How to increase profit margin 5 times? Dillard’s
The department store industry is hit hard by COVID and e-commerce, becoming less profitable. But only Dillard’s achieved a fat profit margin, and its stock price became insanely 15 times higher since April 2020. Why?
The net income rate (net income/sales) increased from 1.8% in 2019 to 13% in 2022, 7 times higher. This is mainly because the company’s cost of sales rate (cost of sales/sales) decreased from 66% to 56%, hence a 10% increase in net income.
Then why did the cost of sales drop significantly? First, we have to understand the cost of sales rate of Dillard’s and its rivals. In 2019:
Macy’s 59%
Kohl’s 60%
Dillard’s 66%
Dillard’s rate was the highest among those rivals. That means there was a lot of room to enhance the situation.
The cost of sales rate was so high because they had to sell a lot of remaining over-purchased seasonal clothes at significantly discounted prices at the end of the season. This pushed up the cost of sales rate so badly.
So, if they sell items without discounting, they improve cost of sales. And to avoid discounts, the best way is to eliminate items that don’t sell well and stay forever before they sell them for pennies.
In 2019, the inventory amount was $1,528 million, and in 2022, it became $1,080 million, a significant cut.
Here is what they do to reduce inventory:
1. They use AI to make accurate demand predictions and avoid over-purchasing. This is a normal act for a big company.
https://research.ibm.com/blog/dillards-ai-snap-ml
2. Managers educated item purchasers, saying buying too many items hurts the bottom line very badly. Maybe to purchasing persons, they can sell the remaining items eventually (by cutting prices significantly) so they buy a lot to not miss a selling opportunity by having too few items. This way they can maximize sales. In their minds, increasing sales will solve every problem. They have no idea that maximizing sales will worsen profitability. Normally those purchasing persons don’t think about company financials, so accounting education for all members is very important.
3. Cut items that don’t sell well. This way they can reduce inventory and avoid clearance sales and at the same time, avoid sales decrease because they have items that sell well. This is accomplished by analyzing data or knowledge from experience.
By these measures, it succeeded in reducing the cost of revenue to a normal level. I mean the cost of sales became similar to its rivals’ levels.
Then why is only Dillard’s winning while others are dying?
Apart from Dillard’s, rival department stores’ net income rates have decreased in recent years. This is because many consumers have shifted to online shopping, why they should bother going to a department store.
Net profit rates:
Dillard’s: 13%
Macy’s: 4.6%
Nordstrom: 1.6%
Kohl’s: 1.8%
The answer to Dillard’s unique success lies in SG&A (selling, general, and administrative expenses). Dillard’s SG&A is significantly lower than its rivals, so by only reducing cost of revenue to normal levels, it could achieve that high profitability.
For example, in the fiscal year ending January 2024, SG&A rates (SG&A/sales) were:
Dillard’s: 25%
Kohl’s: 31.6%
Macy’s: 35.1%
Nordstrom: 33%
This is mainly because Dillard’s depreciation+lease rate ((depreciation+lease fee)/sales) is very low at 3%. The depreciation is around $200 million, and lease costs are almost $0, as the majority of stores and lands are owned by the company. The depreciation+lease rates of other companies are around 6-7%, so if Dillard’s were a typical company, its SG&A would increase by $200 million.
Leasing is beneficial for high-growth companies as it reduces capital requirements for expansion. However, it’s a disadvantage in stable businesses like department stores. Lease costs are typically more expensive than owning properties. Also, a lot of Dillard’s properties were bought long ago, and depreciation for these properties has finished, so very few depreciation costs are incurred each year.
Additionally, Dillard’s advertising cost is very low. Only $38 million (0.5% of sales) in 2023, which is next to nothing. Rival department stores’ marketing costs are much higher: Kohl’s spends $839 million (5% of sales) and Macy’s $1.1 billion.
The reason why advertising fees are so low even though sales aren’t declining is because Dillard’s “owned a ton of real estate. Its stores are generally located in good malls” These department stores have been there for a very long time, local people recognize them, and customers come to the good shopping malls without advertising. So if they don’t have to pursue rapid sales growth, they can operate without spending much on advertisement.
This is the strength of local business.