Engineering a retail scam like Reebok? Here's how

"Greed, for lack of a better word, is good" - Gordon Gekko (Wall Street).

Okay, so there is another instance of greed and possible financial mischief unfolding in Corporate India. Leaving aside what has been - and will be - reported on the Reebok India story, here are some pointers which may help you decipher how things come to a pretty pass where Corporate Governance norms are merrily compromised in some Retail Firms.

Reebok India, Koutons Retail, Vishal Retail, Lilliput Kidswear, Subhiksha etc. are merely the ones where blatant violation of good governance and strategic blunders were difficult to hide under the executive carpet anymore - and if the lessons from these are not learnt by others, the possibility of an encore elsewhere can't be ruled out.

The impact of such misdemeanors in terms of the air at the workplace turning toxic - vindictive, authoritative, replete with whimsical decision-making, sudden exits of senior executives, nepotism etc. being some manifestations of such toxicity - is not even factored in. Those indulging in misrepresentation of facts and/or embezzlement of funds expectedly guard their secrets and reputations fiercely, completely flushed with vindictiveness when challenged internally. Look closely, and chances are you might find huge churn in the Leadership Team in such organizations- the CEO being the only constant. To me, that has always been a red flag.


Audit Firms asleep at the wheel....get off the road: A retail entity deals in thousands of sku's and lacs of units of merchandise. Misreporting inventory values to the Board/Parent body (and the bankers as well) using cooked books can be an alluring proposition for an ambitious and unethical CEO - stocks in the warehouses/distribution centers, stocks in transit, stocks on consignment, under-reported shrinkage levels, stocks sold outright, shelf stocks, damaged stocks, customer returns, fresh goods, marked-down goods, RTV goods (Return to Vendor) is a complex maze.

Furthermore, undeclared warehouses where damaged goods, excess fixtures and millions of rupees worth of scrap is sometimes diverted to, could be owned by friends or relatives of an employee close to the CEO. The trail, if any, will rarely lead to the CEO directly.

Auditors who come in wearing suits and an attitude, will struggle to get at the real numbers at any given point in time. They reconcile the facts using documents and system figures - getting their hands dirty beyond such perfunctory acts is not in their genes. Such misrepresentation of inventory values to the Board is unlikely without the CEO being entwined in a carnal embrace with the CFO (or with someone else who wields enormous clout within the Finance function). Instigating a Coitus Interruptus is laden with career-risk, so be careful there.

Property Acquisition Decisions......ah, the stink: Occupancy costs, as a percentage of revenues, typically range between 12-20% for a brick-and-mortar retail establishment. There are formats which fall outside this ratio - a hypermarket, for example, may work on about 5-6% of revenues. While leasing properties, a 5-10% bump-up on per sq ft rates as well as leased area is not entirely unheard of.

The kickbacks on these deals can be substantial, as is clear from the workings below.

The Third Party Vendor Gravy Train....rolling along nicely: Retail entities frequently outsource activities such as Housekeeping, Security, Parking Management and Manpower Recruitment (of floor-staff). This is where some unscrupulous mammon worshippers may hitch a free ride on the gravy train. Other than contracts signed at inflated commercial terms (who approves those?), the other racket that may kick in is fudging the man-hours and head-count. Payments made to manpower agencies for supplying floor-staff who are no longer on the rolls of the company (on paper they continue to exist) as well as payments made for totally fictitious staff, are not unheard of. Nice little sweetheart deals stuck here as well.

Projects & Capital Expenditure vendor costliest: A typical retail store needs an investment of approximately 2000-4000/- psf (per sq foot), excluding cost of real estate. Multiply that by the size of a typical store, and then multiply it by the footprint (number of total stores). The final number is not insignificant.

"Multiple bids are avoided on high-ticket items. Favored vendors or suppliers are quietly selected, at uncompetitive rates. Parent bodies sitting on their derrieres in far off Europe or US (or even within India) are usually putty in the CEO's hands - the equations are rather chummy in most cases. Furthermore, the communication links between other key members of the Management team & the Board are deliberately shut down - the CEO guards the door on this one with his life. And this leaves enough room for the CEO/Projects head nexus, to quietly milk the system to the tune of a few crores, with impunity", a friend who is still associated with the industry in a leadership role confided to me last week.

Merchandise Procurement....keep them coming baby: This is perhaps the most difficult to nail. It could take the form of a complicated web of deceit spun over a period of time, incorporating nepotism, favoritism, inflated sourcing costs, mismatch between physical receipts and the GRN quantity (Goods Received Note) at the warehouse, part-deliveries against a PO etc. Audit firms are clueless on this front, since the entire situation is very fluid and the red-herrings of "transit goods", "price under re-negotiation", "RGRN" (Reverse GRN) etc. can be deployed quite effectively to throw the auditors off scent. This is accompanied by inserting people from one's own family/friends/"native place" in key positions in Buying & Merchandising, as well as in Stock accounting.

Audit firms who smell a rat will submit a detailed heat-map risk study to the Culprit-In-Chief himself; such reports will relax undisturbed in the CEO's cabin, somewhere under a pile of 3 year old competitive surveys, which in turn, would be right next to the stack of industry news-letters, pristine and unread inside the manila envelopes, name of top-dog and address label intact.

Franchise Deals.....while you were fornicating on satin (excel) sheets: This is another area, where the Board could wake up from its slumber too late. Drunk and deliriously deluded by those (a) impressive looking 5 year projections submitted by the Management team, (b) number of new stores to be opened, (c) economies of scale kicking in to improve profitability (read: reducing losses at EBITDA level), (d) buying revenues while ignoring concomitant costs and other such euphemisms for i-have-no-clue-how-to-deliver-profits, the board will happily munch on bourbon biscuits (and the occasional blueberry muffin) in the board-room, till finally the excreta hits the fan.

And by then it may be too late. Hidden under those decisions taken by the CEO could be layers and sub-layers involving franchise fees, management fees and minimum guarantees. Sweetheart deals are usually lodged somewhere within those multiple layers. Even when there are no sweetheart deals, these executive decisions usually are not in the Company's/Investor's best financial interests.

Unfortunately, the ground reality is known widely - but largely ignored as it is written off as a cost of building the business. The hoot and holler commences only when the costs associated with unscrupulous conduct exceed some unsaid unethical benchmarks. Till those levels are breached, sub kuch chalta hai, and ha-ha-ho-ho-hee-hee! Corporate Governance? What is THAT? So you manipulated the P&L a tad ol' boy? No worries, no worries - get us footprint and fancy valuations and we will drown you in fat bonuses and eye-popping ESOPs.

The first hint of Corporate Governance being compromised in any organization is when a few senior executives and perhaps a CFO or two leave in a huff - under mysterious circumstances (typically within 6-18 months of being brought on board) - with the anhedonia-afflicted CEO using his dirty-tricks department to very artfully malign the said executives. The employees (lab rats?) rarely get to drink from the fountain of truth, save for the occasional sip from the stream of muddied waters that flows through washrooms, cafeteria and the water-cooler.

The can, in cases like these, is kicked down the road; from one quarter to the next, from one FY to the next...

Promoters and investors drooling over fancy business models, spin-doctored and suitably decorated with bells and whistles, would do well to get their hands dirty and count the merchandise in the warehouse(s) themselves.....else they run the risk of seeing their investments and dreams crinkle away and die, like cellophane to a flame.

In the case of Reebok India, media reports suggest that they could not even count the number of warehouses properly.

And yes. Screw Gordon Gekko.


Updated Date: Dec 20, 2014 08:43 AM

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