London’s first department store opened its doors in 1796, offering Georgian shoppers everything from hats to clocks, and by the early 20th century Selfridges and Harrods had arrived. Over the past decade, however, these “cathedrals of commerce” have struggled. British Home Stores, House of Fraser, Debenhams and Edinburgh’s Jenners have all closed, and even John Lewis – the mothership of Middle England – is under pressure.
Don’t sound the death knell just yet, though. Marks and Spencer (MKS) and Next (NXT) have spotted an opportunity, and are looking to fill the void by buying up sinking brands and trying to widen their appeal. The question is: will they succeed where others have failed?
M&S and Next had not previously been acquisitive companies. Until 2021, Next had made just one material acquisition in 30 years. Similarly, the last fashion brand M&S purchased before Covid-19 was Per Una in 2004.
The pandemic changed things, however. In January 2021, M&S fished Jaeger out of administration, and has since bought stakes in Nobody’s Child and The Sports Edit. It has also struck partnerships with 40 other fashion retailers, including Hobbs, Seasalt and White Stuff, and just poached a director of third-party brands from Amazon.
Next has had a similar idea. After building a majority stake in Reiss in 2021, it moved onto distressed brands, hoovering up the likes of Joules, Cath Kidston, the UK franchise of Victoria’s Secret and Made.com.
Perhaps it was only a matter of time. The biggest challenge for mature retailers, after all, is staying up-to-date and fashionable. “If you’re not relevant to your customer base, you’re dead,” said Peel Hunt analyst John Stevenson.
M&S’s clothing and home division has long underperformed its food halls, and Next has been open about its “unexciting” absolute returns over the past eight years. By investing in third-party brands, there may be more hope of enticing younger shoppers – and economic pressures mean there are plenty going cheap. Majority stakes in high-end retailers such as Reiss and Jaeger could also lure wealthier customers away from the likes of John Lewis.
Margin pressures
The logic looks sound, therefore. But is the shift to a department store-esque model harder than it looks? At the moment, it’s difficult to tell – particularly at M&S. The third-party offer, referred to as Brands at M&S, is still “nascent” and generated just 3.5 per cent of online sales in financial year 2022.
Next's results are more illuminating, however. Despite avoiding acquisitions for much of its life, Next has partnered with external brands for several years via its Label division, which sells third-party goods on the group's main website. The products are either sold on commission or purchased wholesale and marked up.
Online sales overtook in-store sales at Next about five years ago, and growth has increasingly been driven by Label. This came to a head in 2022, when Label's revenue and profit continued to climb, while Next’s core online business went into reverse. “Bringing third-party brands onto the platform has widened its scope massively,” said Peel Hunt’s John Stevenson. “It has grown all ends of the customer base”.
Next chief executive Simon Wolfson also told analysts that average sales per customer had risen as a result of Label. “It's all about increased offer on our website,” he said.
This is all well and good, but profits matter more than revenue. Label products are sold at a significantly lower margin than Next’s own online selection, and the change in sales mix has contributed to a four percentage point fall in total online margins since 2019. A push for more goods to be sold on a commission basis – which lessens the stock risk for Next – is likely to increase the discrepancy.
This is not necessarily a big problem in its own right. However, the changing sales mix has collided with higher warehouse, distribution and technology costs, which have also weighed on online profitability, reducing Next's margin for error.
Wolfson said the company had done an “enormous amount of work” to improve the profitability of Label by eliminating specific unprofitable items. “If you've got a low enough average selling price and a high enough returns rate, you don't make a profit,” said Wolfson. “And brand-by-brand, territory-by-territory, country-by-country, channel-by-channel, we've gone through to identify all of those items and eliminate them,” he said.
However, as Next and M&S partner with ever more brands, they will need to monitor their portfolios constantly, and the risk of making a mistake will grow.
Customer returns are likely to be a particular problem. “The thing to bear in mind about platforming is that it’s not easy to do,” said Panmure Gordon analyst Tony Shiret. “Within clothing online, a very high proportion of products get returned. But the complexity of returns is one of the main problems with online retailing. By the time it lands with someone who actually wants it, it might have gone out four or five times. Dealing with that soon erodes your profit margins.”
The pandemic kept customer returns unusually low, so the full effect of this might take some time to emerge.
Brand risk
By actively investing in retailers – as opposed to just partnering with them – Next and M&S are trying to offset some of these margin pressures. Next realised, for example, that its ‘Total Platform’ division – which goes a step further than Label, allowing retailers to use its logistics infrastructure and have their websites fully serviced, in exchange for a percentage of turnover – created more value for clients than for the group itself. So it decided to put some skin in the game.
So far, the approach seems to be working well. In 2022, investments in the likes of Gap and JoJo Maman Bébé among others generated £16.8mn of profit, compared with just £5.4mn from the Total Platform service itself.
There are different risks involved, however. For starters, Next and M&S have to cough up for the brands in the first place, and the sums in question are not always insignificant: it cost Next £34mn to buy Joules out of administration.
Then there is the image risk. Both Next and M&S say that developing their own brands is still their “highest priority”, but it's possible that acquired companies will damage their overall reputation. After all, buying distressed brands such as Joules, Cath Kidston and Victoria’s Secret – all of which have fallen out of fashion in recent years – is unlikely to improve a company’s trendy credentials.
As with brand partnerships, there is also the issue of complexity. “One of the issues for Next is that it has been a relatively straightforward business for a long time,” said Shiret. “But since it has been trying to expand its range, it has massively increased the number of [stock keeping units] it is selling, and the complexity of servicing them…You have a very wide, but very shallow selection in these platforms. What Next is historically good at is selling a narrow range with good depth, so there’s a lower markdown.”
Ecommerce vs the high street
One other question remains unanswered. Will Next and M&S embrace a full department store experience, and bring different brands into their physical shops, or will they be consigned to the digital world?
Next's Oxford Street store does contain a few concessions, but it plans to keep the vast majority of external brands online for now. “If you look at the net margins of our retail business, I'm not sure there's enough profit there for two brands,” Wolfson told analysts last month. “Once you looked at the margin diminution necessary to pay the brand something, it just wasn't worth it.”
This isn’t necessarily a problem – people still like internet shopping. But the ecommerce boom that took place during lockdown has certainly waned. Next and M&S – together with companies such as Hotel Chocolat (HOTC) and Dr Martens (DOCS) – all saw online sales fall in recent months and in-person sales jump up. As a result, several are proceeding with bricks-and-mortar expansion plans.
M&S is less wedded to the digital world. It has such large legacy stores that it is actually boxing in walls to make shops feel less cavernous, so the addition of some third-party brands is less likely to cannibalise the profits of its core business. Indeed, it has already added the likes of Seasalt and the Early Learning Centre to some of its bigger shops.
In the case of both M&S and Next, questions about margins, branding, growth and popularity remain unresolved. As analysts fret about short-term forecasts, therefore, and the immediate impact of weak consumer spending, it is worth keeping an eye on bigger internal changes – and what we want from our retailers in the longer term.
