Erik Nesler: Retailer woes

Sunday, October 21, 2018 - 4:29pm

Erik Nesler

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Sears, the retailer found in shopping malls across the U.S. and “The Original Everything Store,” filed for bankruptcy early in the morning Oct. 15. The 125-year-old American staple reached a deal with lenders that involved closing 142 stores by the end of the year. What lies ahead for the company is uncertain, but its seven-year streak of net losses signal that the company may face complete liquidation in the foreseeable future.

Liquidation will have overarching  implications for the nearly 70,000 individuals currently employed by Sears. These lives will take a drastic turn for the worse when the company finally closes all of its doors and these individuals find themselves out of work. The liquidation will also affect over 100,000 pensioners who earned that regular income when they once worked at the company.

Sears is yet another instance of the serious implications that technological disruption has had on the retail industry. The expansion of online shopping, due to the rise of Amazon, has had drastic consequences for the U.S. economy.  

In the years from 2012 to 2017, 250,000 department store employees found themselves unemployed from aggressive industry-wide layoffs. While this statistic is concerning, it’s nothing compared to the 6.2 million  individuals who could find themselves without a job in the future thanks to intense competition with Amazon.

While technological disruption and Amazon is certainly causing headaches in the retail industry, many retailers struggle with something else: Retailers are battling to overcome the hefty debt burdens brought on by private equity investors.

To illustrate this problem, let’s look at Toys R Us, the toy retailer that was forced to liquidate in June this year. Toys R Us was bought out in 2005 by the private equity firms Bain Capital and Kohlberg Kravis Roberts along with the real-estate firm Vornado Realty Trust. To purchase the company, the private equity investors loaded the company with debt to minimize risk and boost their eventual return.

Bryce Covert detailed the impact of this buyout in a piece published by The Atlantic. He wrote that 2007 interest expense (cash that needs to be paid every year to creditors) consumed 97 percent of the company’s operating profit. As the company faced fierce competition, Toys R Us should have used this operating profit to fund projects that could have improved the company’s performance, like upgrading stores or enhancing its online presence. Instead, the firm was forced to use its capital to pay off creditors.

When the Great Recession hit and revenue fell, Toys R Us struggled to afford its regular interest expenses and debt repayments. The debt burden hurt the firm’s chances of weathering the recession and overcoming the challenges posed by the rise of online shopping and Amazon.

As it turns out, private equity-backed retailers that have filed for bankruptcy are more common than you may expect. In this past year, Payless ShoeSource Inc., the shoe retailer with 22,000 employees worldwide, and Gymboree, a clothing outlet with 11,000 employees, filed for bankruptcy. Both companies, along with a slew of others, struggle with the massive debt burden forced upon them by private equity investors. FTI Consulting found  two-thirds of the retailers that filed for Chapter 11 bankruptcy in 2016 and 2017 were backed by private equity.

As retailers struggle to fight back against Amazon, their debt burdens will put them at a serious disadvantage. The combination of these components will have major implications for the millions of individuals affected and the U.S. economy as a whole.

As Amazon grows, retailers will increasingly end up like Sears or Toys R Us. Amazon needs to recognize and manage its immense impact on the economy. While the company has made progress in providing more value to the workforce, like its recent decision to raise its minimum wage to $15 an hour, the company could be doing more. 

Erik Nesler can be reached at egnesler@umich.edu

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