August 05, 2006

Business Review: Sharper Image

If a tree fell in a Sharper Image store, would any customers or employees hear it fall?

The story of Sharper Image, and their quick fall from grace, illustrates the razor-thin margin of error businesses have. Mis-steps in just one or two items can lead to the collapse of a 2,500 employee company that spent three decades building its reputation/brand.

This MSN article, from a little over a year ago, outlines problems Consumer Reports found with an air purifier sold by Sharper Image.

All of the facts listed in this discussion are from the Sharper Image 2006 10-K filing.

In 2003, Sharper Image operated 149 stores, a catalog division, and a website. Combined, these channels drove $648 million in net sales, and $39 million in pre-tax profit. At a six percent pre-tax profit, Sharper Image posted average, if not spectacular, results.

Just two years later, Sharper Image operated 190 stores, a catalog division, and a website. Combined, these channels drove $669 million in net sales, and an amazing pre-tax loss of $27 million.

Along the way, a perfect storm of problems confounded Sharper Image management. Negative press about the failure of air purifiers to purify the air caused a dramatic drop in sales of these items. In addition, a significant portion of sales came from massage chairs. The vendor responsible for producing the massage chairs elected to sell cheaper versions to Sharper Image competitors, undercutting Sharper Image. Air purifier and massage chair sales plummeted by an amazing $126 million.

Sales of other items increased by $35 million, providing hope for Sharper Image. However, sales increased in product lines like branded MP3 players, which carry low margins, reducing profitability. In fact, cost of goods sold were nearly identical in 2005, compared with 2004.

Given the dire conditions at Sharper Image, management undertook several cost-cutting measures. Between 2004 and 2006, advertising expense will be reduced from $150 million to about $80 million. Reductions are across the board, with the notable exception of online marketing, which will be increased in 2006. Catalog page counts are being reduced from 88-96 pages to 52-76 pages. The catalog business decreased, from $131 million in 2004 to $87 million in 2005, in part to lower demand, and advertising reductions. Even the online channel, growing by 20% to 40% at most companies, failed to grow in 2005, decreasing from $116 million in 2004 to $107 million in 2005.

At the corporate office, headcount was cut by twenty percent. In stores, staffing was reduced from 8-12 employees per store to 7-10 employees per store. In addition, employees lost their sales commissions. Instead, management instituted bonuses based on achieving sales goals and expense management. Executive pay was reduced by fifteen to fifty percent, though executives somehow got to keep their jobs.

The bad news continues for Sharper Image. May same store sales are down an amazing thirty-six percent. A first quarter investor conference call is scheduled for June 8. Disenchanted investors forced a change on the Board of Directors, hoping to increase future sales and profit.

This business review clearly illustrates the razor-thin line that separates success from failure. Two years ago, the sky appeared to be the limit for Sharper Image. Impressive sales per square foot of more than $600, and huge comp-store sales gains, resulted in an aggressive expansion plan.

Mis-steps on only two items paved the way to collapse. I would be curious to hear what branding experts have to say about Sharper Image. If this company had a 'strong brand', then why would customers leave in droves when just a few mistakes were made? If this company had a 'weak brand', then why was it driving sales per square foot figures that were industry-leading, at over $600? What would a branding expert recommend to save this business?

Ultimately, no amount of branding, CRM implementation, target marketing, word-of-mouth marketing, return-on-customer studies, leadership blogging or other window-dressing can save a business when the fundamentals are messed up. In this case, customers did not forgive Sharper Image for making one mistake. In addition, customers did not exhibit any customer loyalty when competitors offered similar massage chairs at lower prices. An apparently healthy and profitable businesses quickly descended into chaos.

I believe the lesson to be learned from Sharper Image is one of managing the fundamentals of your business. Dependence upon a breadth of quality products helps a company ride out storms like this. In retrospect, the company expanded so quickly that, when everything turned bad, the added expense and lower sales-per-square foot of new stores caused the profitability of the company to suffer. In the rush to grow sales, the company relied upon products with low margins, making profitability even more challenging.

Unfortunately, the employees, the very same employees who did the same level of work two years ago when the business was successful, bore the brunt of this downturn. The importance of quality merchandising cannot be under-stated.

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