Australian supermarket industry has a requirement that “retailers and wholesalers act lawfully and in good faith”. What do you think is meant by the term “good faith”?
2. Why do you think the Food and Grocery Code of Conduct is a “voluntary” code? Why hasn’t the ACCC moved to have government legislate this code into law?
3. Strategic theory suggests that having power is a good thing. Generally, it is thought that having power is better than being powerless. For example, pricing and purchasing power brings bottom-line But when is it appropriate to use the power you have? How do you assess if the use of your decision making power as a senior manager and/or group is legitimate?
4. If you are the Chief Financial Officer and you are approached by the CEO or other senior manager to deliberately delay the payment to the supplier simply to improve your company’s cash position, how would respond? On what grounds would you base this response?
5. To what extent do you believe that you can apply developed country standards of employment conditions to less developed countries? What information and/or frameworks can you use to determine what is appropriate?
6. The case says (p4) that an OxFam Australia survey suggests that Australian consumers are willing to pay more garments if this means that less developed country suppliers are also paid If you felt strongly about this and you were on the senior management team discussing this idea, how would you convince a CEO or Chief Marketing Officer that this is a good thing if the company’s strategy follows a cost (price) leadership model?
7. The case states (p4) that even where retailers try to do the right thing and conduct audits on their suppliers, “audit fraud” is a problem – workers being coached to say the right things even to independent If you were conducting the audit how would you approach this possible problem particularly given that the employees and management you are auditing may be in fear of losing their jobs if they are truthful?
8. What is Integrated Reporting and what is it trying to achieve? How do you think the use of this framework may change performance and remuneration system design?
9. What do you understand by the concept of an “at risk” component of remuneration? Why do think it appears to be a larger component of total remuneration for CEOs and senior management the bigger the company as found by the Productivity Commission report?
10. What is your understanding of who the stakeholders of a company are? Who do you think are the stakeholders of a large supermarket company? Why is the concept important to ideas concerning the ethical behaviour of companies?

Real Pressures on the Australian Retail Industry

The Food and Grocery Code of Conduct is a voluntary code under the Competition and Consumer Act 2010 that governs the behavior and the performance of wholesalers in how they deal with suppliers in Australian supermarket industry. According to this conduct, the retailers and the wholesalers should act lawfully and in good faith. This means that this requirement includes the wholesaler, retailer, supplier in their everyday interaction and in their dealing whenever they sign contracts.

Even though the code does not directly define the meaning of good faith in any of its provisions, it shows and clearly explains what good faith could look.  From this, we could determine good faith as a provision in the code that requires the wholesaler, retailers to act within their agreement with the supplier reasonably in exercising their powers (Tricker 2015). It means that their behavior should not have some illegitimate interest or their actions should not be dishonest with ill motives to the supplier.

Despite the code requiring the wholesaler and retailer to pay attention to the rights of the supplier in their agreement, it does not limit the retailer or wholesaler from thinking of their interest in making profits in their businesses.  It also does not advocate for the wholesaler or retailer to act just according to the interest of the supplier (Whish 2015).

The code provides the determinants that the courts should have in recognizing whether the actions are done within the provisions of good faith which include:

(a) If the supplier's action or business relationship is because of pressure or threat

(b) If the relationship between the supplier and the wholesaler is conducted in “recognition of the suppliers, need for certainty about the risks and                 costs  or trading, particularly about production, delivery, and payment.”

(c) If the supplier action is by the good faith requirements 

As mentioned earlier, under Competition and Consumer Act 2010, the Food and Grocery Code of Conduct is a voluntary code. It regulates the conduct of wholesalers, retailers, and suppliers by ensuring transparency in their commercial dealings and the ACC has not moved to have the government legislate this code into law since it is a voluntary code. Therefore, the question is, does it mean to be a voluntary code?

This code of Grocery code of conduct is a voluntary code in that it is only applicable when the retailer, wholesaler and the supplier voluntary choose to be bound by the Code (Yeager 2015).

International Retailers and New Business Models

The retailer is bound by the code if the retailer, by use of a written notice, writes to the corporation an application and then the corporation agrees. At this point, the retailer is bound by the code. Individually, section 4(1) or if the retailer was a party to a grocery supply agreement that the retailer was tied to before being banded by this code, section 5(1) and lastly if the supplier concerned accepts the offer within six months, section 5(3).

The wholesaler becomes a member of the corporation has agreed to a written notice written to the commission from the wholesaler, section 4(2) and if the concerned supplier accepts the offer within six months. The same rule applies to the membership of the supplier.

All the parties which entail the wholesaler, the retailer the supplier have the option of quitting this agreement by use of a withdrawing agreement that bounds them to the code and the requirements attached to them during the signing of the code agreements.

It is suggested by Strategic Theory that being in possession of power is desirable and is better than lack of it. Having power is better than being powerless. An example of power is purchasing and pricing power. It is desirable because it brings bottom line benefits. The only problem is how to determine whether the decision made is legitimate even as one possesses power (Goodwin and Wright 2014).

The senior manager will assess whether the decision made is legitimate if it is by the regulations and principles of Australian corporate governance principle which are:

The manager will recognize if the decision made is ethical according to the available legislation and codes such as Food and Grocery Code of Conduct and Competition and Consumer Act. The decision should create a safe and nondiscriminatory judgment should be environmentally friendly and should promote honest dealings between wholesalers, retailers, and consumers in an organization, lastly responsibility should be portrayed in the decision especially when dealing with other partners or fellow workers (Shapiro and Stefkovich 2016).

A manager should make decisions at the correct and relevant time, and the decision should safeguard confidential information of the organization, they should ensure that the decision made is honest that the decision does not undermine the power or responsibility of others in the organization just because of possession of the power to do so.

The decision made should be able to deal with the issue at hand peacefully without rating further conflicts within an organization

Reducing Costs to Improve Profits

The decision made should not infringe the rights of anyone in any way according to the Australian Bill of rights (Furman, Branden and Spaller 2018).

The decision made should be a representation of the docket occupied with the voice of the whole organization at mind and heart and a decision that can clearly be defined further

The decision made by the manager should not in any way violate the vision and mission of the company since decisions made by the manager are the ones that mostly run the organization

As a chief financial officer, when approached by the CEO of the organization I work for to postpone the payment of supplier for our own company to improve its capital position, I would respond by telling him that I will not do it. Instead, I will insist on paying the supplier at the correct time as stipulated in the contract.

I will do this because according to Competition and Consumer Act 2010 division two on payment of suppliers, the retailer should pay the supplier for their service delivery by the agreement in the contract. This entails the correct time frame as agreed 1(a) and within a reasonable time after receiving the supplier's invoice for the product. In this case, if I delay the payment, I will be going against this policy.

Secondly, the same act warns against the setting of any amount or time in the supplier’s invoice or remittance unless the supplier has consented in writing so unless the supplier agrees without any form of pressure to the decision of delaying the payment I won’t suspend the payment.

In looking at the case study of Tesco Company that knowingly, delayed paying money to the suppliers to improve its financial position for a period of twelve to twenty-four month. After investigations, Tesco's management was questioned for ethics and administration. Thus it was found that there was a need to train the finance and management in ethics in business.

I will also fail to delay the  payment as an accountant in the institution according to section 100 of  Code of Ethics for professional Accountants 2010 that clearly points out that an accountant responsibility is not to satisfy the needs of an individual client or employer in action but the needs of the public interest should be the priority and in this case scenario the need of the supplier will be my priority and not my obligation as a member in the organization or the lack of the CEO according to the ethics of the accountancy professing that I am pursuing.

Sourcing Products from Overseas Suppliers

Applying advanced country standards of employment conditions to less developed economies is possible to a considerable extent depending on several factors that can be considered based on the framework obtained in The Fair Work Act 2009 and the Employment Standards Act which entails:

To change the standards of the less developed countries, one must inquire whether there are the available professionals that are needed to do this and in the new framework, one would wish to come up with. An example is when one wants to change the education system of a country I is right to ask whether there are available teachers to undertake to teach the new curriculum the same applies to any employment profession especially if adjustments are to be made in the business.

There is need to consider the available policies and laws in issues to do with the duration of work, the taxation policies, the payment, and punishments. It could be challenging to introduce new employment standards in an area where the systems do not allow. For example, if Australia provides a law on the considerations of scrutinizing commodities produced another country say, New Guinea, it might never work.

 A very critical issue to consider is financing budget allocated in the employment sector to the employees in the country that is in question. There is need to determine the payment range of professions and the taxation system. There is also need to specify the overtime policy of the country or organization in question whose employment standards you need to change. An example is in a state where there is little money allocated as wages. If you increase the standards of quality delivery in the sector of employment, there will be demand for more standards that cannot be produced by the government.

A survey by Oxfam Australia shows the consumers of Australia can pay  extra cost for garments so long as the suppliers from less developed economy is also paid high. This is about the fact that most of the garments (of up to 90%), imported into Australia come from Asia. However, Asia is experiencing a low wage environment. I have felt strongly about this and as a member of the senior management team discussing this idea, I would convince the Chief Marketing Officer that this is a good thing. This is because we will be doing it as a way of charity in that, if the Australian citizens have agreed to pay more garments for the sake of the suppliers in the less developed country our organization could we could do this even without the aim of soliciting profit but just as a way of charity. Secondly outsourcing for the garments, our organization would be the best practice since it will be a cost reduction strategy (Dumay 2016).

Ethical Implications of Overseas Sourcing

The survey conducted by Oxfam Australia indicate that the consumers Australia are ready to make payment expensively for garments so long it implies less developed economies suppliers are further paid expensively. In case a consumer strongly feels the expensive cost paid and given an opportunity to be a part of senior management to discuss it, what strategy would you employ to persuade the chief executive officer or chief marketing officer that it is a promising thing so long as the strategy of the firm follows price- or cost-leadership model. The organization needs to manage our supply chain. This entails being able to monitor the way that the products we are outsourcing are coming from and if an audit is carried realizing that the garments are made amidst overwork and minimum wages we should be responsible for trying to help this organization as a company.

In trying to convince him I will base my argument on the case of RANA Plaza located in Asia, Dhaka where thousands of people worked for about 14-16hrs a day each day in poor working conditions until which led to collapsing of the story building hence killing people. 

I am external auditor called to investigate the performance of an organization conducting an audit. The audit is performed on organization's suppliers, but there is no cooperation or withdrawal of information. This is because of fear in the employees and the management that they might lose their jobs. They are fearful because as an auditor, I report to the board of management or top management or ministry in charge (Goetsch 2014).

Firstly, I would consult the executive board assessing the possibilities to commit audit fraud and assuring them of the need to undertake this audit as a way of increasing the performance of the organization and convince them that I will give them a copy of report so that they can improve in the areas mentioned furthermore I would need their support during the study to assist in answering the question and to tell the other employees that everything would be okay.

Secondly, I would try to identify possible fraud schemes and scenarios between the management and the employees and amongst employees in the organization, then I would try to break this fraud ties by talking to the necessary people.

Thirdly, I would assess the degree of evaluating possible losses that could arise from the audit fraud in my work as I seek to determine the supplier problems in the organization. After this, I would then formulate or modify the audit plan based on the results of assessing fraud risks. An example is if I were supposed to start with the manager who could go and train the other workers how to respond I would then change my plan by beginning to question the other employees, or I would change my method of asking from being systematic to being randomized.

Monitoring Supply Chains to Avoid Worker Exploitation

 Today's organization must manage an extensive range of resources which are tangible and intangible assets to create value over time. This includes intellectual capital, natural and human capital, research and development which represent a significant portion of market value (Adams 2017).

Integrating report is a communication of an organization evaluation on areas such as financial sector, performance, strategy, governance, and prospects explaining how they are going to create value in their organization which could be short term, medium or long term.

Some of its benefits are that it provides an organization with a platform for performance analysis overviews of external environments, room for the creation of strategies and planning of resource allocation (Busco 2016).

It helps the organization to emphasize the future strategic focus and directions regarding information access, connectivity, and simplicity of the information.

It helps in remuneration in that, during the process of developing an integrated report, one can develop skills and techniques that are necessary to build an organization. This can by coming up with financial reports with future issues, and it can help future remunerations by enabling planning of activities, and it may change remuneration system design in that it will make it easier to deal with.

Decision made by the management sometimes are of short term benefit yet they have a negative impact in the long run just because they have the buying power to do so, in order to deal with this there have been discussions an agency dilemma that suggests the separation of shareholders and the management  who are the directors and managers (Melis,2015),but this has caused a problem as management will act in their interest and not necessarily the expectations of the organization, this model has been tested by starting a senior management remuneration where the managers are rewarded based on measures like Total Shareholder Return.

The “at risk” concept is where a portion of the total remuneration of the senior management is held so that the managers will get it only if the shareholders gain (Bertone 2015). The structure of this remuneration is determined by a fixed element such as short-term incentive that is paid as cash and long-term incentive payment that is funded by issues of shares based on performance over an extended period (Bertone 2016).

It is a more significant component of total remuneration for CEOs and senior management. This is because the CEOs and the senior management are the people in charge of decision making. Therefore, they are the ones who run the organization. This person determines the profit or loss in an organization thus playing a vital role in the shareholder. The bigger the company, the higher the need for a more critical decision, therefore, a more significant component of the total remuneration is taken.

Active Stance on Managing Supply Chain

Stakeholders are a group, persons or organizations that are concerned or have interest in an organization. A stakeholder refers to a group of people who are affected directly or indirectly by the decisions that are made in the organization example of stakeholders in an organization include the customers, the creditors, employees, community, government, suppliers, and shareholders.

For a company or organization to be successful the expectation of both the shareholder and the stakeholder need to be met (Ferrell and Fraedrich 2015). In a supermarket company, the stakeholders are customers, employees, shareholder and the community. The stakeholders are very crucial in the ethical behavior of a company because for a company to be successful the stakeholders should be treated with respect even though they don’t have to manage all the stakeholders equally (Bolman and Deal 2017). 

References

Accounting Professional and Ethical Standards Board 2010, APES 110 - Code of Ethics for Professional Accountants https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf 

Adams, C. A., 2015. The international integrated reporting council: a call to action. Critical Perspectives on Accounting, 27, 23-28. 

Adams, C., 2017. Understanding integrated reporting: The concise guide to integrated thinking and the future of corporate reporting. Routledge. 

Australian Competition and Consumer Commission 2015 Food and Grocery Code of Conduct https://www.accc.gov.au/business/industry-codes/food-and-grocery-code-of-conduct. 

Bernstein, M. and Jain, V. K., 2014. Ethical decision-making. In Neurosurgical Ethics in Practice: Value-based Medicine (pp. 135-146). Springer, Berlin, Heidelberg. 

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Bertone, M. P., Lagarde, M. and Witter, S., 2016. Performance-based financing in the context of the complex remuneration of health workers: findings from a mixed-method study in rural Sierra Leone. BMC health services research, 16(1), 286 

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Busco, C. A., 2016. Integrated Reporting. Springer. 

Cheng, M., Green, W., Conradie, P., Konishi, N. and Romi, A., 2014. The international integrated reporting framework: key issues and future research opportunities. Journal of International Financial Management & Accounting, 25(1), 90-119. 

Council, A. C. G., 2007. Corporate governance principles and recommendations.

Dumay, J., 2016. A critical reflection on the future of intellectual capital: from reporting to disclosure. Journal of Intellectual capital, 17(1), 168-184. 

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Furman, A., de Branden, P. V. and Spaller, A., 2018. Ethical Decision Making. 

Goetsch, D. L. and Davis, S. B., 2014. Quality management for organizational excellence. Upper Saddle River, NJ: Pearson. 

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Yeager, A. L., 2015. Ethical decision making. The Journal of the American Dental Association, 146(8), 568-569.