Retail Restructuring 101

Retail is Dead!?

How many times have you heard or read some variation of that claim from “experts” over the last year?  Last time we checked, consumers still need or want goods (and services, although this article will focus solely on goods) and they need to purchase those goods somewhere.[1]  The question is, where?

Consumers can purchase goods in a physical brick-and-mortar store or online.  While total retail sales were up 2.7% in 2016 (and 5.1% in the first quarter of 2017), e-commerce sales were up 14.9% over that same period (and 14.7% in the first quarter of 2017). [2] E-commerce sales continue to account for a growing portion of total retail sales.[3]  In the first quarter of 2017, e-commerce sales accounted for 8.5% of total retail sales (up from 7.8% in the first quarter of 2016).[4] This trend reflects the fact that individuals are comfortable purchasing a growing list of goods online.  Some of those goods, such as cars, diamond rings, and mattresses are items very few “experts” predicted would be sold online.

Consumers shifting their purchases online present brick-and-mortar retailers with a myriad of issues.  Those issues are further compounded considering the U.S. retail market is dramatically “overstored.”  Per the International Council of Shopping Centers, the U.S. has 23.5 square feet of retail space per capita (the most in the world) compared with 16.4 and 11.1 square feet per capita in the next two highest countries, Canada and Australia, respectively.  The growth in e-commerce will only continue to put pressure on an already “overstored” U.S. retail market.  Your view on where e-commerce sales will peak and stabilize as a percentage of total retail sales will help inform your response to the following question:  How “overstored” is the U.S. retail market?

Let’s review a few of the dynamics in the specialty mattress retail market.

There Are 10,000 Mattress Stores In The U.S.!

There are not exactly 10,000 sleep shops in the U.S. (yet).  According to data from IBISWorld, there were over 9,200 mattress stores open in the U.S. in 2016 (with 10,000 projected by 2018)![5]  Let’s do some back-of-the-envelope math.  The population of the U.S. is approximately 325.5 million.[6] That means there is a mattress store for every 35,000 people in the U.S.  Keep in mind, a mattress has an average lifespan of around eight years. [7]  That means 10,000 stores selling an item that is purchased once a decade!  For comparison, as of December 31, 2016, McDonald’s had approximately 14,155 restaurants or one restaurant for every 23,000 people in the U.S. [8] And people buy many more hamburgers, in this case, Big Macs, than mattresses.  Is the mattress retail market “overstored”?

Specialty mattress retailers are also dealing with a proliferation of mattress e-tailers.  A host of these mattress e-tailers – including Casper, Leesa, Saatva and Yogabed – sell direct-to-consumer.  In 2016, e-commerce mattress sales accounted for approximately 10% of the mattress industry’s $15.0 billion in total sales (note:  both e-tailers and brick-and-mortar mattress retailers contribute to online sales).[9]

Same story, right?  Specialty mattress retailers are facing the exact same issues the broader retail market is facing.

Let’s “Go To The Mattresses!”

Recently, MorrisAnderson was retained as restructuring advisor to a specialty mattress retailer with approximately 100 retail locations.  As a condition to close on a line of credit two months later, we took over the day-to-day operations of the business; in addition, we were responsible for all restructuring-related efforts.

Here’s a little background on our specialty mattress retailer.  In 2016, the company lost millions on $50.0 million in net sales.  They managed to lose over $5.0 million dollars while selling a product that realizes a gross margin of 55%!  At the time of our retention, the company was bleeding approximately $350,000 in cash per month.

As we all know, bleeding cash is a symptom of an underlying business problem.  Before we describe that problem, let’s highlight a few company specific issues (internal and external) we discovered that aided in the company’s downward spiral.


  • Competed primarily in an “overstored” market against national sleep shop chains as well as regional sleep shop chains and numerous other mattress retailers.
  • Data Analytics / Information:  Decided to switch financial reporting systems and lacked a comprehensive transition plan to the new system.  Resulted in a lack of timely or complete financial information to drive decision-making.  In some cases, management simply opted not to track key performance indicators (for example, daily store traffic…by the way, tracking store traffic would have shown it was falling off a cliff).
  • E-Commerce Strategy:  Consisted of selling discontinued mattresses online.  Not exactly a comprehensive strategy given the trend that e-commerce mattress sales are growing as a percent of total retail mattress sales.  In addition, not exactly a digital strategy that puts them on equal footing with the competition.
  • Management Decision Making:  Decided to expand the company’s footprint while facing double digit year-over-year comp store sales declines instead of addressing the underlying business issue.  Decided to reduce ad spend instead of right-sizing the cost structure to the shrinking topline of the business.  Decided to continue to pay management (read: themselves) significantly above market compensation packages and benefits while the company was severely distressed and cash was trending towards zero.
  • Policies & Procedures:  Lacked store opening and closing checklists.  Lacked ability to track cash in stores (reconcile cash).  Deficient inventory management controls.
  • Vendor Management:  Decided to stop communicating with advertisers, landlords and suppliers.  Management hid from stakeholders during a time when being transparent was necessary.  It is difficult to expect support when stakeholders are in the dark.

What was the company’s fundamental business problem?  No doubt increased competition and dramatic reductions in ad spending adversely impacted store traffic.  Declines in store traffic negatively impacted sales.  But those were not the company’s fundamental business problem.  The company lacked a sustainable competitive advantage.  A very simple but fundamental question went unanswered.  Why do (should) customers walk through your doors?

It is great to be a “family owned and operated” business.  In fact, “family owned and operated” businesses can gain a sustainable competitive advantage in terms of trust and reputation over corporate competitors.  However, our specialty mattress retailer had a few competitive issues stacked against them.  The company’s product offering was substantially the same as its competitors, ad spend was millions of dollars less than its largest competitor, and liquidity constraints strained stakeholder trust (from advertisers to landlords to bedding suppliers to customers) in management.  The company needed to identify a sustainable competitive advantage.

The Nuts And Bolts:  A Primer On Specialty Mattress Retail

Product:  Each Mattress Retailer is Selling Substantially Similar Products

The U.S. bedding market is dominated by four brands manufactured by two companies:  Serta Simmons Bedding, LLC (“SSB”) and Tempur-Sealy International, Inc. (“TSI”).  In 2016, SSB and TSI accounted for approximately 70% of the overall wholesale bedding market with revenues of $3.2 billion and $2.6 billion, respectively.[10]

Mattress retailers typically negotiate supplier agreements with SSB and/or TSI (as well as with other mattress manufacturers).  Supply agreements are often multi-year agreements in which the retailer will agree to allocate a certain percentage of their floor in each location to the supplier’s mattresses.  In addition, most supply agreements will include volume commitments from the retailer (i.e., the retailer must purchase a minimum amount of product per annum or over the life of the agreement).  In exchange, the retailer often gets some combination of the following: volume rebates, co-op advertising funds, one-time upfront credits, free merchandise, new store allowances, discounts on floor samples, free point of purchase materials and favorable credit terms.

Once an agreement is reached, retailers often get “exclusive” lines (or seemingly exclusive names on mattresses) making it difficult for consumers to compare prices between mattress retailers in the same geographic market.  Only educated consumers know a quick review of a mattress’s law tag (a tag legally required on each mattress listing the product’s specs) will provide them with the necessary product content information to compare mattresses between retailers.  At the end of the day, specialty mattress retailers are effectively selling the same mattresses just under different names.

People:  A Mattress Retailer’s Most Important Asset

Arrgghhh…it’s time to purchase a new mattress.  Very few consumers browse for mattresses; a mattress is a purchase out of necessity.  A consumer who walks into a mattress retailer is doing it for a reason.  The sales team knows they have a potential customer.

A mattress retailer’s sales team is critically important to its ultimate success.  They are the face of the retailer.  They control a retailer’s first interaction with potential customers.  Perception is reality.  How are they dressed?  How do they present themselves (it is ultimately a reflection of the retailer)?  How well do they keep the store?  Are they knowledgeable (mattress specs, pricing, promotions)?  How do they negotiate and sell?  Are they trustworthy?  The sales team is the lifeblood for any mattress retailer – they will either turn that consumer into a customer or not (i.e., lose that sale to a competitor).  As such, how you decide to compensate and treat your sales team will have a direct impact on your success.

Do you compensate your sales team by piece, ticket (revenue), margin or some combination?  Hourly, salary or commission only?  Budget bonuses and/or spiffs?  Guaranteed draw that must be met prior to receiving commissions?  Percentage of four wall profitability (store level EBITDA)?  There are many options for management to evaluate (each of which have pros and cons).  A mattress retailer must develop a compensation structure that truly motivates its sales team.  When the face of your company only sees a limited number of consumers in a month (i.e., traffic), close rates (i.e., the number of consumers converted to customers in a period divided by the traffic in that same period) need to be high.  Close rates are highest when your sales team knows they are being directly compensated on every sale.

Given specialty mattress retailers are effectively selling the same mattresses just under different names, your people will make all the difference.

Footprint:  Location, Location, Location!

Site selection is critically important to the long-term success of a specialty mattress retailer.  While we have no analytical support for the following, industry insiders have told me that a population of 15k to 20k can support one sleep shop.  We believe site selection demands a more rigorous approach which requires detailed quantitative and qualitative analysis.  While the current population is important, how is the population expected to change over time?  What are the vehicle counts on your block (and nearby blocks) by day and time (as well as side of the street)?  What is the average household income, or more important, what is the average disposable income per household for your population radius?  The answer to that question can help inform your product offering (e.g. What price points should you floor?  Should you floor Tempur mattresses or not?).  Where are your existing locations (might you cannibalize some business)?  Where are your competitors (do you want to be a block away)?  Who are your neighbors (which businesses are complementary and will help drive traffic)?  How will this location impact logistics (delivery costs and customer service)?  There are many factors to evaluate when selecting a site for your first or next retail location.

Pari passu with site selection in importance are the economics and terms under which you lease (or own) your space.  The economics of a leased space – viz. are you paying below, at or above market rents – could be the deciding factor if a location is profitable or not.  Is the lease gross or net?  Who is responsible for tenant improvements?  Does the base, or minimum, rent escalate over the life of the lease?  What is the initial lease term?  Does the tenant have the option to extend the lease?  If so, how many options and for what duration?  Are there go-dark (or go-dim) clauses in the lease?  Co-tenancy clauses to protect the tenant?  There are many ways to structure a lease that balances the risks and concerns of the landlord and tenant.

Lease agreements dramatically impact the flexibility, or lack thereof, of a mattress retailer’s cost structure.  Given rent payments are contractual, they should be viewed as a fixed cost.  It is terribly difficult (and usually costly) to terminate or modify an unexpired lease absent the powers of Section 365 – to accept, reject or assign unexpired leases – afforded by the Bankruptcy Code.  A mattress retailer needs to complete a thorough analysis before selecting a new site as well as negotiate the most advantageous lease agreement possible.

Ad Spend:  Is It Effective?

Depending upon your supplier agreement, ad spend is often stimulated through cooperative advertising agreements.  Cooperative advertising programs are designed to help you create traffic in stores by enhancing recognition of supplier brands and build customer confidence associated with those brands.  Essentially, a mattress retailer will earn advertising funds based on an agreed upon percentage of net purchases.  The retailer will place an advertisement (print, radio, television or digital) and is reimbursed through a credit memo against their outstanding balance with the supplier.  From a retailer’s perspective, this creates the concept of free money that they must use to advertise.  Practically speaking though, the retailer is just paying more for product upfront and the supplier is safeguarding the funds to ensure the retailer does what is in the best interest of both parties which is to advertise.

Ad spend, effectively placed, is crucial to the success of a specialty mattress retail chain.  Many consumers become customers in the first specialty mattress retail chain and store they walk into (for the myriad of reasons cited above).  Thus, it is important for specialty mattress retailers to be top of mind with consumers.  One way to achieve that is through constant advertising.  As such, advertising budgets (and actual ad spend) at mattress retailers oftentimes exceed the cooperative advertising reimbursement from suppliers. Mattress retailers need to develop the tools necessary to track return on investment (and really, store traffic) to ensure ad spend is not being thrown away on ineffective ad campaigns.

Now that you have some background knowledge of retail, the factors impacting specialty mattress retailers in general, and the issues at our Midwest specialty mattress retailer specifically, let’s highlight the playbook we used to mitigate our mattress retailer’s monthly cash burn and extend its runway to explore strategic alternatives.

Another Name For An Operational Restructuring In Retail?  Survival Of The Fittest (Who Knew Darwin Was A Restructuring Professional?)

Once we assumed responsibility for the day-to-day operations of the business, we had our work cut out for us.  While there were many tactical issues that required our immediate attention (not the least of which was mitigating or, ideally, eliminating the company’s cash bleed of $350,000 per month), we also needed to quickly assess if the company, or any portion thereof, was worth saving as a going concern.  Don’t’ miss the ‘forest for the trees’.  Be sure to evaluate the following:  Is this company (or any portion thereof) worth saving?  How do we maximize value for all stakeholders?  What are the ideal, expected and likely outcomes for the company’s different stakeholders (board members, employees, senior creditor(s), unsecured creditors (primarily advertisers, landlords, and mattress and bedding supply vendors), and equity (or member) interest holders)?

Since we were originally retained as restructuring advisor to complete an assessment of the business and present the Board with various strategic alternatives, we already understood why the company was bleeding cash and had a reasonable view of how to maximize value for all stakeholders.  Experiencing double-digit comp store sale declines (for at least the previous 18 months, although in times of distress you only need a quick history lesson), the company needed to reduce its’ bloated cost structure which management was not willing to do…hope was their strategy.

The company needed to dramatically reduce its store footprint from 100+ locations to approximately 40 profitable locations.  But, we are getting ahead of ourselves.  How did we conclude to reduce the company’s store footprint?

In a specialty mattress retailer, it is easy to find the margin.  Every mattress sold realized, on average, a 55% gross margin.  Sure, there are bedding accessories that retailers give away, such as pillows and adjustable bases to name a few, but for the most part we didn’t change the retailer’s product offering (or pricing).

Since product level profitability was not an issue, we evaluated the four-wall profitability of each store.  Four-wall profitability analysis evaluates the revenue and expenses of each store on a standalone basis prior to any overhead allocation (general and administrative expenses, warehousing expense, et. al.).  We decided to focus on four-wall profitability due to our retailer lacking a multichannel approach to sales (something to think about: How does the arrival of omnichannel selling impact the traditional four-wall profitability analysis?).  After internalizing the results of the analysis, four things were crystal clear: (1) a majority of the retailer’s stores were unprofitable (unprofitable for many reasons but two standout causes were poor site selection and poorly negotiated lease agreements); (2) the retailer needed to exit one metro area; (3) a number of the retailer’s profitable locations were unprofitable after an overhead allocation (even an overhead allocation based on a right-sized corporate overhead structure); and (4) a majority of the retailer’s “newer” locations were dramatically underperforming management expectations (this should not have been a surprise given those locations faced the same traffic-related challenges as the retailer’s established locations).

So, how does a retailer terminate or modify unexpired leases outside of a bankruptcy proceeding?  Since the retailer cannot compel a landlord to terminate or modify an unexpired lease, it requires a discussion with each landlord.  There are a couple methods to tackle these discussions.  Our preferred approach is to have a single meeting with all landlords.  Due to a heightened sensitivity to bankruptcy, the company’s Board decided on one-on-one discussions.  Based on many factors, including, but not limited to, historical and projected four-wall profitability, comp store sales trends, occupancy costs (as a percentage of net revenue) as well as the economics and terms in each lease, we separated the retailer’s stores into different categories – A, B and C locations – so that we could prioritize our discussions.  The category determined our “ask” of the landlord (viz. was our “ask” to terminate the lease based on an expected recovery in Ch. 11 on their 502(b)(6) claim or to forgive past due rents along with a reduction in the monthly base (or minimum) rent for a period).

We always recommend being honest, professional and transparent with landlords (as well as all creditors and stakeholders).  In general, for a retailer to achieve a successful operational restructuring outside of Ch. 11, broad landlord support is required.  Our landlord negotiations – through buyouts, rent forgiveness, and future rent concessions – reduced the retailer’s monthly cash burn to approximately $150,000 (not quite to cash flow breakeven but moving the needle in the right direction).

We were extremely transparent with our landlords.  They understood the retailer’s current situation.  More importantly, they also heard our plan for the retailer’s path forward.  In addition, landlords weren’t the only creditors being asked to be part of the solution.  We also negotiated with our advertising partners as well as our mattress and bedding accessories suppliers.  We made many internal changes to reduce cash disbursements.  We significantly reduced management compensation and benefits (by 55%), reduced headcount throughout the organization (approximately 74 team members which resulted in annualized cost savings of $2.5 million).  Despite continued double-digit same store sales declines during our tenure as restructuring advisors, we were still able to mitigate a significant portion of the company’s monthly cash burn.

Our cash savings initiatives enabled the company to pursue a capital infusion or to identify a stalking horse bidder while also preparing for a Ch. 11 filing (i.e., fully develop a strategy to “go-dark” at select locations where we ultimately would reject our unexpired lease). The ultimate result was a refinancing transaction that provided our retailer with liquidity to stave off Ch. 11 in the near term.  The company still has a long way to go – identify a competitive advantage, stabilize sales, and repair relationships with stakeholders to name a few – but at least the retailer has a chance.

This article is based upon our experiences in private equity working with mattress and upholstery manufacturers and specialty retailers.  In addition, the article relies upon MorrisAnderson’s experiences advising mattress manufacturers, brand licensors and specialty retailers.  Based upon our prior experiences advising or in senior management positions at various retailers, the approach detailed in the article above can be leveraged by many types of retailers (not just specialty mattress retailers).

If you have a retail client or a retailer in your credit portfolio that is distressed, please don’t hesitate to contact us.  We would be more than happy to provide an assessment of the situation and our thoughts on a path forward.

  1. In 2016, total retail sales were $4.850 trillion (up 2.7% from $4.724 trillion in 2015). Source: Quarterly Retail E-Commerce Sales, 1st Quarter 2017, U.S. Census Bureau News, U.S. Department of Commerce, May 16, 2017.
  2.  In 2016, retail e-commerce sales were $389.9 billion (up from $339.3 billion in 2015). Source: Ibid.
  3. In 2016, retail e-commerce sales accounted for approximately 8.0% of total retail sales (compared to 7.2% and 6.4% in 2015 and 2014, respectively). Source: Ibid.
  4. Source: Ibid.
  5. Source: IBISWorld, Bed & Mattress Stores: Market Research Report, September 2016.
  6. Source: United States Census Bureau (
  7. Source: National Sleep Foundation (
  8. Source: McDonald’s Corporation, Form 10-K, for the fiscal year ended December 31, 2016.
  9. Source: Soft Landings in Mattresses, Fortune, January 1, 2017.
  10. Furniture Today, Serta remains No. 1 on list of U.S. bedding producers, June 13, 2017 and Furniture Today, ISPA reports 2016 dollar shipments up 3.4%, June 20, 2017.