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The retail game has undergone a major facelift over the past two decades. First came the development of category killers, with specialized merchandise and service. Chains such as Home Depot and Lowe's put many smaller, regional players out of business in the home improvement area. In 1992, the two firms posted combined sales of $8 billion; in 2OO2, they sold more than $80 billion worth of nails, hammers, and appliances. Office Depot, Office Max, and Staples did the same thing to the office supply business in the late 1980s and 1990s.

The second major shift has been the move off the mall. Once upon a time, department stores were infallible in the world of retailing. Well-known chains such as Sears that were once destinations in their own right became the anchor tenants for malls. The stores aimed to provide customers with a one-stop shop­ping experience, and some even housed full-service restaurants. Customers had more time to shop and placed more value on the personal attention these stores provided.

Over the past 2O years, however, traditional department stores have become dinosaurs. Nowadays, companies such as Sears and JC Penney are struggling to remain relevant—a battle that chains such as Montgomery Ward and Woolworth have already lost. Changing consumer trends are largely, but not totally, to blame. In this era of dual-income households, shoppers want selection, quality, and reasonable prices, and they want it fast. And they've shown a willingness to shift their spending to stores that can provide this experience.

Firms such as Wal-Mart, Target, and Kohl's have stolen the thunder of the traditional department stores "with innovation and efficiency. These are the firms that developed everyday low prices, pioneered centralized checkouts at the front of stores, and set up shop in freestanding locations with more convenient parking. Whereas, Sears and Penney averaged O percent and I percent annual sales growth, respectively, from 1998 to 2OO2, Wal-Mart, Target, and Kohl's averaged 15 percent, 10 percent, and 24 percent, respectively. Over the next several years, we expect this divergence to continue.

Investing in Retail: Understanding the Cash Conversion Cycle

One of the best ways to distinguish excellent retailers from average or below- average ones is to look at their cash conversion cycles. The cash cycle tells us how quickly a firm sells its goods (inventory), how fast it collects payments from customers for the goods (receivables), and how long it can hold on to the goods itself before it has to pay suppliers (payables). Figure 15.1 illustrates the cash conversion cycle, and Figure 15.2 shows the conversion cycle for Home Depot.

Naturally, a retailer wants to sell its products as fast as possible (high in­ventory turns), collect payments from customers as fast as possible (high receivables turns), but pay suppliers as slowly as possible (low payables turns). The best-case scenario for a retailer is to sell its goods and collect from customers before it even has to pay the supplier. Wal-Mart is one of the best in the business at this: 70 percent of its sales are rung up and paid for before the firm even pays its suppliers.

Looking at the components of a retailer's cash cycle tells us a great deal. A retailer with increasing days in inventory (and decreasing inventory turns) is likely stocking its shelves with merchandise that is out of favor. This leads to excess inventory, clearance sales, and, usually, declining sales and stock prices.

Days In receivables is the least important part of the cash conversion cycle for retailers because most stores either collect cash directly from customers at the time of the sale or sell off their credit card receivables to banks and other finance companies for a price. Retailers don't really control this part of the cycle too much. However, some stores, such as Sears and Target, have brought attention to the receivables line because they've opted to offer customers credit and manage the receivables themselves. The credit card business is a profitable way to make a buck, but it's also very complicated, and it's a completely different business from retail. We're wary of retailers that try to boost profits by taking on risk in their credit card business because it's generally not something they're very good at.

If days in inventory and days in receivables illustrate how well a retailer interacts with customers, days payable outstanding shows how well a retailer negotiates with suppliers. It's also a great gauge for the strength of a retailer. Wide-moat retailers such as Wal-Mart, Home Depot, and Walgreen optimize credit terms with suppliers because they're one of the few (if not the only) games in town. For example, 17 percent of P&G's 2OO2 sales came from Wal-Mart. The fortunes of many consumer product firms depend on sales to Wal-Mart, so the king of retail has a huge advantage when ordering inventory: It can push for low prices and extended payment terms.

Home Depot finally started taking advantage of its competitive position by squeezing suppliers in 2OOI and 2OO2. Days payable outstanding for the home improvement titan has historically been around 25. In 2001, the figure hit 33 days, and by 2OO2, it exceeded 40 days. By holding on to its cash longer and reducing short-term borrowing needs, Home Depot increased its operating cash flow from an average of $2.4 billion from 1998 to 2OOO to $5.6 billion from 2OO2 to 2003.

Hallmarks of Successful Retailers

Sometimes you never get a second chance to make a good first impression. Retail is a fickle business, and shoppers have plenty of alternatives

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