Were accountants to blame for the failure of HMV?

Posted by on Mar 26, 2013 in Accounting Innovation | No Comments

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 Were accountants to blame for the failure of HMV, Blockbuster and Jessops?

HMV has been in and out of the news in the past few months but sadly after starting in 1921 in Oxford Street and growing to 239 stores has finally died. However this was not a sudden death as a result of some corporate fraud or bank collapse but a very slow one over the past 10 -15 years. The main cause of the collapse has been the emergence of e-tailing which has enabled companies such as Amazon and iTunes to take a big chunk of their market.There is an argument that this could have all been avoided had it not been for the attitude taken by finance professionals. The whole saga provides us with a salutary lesson on how we should not put all our faith in the opinion of accountants.

The reason for blaming the accountants would be the result of their attitude to investment appraisal.  When evaluating investment opportunities they assess the proposal using investment appraisal techniques using discounted cash flows. I have gone in to detail on the mathematics of this in a previous blog but in essence the calculations evaluates all the expected costs and returns and discounts them to reflect them being paid in one go today. This might seem a mathematically sound idea and there is no doubting it is, but the flaw in the evaluation is that it makes an assumption that the current position will continue to generate the returns it always has done.

Therefore if we were to go back 10-15 years at HMV when companies such as Play.com, Amazon and ITunes were starting up, HMV were likely to have evaluated the cost of developing an e-tail based service delivery system. This is likely to have factored all the costs of the associated distribution and web design and then compared it to the returns that the retail division was making. On the basis of the these calculations the e-tail proposal would be binned as it would not provide enough return when compared to their retail activity at the time. The flaw in the accountants calculation is that they assumed retail revenues would continue in perpetuity.

The same story can be told of Blockbuster the global video rental company which had revenues of $6billion dollars and 60,000 employees in 2004 and then folded in January 2013. One of the main causes of its demise was Netflix which started out as a mail order video business. Blockbuster at the time evaluated mail order as a potential business but the figures didn’t stack up. It was making more money from fines for late returns than it was making from standard rentals and was quite happy. Again another flaw as the main cost in the business was the actual videos – by allowing customers to keep them at home their was an opportunity cost of them not been rented. Even more bizarre is the fact that, in 2000, Blockbuster declined several offers to purchase Netflix for a mere $50 million which was a reasonable offer for a company that was, at the time, bringing in billions of dollars in revenue. Blockbuster is certainly hitting themselves for not jumping at the offer, which may have seemed irrelevant and unimportant at the time. Today the number of Netflix subscribers in the United States and Canada is equal to the population of Australia! The decline really started 10 or even 15 years ago, when the Internet was in it’s infancy. Back then HMV was the pre-eminent retailer in it’s sector and had huge goodwill. However they failed to capitalise by building a decent on-line presence early. Amazon and ITunes came along and took a huge bite out of their customer base. From this point it was only a matter of time.

HMV has been in and out of the news for what seems like months. It is probably the best-known example of how a once dominant brand has been destroyed by a lack of foresight and strategic planning.

The deep recession that we have been enduring since 2009 has been especially painful for the high street and I am surprised that HMV has lasted so long. It was on 13th December that HMV revealed that it has breached it’s banking covenants, which was a very serious development as it flagged poor financial performance and led to an eventual withdrawal of support from lenders.

The final nail in the coffin was the withdrawal of supplier support that led to the inevitable collapse. This is not dissimilar to the failure of Jessops – in this case the credit insurers withdrew cover on Jessops trade debt, which meant that suppliers could no longer raise finance on Jessops invoices, the knock on effect being that suppliers ceased to offer normal trade credit, in turn leading to an immediate cash-flow crisis.

There is no doubt that the root cause of the demise was the failure to build an on-line presence when competitors were doing so. The rest has really just been a process of attrition that we see time and time again – business begins to accumulate debt, debt becomes unsupportable as cash dries up, bank covenants breached, credit insurers get nervous and withdraw cover, suppliers then withdraw credit terms – game over.

If you find yourself under pressure from your lenders or key stakeholders I recommend that you open dialogue to give them reassurance and to preserve their support. I have seen instances where credit insurers have threatened to withdraw cover on client’s debts. My advice is to talk to the insurers and share financial information. If you do nothing and ignore their requests, the result is almost inevitable. I would caveat this by saying that you should always be conscious of the risks of trading while insolvent – You should not give assurances or make statements which are not supportable – always ensure that your management information is accurate and up to date.

…be more than just an accountant!