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At toy retailer Funtastic’s AGM today, CEO Stewart Downs had good news for shareholders – the promise of the first dividend in five years as the company delivers a $10.4 million net profit after tax, or 6% of its $170.7 million revenue in 2011-12.
“We are saying we anticipate being able to declare a dividend after our first half results,” Downs tells LeadingCompany after the AGM. “We want to reduce debt by another $10 million. It is currently in the mid-fifties.”
The improved result comes after four years of losses and represents a 127% net profit after tax increase from 2011.
The magic formula? Downs says it’s going back to basics. “[We are] doing what we are good at. We are not scared to make the tough decisions so that all of our sales are about profitability.”
Here’s what simplification looks like at Funtastic: their toy brands have been slashed from 66 to 22, the number of stock-keeping units is down from 8,600 to 1,700, they’ve halved their warehouse space, their overseas suppliers have been trimmed from 28 to seven, and staff numbers are down by over 50% to 180.
Simplification is a great profit strategy, but it is not one that will deliver growth, says David Knowles, a partner at accounting firm, PitcherPartners. “Simplification is about saying where are we going to get the best returns. We focus our effort and that allows us to trim the sails and release capital as efficiently and effectively as possible.
“[The global electronics company] GE was famous for this. Its strategy was: if we are not number one, two or three, we are out. We are a major player or we don’t play at all.”
The idea of simplification is to go back to the tried and true products that are the most profitable – even if they are not the ones that deliver the most revenue. This can also allow companies to trim suppliers and other costs, like Funtastic has done.
Downs says: “We had one product where we didn’t want to be working with that supplier; we couldn’t make it sustainable. A couple of the bigger brands accounted for $25 million in sales but we made no money. At the end of the day, with where the business was at, it is all about profits.”
Revenue at Funtastic fell 7% from $182.9 million in 2011 to this year’s $170.7 million. But profit is way up.
There is a national trend towards heavily-targeted, simplified businesses, Knowles says. “You do see a proliferation of niche businesses, and not so many broad-based conglomerates, although Wesfarmers is an exception. At the moment, businesses either are getting bigger – there has been plenty of consolidation over the past 10 years – or going micro. When they are going smaller, it is about having deep expertise.”
Paul Hunter, CEO of the Strategy Management Institute, says simplification is a good thing to do. “It is very much an operational thing, it about getting back to basics and doing what you do well. Organisations need to grow from a strong position.”
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Simplification is not without risks
Simplification is the antithesis of innovation; it is a strategy used to consolidate in preparation for growth. “When going into a simplification, it needs to be set its context, [which is] the need to restructure now so we can be stronger later on,” says Hunter. “Rather than getting on the bandwagon of continual cost cutting, it is a strategy of getting your house in order to be more competitive in the future. But if you don’t have a plan from the start for when you get there, it is too late to ask that question. You become commodity-driven.”
Downs has kept this principle in mind: “Now the cost base is in a good zone, we can grow out of this cost base, with brands and intellectual property that we own, and sell to more markets outside Australia,” he says. “At the moment, 10% of our sales are outside Australia. Hopefully by end of this financial year, it will be 20%. And with new brands launched in Australia, we expect modest growth.”
Funtastic’s own brands include the La Dee Da Dolls and Nano Speed cars.
Customers as well as profits can be sacrificed by a long period of cost cutting, Knowles says. “There are lots of examples: banks saying we don’t want a branch network, then saying, hang on! Our customers are not engaging with us, they don’t love us.
“Or the [American car company] Detroit, saying we build big cars and every year we screw our suppliers so we can make them cheaper. Our customers don’t want a big car, but think, it is cheaper so it will do. Then finally people say, I don’t want that and I am going to buy something else.
“Or there are retailers, like Myers and David Jones. Customers are saying if they’re going to come into the store, they want service, so if it isn’t there they’ll just go online.”
The decisions about what to cut are difficult and risky ones – in periods of growth, leaders can afford to allocate risk capital to invest in many different things. Only one needs to do well to pay for all the others. Knowles says: “It is easier to get it wrong in a shrinking organisation.”
For example, shrinking the base of suppliers can lead to an over-dependency on the few left.
Downs has two answers for this problem. One is to work with brands that are innovators – he names Mattel, Lego and Hambro. “If they can’t power our business with brands and innovation, they won’t be powering their own,” he says.
The other is to make more off its own toys. “We have always done single digit sales in proprietary toys, but today it is about a third of what we sell today. Ultimately we’d love to make more and own more of what we sell. If you are a distributor, there is another margin in the mix. If you have it yourself, it leads to higher profits.”
A final risk is losing intellectual capital in the process of job cuts, says Knowles. “The heads who have been in the organisation for a long time tend to be cast aside, and it is not easy to get back that knowledge with the new strategy. It is like manufacturing: if it dies, you can’t get it back.”
Leadership through tough times
Downs says he finds the fast moving “fashion” in the toy sector exciting. “Each day is different. And I have four kids of my own so I see the fruits of what I do every day.”
While demanding high performance, Downs says he tries to foster a “learning and development culture” by letting his team get on with business. “My key strengths are strategy and objectives, while giving the team the imprimatur to get on with the job.”