Following HMV’s warning on covenants last week, Retail Week takes a look at seven areas the retailer needs to focus on to survive.

After trading went from bad to worse at HMV in its first half, this Christmas could prove make or break for the beleaguered entertainment specialist. Retail Week lists the seven areas of focus HMV must prioritise to survive.

Product offer

One of HMV’s biggest barriers to growth has been its product offer. Its business model - making money through selling CDs, games and DVDs - has been turned on its head amid the digital revolution. Its core markets are in decline, and its main product offer can be bought cheaper elsewhere - either in physical format from supermarkets and etailers, or digitally from iTunes and Lovefilm, for instance.

Although HMV says it increased share in the three product categories in its first half, it is pinning its revival hopes on a new area - technology. Entertainment-related tech products, such as tablets, headphones and speakers, now make up 14% of the product mix, up from 11% last year, as it devoted more space to them in store.

On the face of it, introducing technology products is a sensible initiative, but many remain unconvinced that HMV can become the go-to place for technology products - particularly given intense competition from John Lewis, Dixons and Amazon. It is also one of the toughest markets to be in because of wafer-thin margins.

There could be more product diversification to come, chief executive Trevor Moore said last week. “We should be looking at how to complement the offer,” he said. “We’re determined to create a business that delivers a proposition that customers can engage with.”

Whether HMV should go down the technology route is still being debated, but in order to survive the retailer definitely needs to refine its product offer.

Store portfolio

The move online of HMV’s core products inevitably means the retailer needs fewer stores. HMV revealed in January 2011 that it wanted to close 60 shops across both its HMV chain and Waterstones, which it owned at the time and has since sold. Since 2011 it has reduced HMV’s store numbers from 285 to 247.

HMV is adapting its offer by dedicating more space to technology

HMV is adapting its offer by dedicating more space to technology

While most observers believe HMV needs to shutter more shops to create a store estate that better reflects the market, Moore insists it is the entertainment specialist’s stores that set it apart from its rivals. He said last week that Christmas has come late this year, meaning desperate shoppers are more likely to turn to the high street rather than chance online shopping so close to Christmas Day.

He pointed out that HMV’s stores attract more than 170 million visits a year. “More than 60% of the population visit us at some point in the year, and shop with us,” he said.

While some kind of high street presence is no doubt needed - particularly as it is rolling out its click-and-collect service - if HMV is to survive it will need a slimmed-down estate that better reflects the growth of online.

Most of its stores are on five-year leases so the retailer is locked in for some time.

Cost base

Former chief executive Simon Fox vowed to return the retailer to the black this financial year and make “at least £10m” after rival Game collapsed into administration in March. If successor Moore is to achieve Fox’s goal then reducing the costs of the business, which has been vastly restructured, will be a priority.

Moore said he has “initiated a comprehensive review of the group’s cost base” to better reflect the size of the business.

“Looking back two years, HMV was a much more complicated business, with Waterstones and the international business. Is the cost base relevant today?” he asked.

Moore declined to say whether the review could result in any job losses. Retail Week Knowledge Bank figures show that the retailer went from a high of a 6,740-strong workforce at £184,260 sales per employee in 2010 to 5,653 staff at sales of £154,450 per employee in the last financial year.

The figures reflect both a reduction in store staff after more than 1,000 employees were made redundant in 2011 as well as further redundancies in merchandising earlier this year.

Moore’s review will doubtless further look at group-level support staffing costs after selling both Waterstones
and elements of its Live division, as well as studying closely whether efficiencies can be created in its supply chain.

Investment in shifting space in store towards technology will also be a key cost as new group finance director Ian Kenyon keeps an eye on every penny.

Digital

The world of entertainment has become increasingly digitised since Apple introduced its iTunes store in 2003 and HMV has struggled to keep up. And if Apple wasn’t enough, HMV has also had to contend with the phenomenal growth of Amazon.

Amazon now holds a 20.3% share of the entertainment market, according to Kantar data for the 12 weeks to September 30, compared with HMV’s 16.1%. iTunes holds 9.1% of the market.

Despite being early to online compared with other retailers, launching a fully transactional website in 1999, HMV was late to debut a download service, which only came in 2010.

The retailer does not suffer from a lack of traffic to its site, with 50 million visitors per year. However, converting visits to sales is the problem. Retail Week Knowledge Bank predicts online sales totalled less than £150m of its £1bn total sales in its last financial year.

However, Moore is focused on building its digital business and much has been done in the past few months.

HMV’s focus on physical product meant it lost out to digital retailers

HMV’s focus on physical product meant it lost out to digital retailers

It launched an online marketplace selling third-party products in October as it aims to make its website “the ultimate entertainment hub”.

HMV is also integrating digital into its store experience. It has introduced in-store wi-fi across the chain along with its new personalised, mobile-based service MyHmv, which gives customers access to deals and events relating to a specific store.

However, Amazon and Apple might have stolen an insurmountable march on HMV, according to Retail Week Knowledge Bank. And with other players such as Google’s Play Store gaining in prominence, it will be tough for HMV to grab share.

Supplier relationships

HMV’s suppliers are crucial to the future of the retailer but in the same vein, HMV’s suppliers need it just as much.

“We’re suppliers’ best route to market,” said Moore. “Where are people going to go for their stocking fillers?You can’t unwrap a download.”

HMV has been working closely with its suppliers to pull in customers, particularly over the summer when there weren’t any big releases owing to the Olympics. HMV and suppliers worked together to introduce promotions such as ‘2 for £15’ on chart CDs, ‘5 for £30’on Blu-ray discs and ‘2 for £10’ on CDs and DVDs.

The offers resulted in increased market share across music and visual but like-for-likes still fell 16% for the 26 weeks to October 27.

The close-working relationship is not new, as a year ago HMV created an alliance with Universal Music, EMI, Warner Brothers, Universal Pictures and Disney to hand 2.5% of its equity to major suppliers in the form of warrants. In return, suppliers would reduce wholesale prices to the business. The deal was expected to help the retailer return to financial health within three years.

But HMV warned in last week’s update: “The recent developments regarding supplier terms increase the certainty of continuing support from key suppliers, but any variation, reduction or withdrawal of support may reduce the group’s margins, which may materially adversely affect the group’s business, financial condition, results, operations and prospects.”

To secure its future, HMV needs the continual support of suppliers.

Store format

As HMV rebrands as a technology specialist, it faces stiff competition from rivals including Apple, which is famous for its store experience.

Although HMV has refitted more than half of its shops to increase the amount of space available for the products, which range from tablets to speaker docks, to be displayed in an interactive way, it is a far cry from Apple’s stores.

However, it is making moves to integrate theatre into its shops with the launch of its new-format multichannel store in Cambridge during the summer.

The retailer’s new store format in Cambridge has an internet cafe

The retailer’s new store format in Cambridge has an internet cafe

Unsurprisingly, interactive technology features heavily, but the store also has a cafe with internet access and phone recharging points to help increase dwell time. HMV is vying to make the store a hub for the community, with a noticeboard for posters for local bands and gigs, and there are plans afoot to develop a live events area in store. However, the retailer will need much investment to roll this out across its estate.

The retailer could also make more use of pop-ups, which it has deployed this Christmas. HMV, which opened 15 pop-ups this festive season, could use the format to drive sales around big events or new product launches.

Brand

HMV’s credibility among music fans has waned over recent years as its reputation as a specialist has deteriorated with the emergence of technology providers such as Apple. Music retail has been transformed into a digital business but HMV’s delayed response to the new age has left its 100-year-old brand feeling stuffy.

Agency Brand Union chief executive for UK and Ireland Toby Southgate says: “It has a history of innovation and pulling retailers and artists together, but this innovation has been fundamentally lost. It is not a leader of innovation anymore. It’s more about a transactional relationship with the customer than an enjoyable relationship.”

Once the go-to place for teenagers and music buffs to hang out, HMV’s ‘cool’ has defrosted.

The retailer has made efforts to make its proposition more relevant, putting more of a focus on technology and headphones, but it still has more work to do to convince shoppers to buy tablets or any other technology from its stores ahead of the competition.

Southgate adds: “HMV doesn’t seem to have a lot of credibility among consumers, who would rather go to people they trust like John Lewis or places of expertise like Apple. There is a lot more HMV could do but it seems it is under a very unsavoury financial position and might not have the time to find out what consumers really want from the brand.”

‘HMV’s fate lies in the hands of its bankers and suppliers’

Nick Bubb

Nick Bubb

Nick Bubb, independent retail analyst

Thanks to the support from its suppliers, HMV has much better stock levels and promotions than a year ago, so operationally the business is in good shape, but will consumers cooperate?

Unless HMV has enjoyed a last-minute spending spree on the high street this week, it will not be possible to avoid some unpleasant discussions next month with its banks.

It’s hard to be optimistic about the outcome, but there is effectively two more days of trading this year before Christmas, given the calendar shift, and HMV desperately needs customers to stop buying online or at supermarkets and rush instead into its stores for last-minute gifts.

Hope springs eternal, but history teaches us that the trend is not HMV’s friend, as the like-for-like sales decline suffered in the first six months or so of the financial year has had a habit of persisting through the key trading period. And if like-for-likes continue to run down by 10% in the second half, as they did in the first, then HMV is likely to incur a full-year loss of £10m on an underlying basis, before exceptional costs.

HMV has not confirmed this scenario, but the writing is on the wall. And whichever way you cut it, the next covenant tests at the end of January are unlikely to be met, with borrowings rising and EBITDA subsiding.

HMV’s fate lies in the hands of its bankers and suppliers. Assuming the suppliers remain onside, what will the bankers do? One option is simply to give Trevor Moore more time to inject more energy and drive into the business, but improved staff morale and customer service doesn’t seem to have made much difference so far.

The first discussion the banks will have with HMV next month will be over further asset sales, but the cupboard is pretty bare. The only remaining asset of any great value is its stake in the loss-making digital music business 7Digital but in a buyer’s market, it’s difficult to see this is worth enough to make much of a difference.

The next discussion will be about HMV raising new equity, but it’s very hard to see that HMV has much scope here, given its lowly share price and a market cap of just £10m.

Existing institutional shareholders won’t want to throw good money after bad, but it is possible that the entertainment suppliers could be persuaded to club together and inject enough new equity to safeguard HMV as their distribution channel.

In the absence of any new equity funding, more store closures are inevitable and, whatever happens, HMV will not be running 230 stores in the UK this time next year. With strong doubts about whether the business is a “going concern”, the end game might well be one of CVAs and pre-packs, but let’s all hope that HMV survives in some form.