The second step in the strategic planning process is to define specific goals and objectives. These goals and objectives should be derived from, and give precision and direction to, the retailer’s mission statement. Goals and objectives should identify the performance results that the retailer intends to bring about through the execution of its major strategies. Goals and objectives serve two purposes. First, they provide specific direction and guidance to the firm in the formulation of its strategy. Second, they provide a control mechanism by establishing a standard against which the firm can measure and evaluate its performance. If the results are less than expected, then it signals that corrective actions need to be taken.
While these goals and objectives can be expressed in many different ways, retailers will usually divide them into two dimensions: market performance, which compares a firm’s actions to its competitor’s, and financial performance, which analyzes the firm’s ability to provide a profit level adequate to continue in business. In addition to the market performance and financial performance objectives, some retailers may also establish societal objectives, which are phrased in terms of helping society fulfill some of its needs, and personal objectives, which relate to helping people employed in retailing fulfill some of their needs.
Let us examine each type of these goals and objectives in more detail.
Market Performance Objectives
Market performance objectives establish the amount of dominance the retailer has in the marketplace. The most popular measures of market performance in retailing are sales volume and market share (retailer’s total sales divided by total market sales or the proportion of total sales in a particular geographic and/or product market that the retailer has been able to capture).
Research has shown that profitability is clearly and positively related to market share.9Thus, market performance objectives are not pursued for their own sake but because they are a key profit path.
As retailers increase their market share, their financial performance will also increase in comparison to their competitors.
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Financial Objectives
Retailers can establish many financial objectives, but they can all be conveniently fit into categories of profitability and productivity.
Profitability Objectives Profit-based objectives deal directly with the monetary return a retailer desires from its business. When retailers speak of ‘‘making a
goals and objectives desires to be compared to its competitors.
Is the retailer’s total sales divided by total market sales.
profit,’’ the definition of profit is often unclear. The most common way to define profit is the aggregate total of net profit after taxes, i.e., the bottom line of the income statement. Another common retail method of expressing profit is as a percentage of net sales. However, most retail owners feel the best way to define profit is in terms of return on investment (ROI).10
This method of reporting profits as a percentage of investments is complicated by the fact that there are two different ways to define the term investment. Return on assets (ROA) reflects all the capital used in the business, whether provided by the owners or by creditors. Return on investment (ROI), also referred to as return on net worth (RONW), reflects only the amount of capital that the owners have invested in the business.
The most frequently encountered profit objectives for a retailer are shown in Exhibit 2.1—the Strategic Profit Model (SPM). The elements of the SPM start at the far left and move right. These five elements include:
1. Net profit margin is the ratio of net profit (after taxes) to net sales, and shows how much profit a retailer makes on each dollar of sales after all expenses and taxes have been met. For example, if a retailer is operating on a net profit margin of 2 percent, it is making two cents on each dollar of sales. In general, retailers operate on lower net profit margins than manufacturers. The net profit margin ratio is derived exclusively from income or operating statement data and does not include any measures from the retailer’s balance sheet. Thus, it does not show how effectively a retailer is using the capital at its disposal.
2. Asset turnover is computed by taking the retailer’s annual net sales and dividing by total assets. This ratio tells the retail analyst how productively the firm’s assets are being utilized. Put another way, it shows how many dollars of sales a retailer can generate on an annual basis with each dollar invested in assets. Thus, if a retailer’s asset turnover rate is 3.0, it is annually generating $3 in sales for each $1 in assets. The asset turnover ratio incorporates key measures from the income statement (sales) and the balance sheet (assets) and, as such, shows how well the retailer is utilizing its capital to generate sales. In net profit margin
Is the ratio of net profit (after taxes) to total sales and shows how much profit a retailer makes on each dollar of sales after all expenses and taxes have been met.
asset turnover
Is total sales divided by total assets and shows how many dollars of sales a retailer can generate on an annual basis with each dollar invested in assets.
general, retailers experience higher rates of asset turnover but lower net profit margins than do manufacturers.
3. Return on assets (ROA) is annual net profit divided by total assets. It depicts the net profit return that the retailer achieved on all assets invested, regardless of whether the assets were financed by creditors or by the firm’s owners. As shown in Exhibit 2.1, ROA is the result of multiplying the net profit margin by asset turnover. For example, a retailer with a net profit margin of 2 percent and an asset turnover of 4.0 would have a ROA of 8 percent (2 percent times 4 equals 8 percent).
4. Financial leverage is total assets divided by net worth or owners’ equity. This ratio shows the extent to which a retailer is utilizing debt in its total capital structure. The low end of this ratio is 1.0 times and depicts a situation in which the retailer is using no debt in its capital structure. As the ratio moves beyond 1.0, the firm is using a heavier mix of debt versus equity. For example, when the ratio is 2.0 times, the firm has two dollars in assets for every dollar in net worth, which is equivalent to a mix of 50 percent debt.
5. Return on net worth (RONW) is net profit divided by net worth or owner’s equity. Return on net worth, shown at the far right of the SPM, is usually used to measure owner’s performance. Note that, as shown in Exhibit 2.1, the ROA multiplied by financial leverage yields RONW. Thus, if a retailer has a ROA of 8 percent and a financial leverage of 2.0, then its RONW would be 16 percent (8 percent times 2.0 equals 16 percent).
The important point to remember from this discussion of profitability is that department or specialty stores, which have higher gross margin (net sales minus cost of goods sold) and lower asset turnover rates, compete differently than dis-counters, which generally have lower gross margins but higher asset turnover. For discounters, this results in less inventory per dollar of sales and a need for fewer capital assets outside of inventory. Discounters expect to gain a higher asset turnover by reducing their gross margins, and specialty stores expect a lower asset turnover rate with their higher gross margins.
Remember that attempts to increase asset turnover by merely reducing inventory levels can have serious consequences for a retailer. These lower inventory levels may produce higher turnover rates, but they can also lead to stockouts (where products are not available for customers), thus creating a dissatisfied customer who may never return.
Managers are usually evaluated on return on assets, since financial leverage is beyond their control. In addition to the five elements of the SPM, another measure of profitability is the gross margin percentage, which is gross margin divided by net sales.
All retailers establish some form of profit objective. The specific profit objectives developed will play an important role in evaluating potential strategic opportunities.
Productivity Objectives Productivity objectives state how much output the retailer desires for each unit of resource input. The major resources at the retailer’s disposal are space, labor, and merchandise; productivity objectives for each may be established.
1. Space productivity. Space productivity is defined as net sales divided by the total square feet of retail floor space. (In this discussion, whenever we refer to net sales we are talking about annual net sales.) A space productivity objective states how many dollars in sales the retailer wants to generate for each square foot of store space. Even service retailers have a space utilization problem.
The chapter’s Service Retailing box describes how service retailers are using yield management tools to improve their space productivity.
return on assets (ROA)
Is net profit (after taxes) divided by total assets.
financial leverage
Is total assets divided by net worth or owners’
Is net profit (after taxes) divided by owners’ for each unit of resource input: floor space, labor, and inventory
investment.
2. Labor productivity. Labor productivity is defined as net sales divided by the number of full-time-equivalent employees. A full-time-equivalent employee is one who works 40 hours per week; typically two part-time workers equal one full-time employee. A labor productivity objective reflects how many dollars in sales the retailer desires to generate for each full-time-equivalent employee.