If the John Lewis Partnership was being given an end-of-term school report, would the headmaster give it 10 out of 10?

If the John Lewis Partnership was being given an end-of-term school report, would the headmaster give it 10 out of 10?

On the face of it, the John Lewis Partnership must be getting a lot right if gross sales hit £10bn for the first time last year and it increased underlying profits by 10% to £376m.

And yet that £376m in pre-tax profit in the year to end-January owed a lot to some fancy footwork on finance costs, with operating profits actually only up by 4% to £471m, despite the strong market share gains seen at Christmas at both Waitrose and John Lewis and their very good like-for-like sales growth, which delivered the 6.6% growth in total sales.

Most retailers would expect that sort of sales growth to produce some operational leverage, other things being equal, assuming that operating costs only rise by the rate of inflation, or less. So why did the John Lewis Partnership operating margin not go up last year?

Part of the answer is that the department store business incurred a £14m restructuring charge in the first half. But even so, underlying profits at the Partnership were not as high as you might have thought and indeed not that much higher than they were three years ago.

Were gross margins under pressure last year? Well, yes and no. In the department store business the sales mix bias towards the lower-margin electrical category clearly had a dilutive effect, whilst Waitrose was rewarding its customers with all sorts of freebies (free coffee and newspapers for myWaitrose cardholders and free champagne in January for new grocery online customers). But overall the Partnership says that the 33.4% gross margin was steady in the year, thanks to good buying economies and supplier support.

So the answer is that operating costs were up by more than 7% last year in both businesses, which says something about the Partnership model and something about the challenges of doing business online.   

With its famously long-term attitude to retailing and its admirable devotion to customer service, JLP is certainly under no pressure to maximise short-term profits and it hasn’t got impatient shareholders breathing down its neck demanding improved performance.

But profits do matter to JLP, as it generates the cash to pay for the necessary capital investment in the business and return a decent bonus every year to the hard-working employees of Waitrose and the department store division.

As it happens, because of the increased interest cost of servicing the pension fund, it was impossible to maintain the previous year’s 17% bonus (which was based on the previously stated £410m pre-tax profit, rather than the re-stated £343m outcome) despite an improvement in the bonus payout ratio.

Most of the “partners” in the business will have shrugged off the fall in the bonus to 15% and say that it could have been worse (some will have feared a fall to 14%), but the fact is that if operating cost growth had been limited to, say, 2% last year then profits would have been high enough to pay a 19% or even a 20% bonus. 

However, one inescapable issue is that JLP can’t really afford to pay a high annual bonus and give the employees such a generous pension, and management are working hard to get across the choice that has to be made here, in terms of the current review of the big pension fund deficit and the contributions that have to be made to it. The cost of supporting that pension fund is clearly one of the factors that are holding back JLP’s profitability.

But another cost of doing business these days is that growing online sales so quickly, as both Waitrose and John Lewis are doing, brings inevitable costs in terms of delivery and distribution and it is these online fulfilment costs that also explain why operating costs grew so fast last year.

At least JLP is still achieving some modest growth in like-for-like store sales (ex-Online), however, which is more than many of its peers are doing and it is not simply running hard to stand still.

Yet when it comes to that end-of-term report for JLP, the verdict must be that although the organisation deserves 10 out of 10 for effort and hard work, when it comes to profits the conclusion must be “could do better”. Because JLP could do better than make a 4.2% pre-tax profit margin on VAT-inclusive sales, notwithstanding its pension fund issues.

Over the last couple of years JLP has been better at growing its top-line than its bottom-line. Waitrose will find it hard this year to increase its profits by much, given the troubled times in the supermarket industry, but fortunately the outlook is better for the department store business.

  • Nick Bubb has been a leading retailing analyst for over 30 years. He is a well-known commentator on UK retailing and is a founder member of the influential KPMG/Ipsos Retail Think-Tank.