Analysis: Dick Smith couldn't compete and that is why it failed

Troubled electronics retailer Dick Smith’s shock receivership leaves investors and customers on tenterhooks.

All those shoppers who bought gift cards during the Christmas retail rush will be outraged to discover they are now “unsecured creditors”, while investors who bought in to the company at $2.20 per share a mere two years ago have lost all their money.

Administrator Joseph Hayes from McGrathNicol is barely in the door but already the post-mortems have appeared.

The future of the business - and its 3300 employees - hangs in the balance. But an important question is whether this is an isolated failure, or the first of many business failures in some sort of contagion?

Woolworths sold the retailer to private equity firm Anchorage Capital Partners in November 2012, which then floated the company on the stock exchange a year later for $520 million. After the sale the new management team set about getting rid of what it called “aged and obsolete” stock, writing down the value of its inventory by $58 million.

It may well be that the business expanded too rapidly in the last couple of years. The retailer’s annual report highlighted the opening of 25 stores.

If, as suggested by Stephen Batholomeusz, the market was at fault for not properly analysing the implications of the restructure before the initial public offering, this is small comfort to employees and consumers now.

In a dynamic economy businesses should fail on a regular basis. In a growing economy those businesses will be replaced by other, more efficient businesses and consequently workers and consumers, and investors too, will be better off over time. This is what Prime Minister Malcolm Turnbull had in mind when he spoke of a disruptive economy.

So on the one hand, a business that expands too rapidly and experiences financial distress, as may have happened to Dick Smith, suggests an isolated failure. On the other hand, with economic growth being sluggish and world economic growth predicted to remain sluggish we might expect more business failures in the short term, with workers struggling to find new jobs and consumers reining in their spending.

Dick Smith has many competitors - including JB Hi-Fi and Harvey Norman, and even Office Works, Bunnings, and Aldi for some product lines. Despite deep discounting well before Christmas, Dick Smith was unable to generate the bumper Christmas sales it was expecting. But it seems Dick Smith was never expecting massive sales growth - looking at its prospectus in 2011 it had revenue of $1.28 billion and by 2014 it was forecasting revenue of $1.226 billion.

Yet investors seemed to believe a company then worth about $20 million was worth $520 million. Investors and regulators are going to look long and hard at private equity floats. But the lesson here is that equity investors need to do their homework before investing. The old adage, “If it’s too good to be true, it probably is” applies.

This all suggests that a poor competitor has exited the market. Sad, and not without a human cost, but that is how our economic system operates and is intended to operate.

That perspective, however, is not grounds for complacency.

All of Dick Smith’s competitors have been expanding too. They too have financing costs that require servicing. They too have to work at meeting the demands of consumers who can be quite fickle. Just because the economy is sluggish doesn’t mean the disruption is going to go away anytime soon, if ever.

On a positive note the failure of a poor competitor does suggest that we’re unlikely to see a wave of business failures. This isn’t the beginning of a contagion where we see a whole spate of similar firms suddenly experience financial stress and failure. There are lessons to be learned (actually re-learned), but no profound revelations.

From a policy perspective the question becomes what, if anything, should government do? Over the past couple of years the government has focused on GST collection as a means to assist Australian retailers compete against internet sales. This is mostly propaganda to justify a tax grab. It is not at all clear to me that diverting money from consumers to Canberra will assist local retailers, or even foreign retailers for that matter.

What needs to be done is to make it easier to start businesses in Australia, easier to employ people, easier to invest in Australia, and easier for Australians to trade with foreigners. I fear that our political elites are currently focused on meeting those objectives.

Surveys on business confidence in the Turnbull Government had mixed results in November 2015.A survey from Roy Morgan showed an increase in business confidence of 6.5 points in October, 16.3% higher than in August. However a NAB survey for the same month reported muted business confidence. The most recent survey results in business confidence are yet to be released.

Yet I remain cautiously optimistic. The economy remains structurally sound – the challenges it faces are mostly political. Politicians need to take their focus away from themselves (and each other) and focus more on getting the economy and business going again. That means cutting the tax burden, cutting wasteful spending, cutting red tape, cutting green tape, and toning the anti-business rhetoric down.

Sinclair Davidson, Professor of Institutional Economics, RMIT University

This article was originally published on The Conversation. Read the original article.