The scale of the department store group’s December profit warning came as a shock. Tiffany Holland looks at why it failed to wrap up festive sales.

The scale of the department store group’s December profit warning came as a shock.

Debenhams had little to cheer about over the festive period. The retailer’s shock profit warning on New Year’s Eve, sparked by a disappointing and discount-led Christmas trading period, was followed days later by the resignation of its chief financial officer Simon Herrick.

The department store group dramatically downgraded its half-year profit forecast 24% to £85m, compared with original forecasts of £112m. Analysts blamed the retailer’s decision to deepen and broaden pre-Christmas discounts to compete in a fiercely fought festive market. It is the second formal profit warning in less than a year for Debenhams.

Cantor Fitzgerald analyst Freddie George says that, while the profit warning itself was not necessarily a surprise because of the way Debenhams had slashed prices in the run-up to Christmas, “the extent of it was a shock”.

Debenhams’ poor Christmas trading performance was in stark contrast to its rivals. Although difficult to compare because of the different reporting periods, Debenhams’ like-for-likes were flat in the 17 weeks to December 28, compared with John Lewis’ 6.9% uplift in the five weeks to December 28 and House of Fraser’s 7.3% increase in the three weeks to December 28.

Meanwhile, fashion retailer Next delighted investors with its bumper Christmas performance as sales in the period from November 1 to December 24 soared 11.9%. It raised its profit forecast for the year to January 25 to between £684m and £700m. 

With rivals delivering such sparkling performances, what went wrong for Debenhams this Christmas?

Early discounting

Debenhams chief executive Michael Sharp described the high street as a “sea of red” in the weeks before Christmas as retailers cut prices to tempt bargain-hungry shoppers. 

“The market was highly promotional in the run-up to Christmas and we responded to these conditions to ensure our offer was competitive,” Sharp said. “However, this extremely difficult environment has inevitably had an impact on both our sales and profitability.”

But not all retailers felt the need to plaster their stores in discount signs.

George says: “Next held its nerve and performed well in the week before Christmas. On the other hand Debenhams panicked.” 

John Lewis stood firm on full price in the run-up to Christmas – although it matched rivals in line with its Never Knowingly Undersold price promise – yet still managed to pull in the shoppers, breaking the £160m barrier for the first time in the week to December 21. 

In contrast, Debenhams said it did not experience the “final surge in sales”, leading to stock clearances that are expected to last until February.

According to George, Debenhams started cutting prices as early as November. “Beauty had 10% off all the way through to Christmas and that’s crazy,” he says.

In fashion, Debenhams blamed the weather in part. An unseasonably warm November led to lacklustre sales of winter clothing, resulting in a higher level of discounting. But one analyst points out that weather was not an issue for Next. 

Discounting has long been part of Debenhams’ approach. Traditionally, it has pulled shoppers through the doors with its eye-catching promotions. But analysts say that its offers were drowned this year by a raft of retailers, particularly fashion specialists and online, who joined the discounting frenzy in the run-up to Christmas. Pre-Christmas events such as Black Friday and Cyber Monday served to up the ante further.

Peel Hunt retail analyst John Stevenson says: “For the past two to three years Debenhams has been able to cut prices before Christmas and not really have much competition, but now the pre-Christmas market will be discount driven.”

Debenhams reacted to the “sea of red” by discounting more broadly across its offer and more deeply than last year. The fact that this failed to pull in shoppers is cause for concern, and the City will expect Debenhams to offer something more than discounts in future. 

“It has been successful in galvanising customers to shop at cut prices in the past but what is different about Debenhams? You need aspirational brands and that is where shoppers will go,” maintains Stevenson. 

Product problems

If the discounts failed to pull in the shoppers, is there something amiss with Debenhams’ product offering?

The retailer reported that beauty, home and gifting were the “better performing categories” but clothing, its key differentiator among its department store rivals, was “weaker”. 

One retail analyst says: “I don’t find Debenhams’ clothing offer compelling any more. Its home offer is a bit naff and it doesn’t take much for shoppers to decide to go to John Lewis instead. Debenhams’ Christmas offer wasn’t very exciting.” 

George observes: “Debenhams has pushed its own brands aggressively and some are a bit down-market.”

But Debenhams has worked hard on its clothing offer, investing particularly in its Designers at Debenhams collection, which includes ranges from fashion names Henry Holland, Julien Macdonald, and John Rocha among others. 

Stevenson says: “These are good performing brands for the business and they generally do outperform the concessions. But there has been an issue in terms of [targeting] the correct customer base.”

Meanwhile, competition has been fierce among the players in the mid-market where Debenhams sits, due to the number of alternatives in the market. 

The analyst, who wishes to remain anonymous, says: “Where has Debenhams lost sales? Is it the good, better or best part of the their pricing architecture? My guess is that it is at both ends. They’ve lost the more affluent shoppers to John Lewis and House of Fraser and the less affluent [to other value players].”

Honor Westnedge, senior analyst at Verdict, says: “Debenhams’ main issue is the strength of product at John Lewis and Next. Next has looked at its menswear ranges and improved them while its childrenswear offer remains strong. Next is probably stealing some sales away from Debenhams, while some customers could trade up to John Lewis.”

Catching up online

Debenhams appeared to perform well online across the festive period, recording sales growth of 27% in the 17 weeks to December 28. Online sales comprised 15.6% of total revenue, up from 12.4% last year. 

Yet it still lags behind digital leaders John Lewis and Next. 

One retail analyst says: “Debenhams missed it online. They didn’t have a strong enough focus.”

George says: “Next has been doing it for a long time, so shoppers trust it and people trust John Lewis.”

Debenhams misjudged its customers when it came to online delivery when it attempted to raise the threshold for free delivery from £30 to £50 in September in a bid to encourage greater spending. The retailer was forced to return to the £30 sum in November after it found customers were abandoning baskets at the checkout.

“The danger is that House of Fraser has moved upmarket slightly but targeted online. House of Fraser grew online at twice the rate of Debenhams,” one analyst adds. 

Multichannel has long been a key part of Sharp’s growth strategy for Debenhams but it is likely that he will now seek to accelerate digital plans following the festive disappointment. 

Over the past two years Debenhams has expanded the number of countries it delivers to from seven to more than 66 and it has launched a German-language website. It also appointed Google vertical sales director Peter Fitzgerald to its board as a non-executive director in 2012.

In 2012 Debenhams introduced its ‘endless aisle’ initiative, which enables it to better use its stock in stores to fulfil online orders. The technology enables the retailer to access stock from 36 of its biggest shops when goods at its fulfilment centre runs out. 

But George says: “I think the internet is cannibalising its stores and costing it money. If you want to do [online] well, it’s costly.”

George believes that Debenhams’ store estate would also need to be refreshed if it wants to attract shoppers and take them away from more upmarket rivals such as John Lewis. 

Debenhams has plans to address its portfolio, after modernising 12 premises in its last financial year, including relaunching its flagship on Oxford Street the week before Christmas.

Management credibility

Sharp’s four-pillared strategy to focus on the domestic proposition, deliver a “compelling” customer offer, grow multichannel, and expand the brand internationally is not necessarily the wrong one.

And as it stands, Sharp, who has worked with Debenhams for the past 15 years taking up the role of chief executive from trading director just over two years ago, still has investor confidence to drive growth at the British brand.

However, it is perhaps the execution of the strategy that could be called into question, as well as the decision making by some of the management team. 

For example, Herrick’s resignation has been linked to a series of communication failures between Debenhams and the City, which some observers say lost the chief financial officer credibility in the Square Mile.

Errors included revealing that Debenhams would incur higher than expected costs for refurbishing its Oxford Street flagship and for moving its head office.

It is understood that Sharp and Herrick didn’t hit it off. 

Then, a week before Christmas, Herrick sent a letter to suppliers asking for a 2.5% discount.

Some analysts have said they “wouldn’t be surprised” if there were some people changes at the top, while others believe there will need to be a root and branch review of the business.

Stevenson says there has been a “catalogue of errors”, but is still positive about Debenhams’ future. “It is shifting to multichannel, the store cost base over time will become better and ultimately it can deliver. On paper it is relatively compelling,” he says.

The pressure will now be on to avoid a turkey of a Christmas in 2014.