Essay: JB Hifi Ltd analysis

to do this through the scale of its operations, high stock turnover and low cost of doing business;

costs down and maintaining its low cost of doing business;

that the Group continues to attract and retain high calibre staff;

has a culture of embracing change, which is seen as a “natural” part of the business;

impulse traffic;

international businesses;

high energy, engaging and entertaining retail format with constantly evolving merchandising. JB Hi-Fi has the

ability to bring brands to life and create engagement in product categories;

and the Reputation Institute (1st in 2014, 3rd in 2012, 2013 and 2015); and

year and accounting for approximately 3.0% of FY2016 sales

Business risks

There are a number of factors, both specific to JB Hi-Fi and of a general nature, which may threaten both the future

operating and financial performance of the Group and the outcome of an investment in JB Hi-Fi. There can be no

guarantee that JB Hi-Fi will achieve its stated objectives or that forward looking statements will be realised. The

operating and financial performance of JB Hi-Fi is influenced by a variety of general economic and business

conditions, including levels of consumer spending, inflation, interest and exchange rates, access to debt and capital

markets, and government fiscal, monetary and regulatory policies. A prolonged deterioration in general economic

conditions, including an increase in interest rates or a decrease in consumer and business demand, may have an

adverse impact on the Group’s business or financial condition. The specific material business risks faced by the

Group, and how the Group manages these risks, are set out below.

competitive advantages set out above and the plans for growth set out below will allow it to maintain its market

leading position.

with its customers could compromise its market leading position and adversely affect JB Hi-Fi’s operating and

financial performance. This could occur as a result of a wide range of factors or events, including:

− a loss or erosion of JB Hi-Fi’s reputation for price leadership and high levels of customer service. The

Group seeks to mitigate this risk through careful monitoring of its competitors’ pricing and market share

data, senior management monitoring of customer complaints, and use of customer service and

engagement analytics;

a major information security breach of JB Hi-Fi’s IT systems. The Group seeks to mitigate this risk through

investment in IT security measures;

− a major workplace health and safety incident or customer injury occurring in a JB Hi-Fi store. The Group

seeks to mitigate this risk through having appropriate occupational health and safety procedures in place

for all of its sites; or

− a significant breach of regulatory or legislative requirements. The Group seeks to mitigate this risk through

appropriate staff training on key regulatory and legislative requirements relevant to its business, as well as

making legal and regulatory compliance a key focus of the management team.

spending cycles and changes in consumer demands. The Group maintains its relevance using its strong

market position supported by its everyday low price proposition. The Group’s stores, which are both in

convenient and high traffic locations, seek to maximise both destination and impulse sales. The Group also

closely monitors changes in the economic environment, consumer demand and new products, and is able to

respond quickly to such changes.

offer, while leveraging the benefits of its physical stores. The Group continues to innovate both in-store and

online in order to give customers the choice as to how to transact with JB Hi-Fi. The Group’s market leadership

drives significant buying power which enables the Group to compete successfully with online players as does

its low cost of doing business. JB Hi-Fi also believes that the existence of its store network will continue to

provide confidence in after-sales service and support to its online customers.

Digitisation of physical software leading to a fall in traditional software sales – the Group will maintain a

software presence in store while the category is still providing solid returns.

impact on the Group’s operating and financial performance. However, the Group has significant supplier

management processes to mitigate this risk and, whilst at any one time certain products and suppliers are more

important than others, the large and diverse range of products stocked by JB Hi-Fi means that reliance on any

one supplier or product is less than for some smaller competitors. In addition, JB Hi-Fi has a proven record of

expansion into new product categories and introducing new brands, rather than remaining reliant on those

products and brands which were successful in previous years. This is reflected in the fact that, despite a

decline in software sales in recent financial years, the Group has achieved positive total sales growth.

Hardware and services sales as a percentage of total sales increased from 74.8% of total sales in FY2011 to

85.9% in FY2016 as a result of the expansion into new product categories and the introduction of new brands.

example the Group’s cost of doing business is impacted by the annual Fair Work Award wage reviews (which

have resulted in increases totalling 15.3% over the past 5 years to 30 June 2016). However, the increasing

scale of the Group’s operations continues to deliver cost reductions which mean that higher wage costs can
be

offset to some extent by cost reductions in other areas.

increased volumes, technological advancements and, more recently, a weakening of the Australian dollar.

existing stores is key to the Group’s ongoing growth and profitability. The Group believes that it will continue to

be able to do this as it has done successfully to date.

critical to its operating and financial performance. In recognition of this, succession planning and

executive/senior management team composition is a key focus for the Board and executive team.

detrimental impact on its operating and financial performance, and any failure to maintain and upgrade its IT

systems over time has the potential to inhibit the achievement of the Group’s business initiatives. To mitigate

the business interruption risk, the Group has documented disaster recovery processes (including off-site IT

back-up infrastructure) and has undertaken disaster recovery testing. The Group also continues to invest and

develop its IT resources and capabilities.

Changes in regulatory environment – changes in the regulatory environment in which the Group operates may

increase compliance costs, and even (in extreme cases) affect the ability of the Group to sell certain types of

products and services or conduct certain activities. Whilst such changes are outside the control of the Group,

the Group monitors proposed changes in the regulatory environment so that it can assess the impact of such

changes and develop appropriate response strategies where possible.

Harvey Norman Holdings Ltd

Harvey Norman® franchisees are leaders in the Home and Lifestyle market in Australia with sales underpinned by the resilient property market, population growth and favourable interest rate settings. However, as part of our integrated strategy we have sought to broaden the core of the Harvey Norman® offering to ensure that our franchisees become leaders in the Home and Lifestyle market, with a focus on the quickly evolving role of connected technology in our everyday lives. Having a retail presence in eight countries affords us a global view of markets working hand-in-hand with our global partners. This market position not only capitalises on the public‟s enthusiasm for the fitness and entertainment aspects of this technology, but also embeds the expertise into the franchised network in preparation for the enhanced connectivity implicit in the next stage of these devices. Our franchisees are at the forefront of the Internet of Things in this rapidly expanding category of connected devices. The everyday benefits of the Internet of Things promises to be a sustained retail trend for the foreseeable future. Harvey Norman®, Domayne® and Joyce Mayne® franchisees are well positioned to understand the potential of these developments and to provide the best service possible to help connect consumers with their technology needs

Business Strategies, Future Prospects and Likely Developments

The OFR provides information to enable shareholders to make an informed assessment of the consolidated entity‟s

future business strategies and prospects. The OFR additionally provides information about, and refers to likely

developments in the operations of the consolidated entity, and detail on risks that could give rise to likely material

detriment to the consolidated entity. The OFR does not include information that is commercially sensitive, confidential,

or which could provide a third party with a commercial advantage.

The objective is to deliver attractive returns to shareholders by growing market share and improving profitability. The

consolidated entity seeks to achieve this objective through the execution of the following business strategies:

Omni Channel

The Omni Channel operating model of Harvey Norman® franchisees continues

to develop and enhance the service offering to their customers. The seamless

experience of the model has been improved over the last 12 months with the

introduction of the “Click & Collect” application; the launch of the “Shippit”

delivery service which provides same day or scheduled delivery times for

consumers and the live chat customer service system which has had further

expansion throughout the year with improved customer ratings.

The importance of the mobile channel has been highlighted as a key enabler

of a quality customer experience in physical Harvey Norman® complexes,

online, or through mobile and/or social media.

Integrated Retail, Franchise, Property and Digital System

The integrated retail, franchise, property and digital system strengthens the

consolidated entity‟s competitive position by offering financial stability. With a

balance sheet underpinned by a $2.44 billion portfolio of property, Harvey

Norman®, as franchisor, is able to provide tactical support where necessary to

preserve its brand and competitive position.

Through effective property management, the consolidated entity attempts to attract more customers into franchised

complexes by ensuring a high quality, cross beneficial tenancy mix.

Customer Service and Engagement

The “Shop with Confidence” customer service model has been supported with increased training by franchisees of

their employees and further developments in the “Customer First” program. These programs capture consumer

feedback and inform and enhance the approach of franchisees with their customers, regardless of channel.

Franchisees monitor the quality of their service through an ongoing mystery shopper program and by collecting

customer feedback. This multi-year program is expected to deliver ongoing process and customer sentiment

improvements.

DIRECTORS’ REPORT (CONTINUED)

Operational Efficiencies

The consolidated entity invests in systems, technology and processes to improve profitability and to achieve

operational efficiencies.

Merchandise, inventory and supplier management:

This year the phased rollout of the merchandise, inventory and supplier management system continued on time and

within budget and now encompasses the franchised complexes in Australia and the company-operated stores in New

Zealand, Ireland and Northern Ireland.

During the past year, franchisees have seen a significant expansion in the utilisation of a new system facilitating more

seamless and effective transactions with suppliers and customers. Franchisees, in key categories, are now able to

replenish inventory using the new merchandise, inventory and supplier management system. Franchisees now have

increased visibility of transactions to effectively manage supplier terms, promoting proactive and more productive

relationships with their suppliers and customers.

Each franchisee now has access to, and can use, enhanced real-time analytical tools to better understand the

individual business of that franchisee, including potential insights into floorspace productivity, and to identify further

opportunities to streamline and improve the broader Supply Chain process. The information of franchisees is analysed

to enable evaluation and monitoring
of the performance of each franchisee.

Workforce productivity improvements:

Each franchisee has successfully deployed on time and within budget, a workforce management system, including

staff forecasting and roster optimisation.

Each franchisee now has the tools necessary to efficiently roster staff based on forecast customer traffic, expected

sales and staff availability. Each franchisee can now plan to have the right staff on the shop floor to effectively service

customer demand, while controlling and managing payroll expense.

It is planned to deploy the workforce management system to company-operated stores in New Zealand in 2017.

Outlook

The strategy of an integrated retail, franchise, property and digital model is the foundation of continued success and

resilience both in good times and during uncertain or challenging times. It is robust and dependable providing stability

when it needs to, yet flexible and swiftly responsive to emerging trends and opportunities in the market place. Harvey

Norman® franchisees operate across a diverse range of key product categories which span vast array of markets,

mitigating the reliance on a single trading source or exposure to the risks of a single product category.

While macroeconomic conditions in the markets in which we operate may change, housing conditions in Australia

remain strong and are likely to remain favourable in the near term.

The emerging lifestyle categories, particularly technology based products, are exhibiting strong demand as consumers

automate and connect across their home, work and recreational lives.

After a period of moderate investment, the consolidated entity intends to open a total of seven (7) new stores in the

2017 financial year. Two (2) franchised complexes will be opened in Australia, consisting of one (1) Harvey Norman®

franchised complex in Queensland and one (1) Domayne® franchised complex in South Australia, and five (5) Harvey

Norman® company-operated stores in overseas markets, consisting of one (1) store in each of New Zealand, Ireland

and Singapore and two (2) stores in Malaysia.

DIRECTORS’ REPORT (CONTINUED)

HARVEY NORMAN HOLDINGS LIMITED | ANNUAL REPORT 2016

Summary of Key Business Risks

The Board is optimistic about the consolidated entity‟s future trading performance but acknowledges that there are

several factors that may pose a risk to the achievement of the business strategies and future financial performance as

outlined above.

Every business faces risks with the potential to impair its ability to execute its strategy or achieve its financial objectives.

There are a number of key risks, both specific to the Harvey Norman® integrated retail, franchise, property and digital

system and external risks, for example the macroeconomic environment, over which the consolidated entity has no

control. The consolidated entity acknowledges the existence of these risks, and in the first instance seeks to identify

and understand individual risks, and then – to the extent possible – manage and/or minimise risks.

(i) Deterioration in macroeconomic conditions resulting in a fall in consumer sentiment:

The consolidated entity has a significant exposure to the economy of the countries in which it operates. There are a

number of general economic conditions, including interest and exchange rate movements, overall levels of demand,

housing market dynamics, economic and political instability and government fiscal, monetary and regulatory policies,

that can impact the level of consumer confidence and discretionary retail spending, thereby affecting revenue from

sales to customers and franchise fees. The consolidated entity seeks to reduce its exposure to these risks by closely

monitoring both internal and external sources of information that provide insights into any changes in demand within

the economies in which it operates.

(ii) Competition resulting in a loss of market share for franchisees in Australia:

The integrated retail, franchise, property and digital system, and diverse category mix aid in maintaining the

consolidated entity‟s competitive position. Franchisees operate across a number of categories including the strongly

performing Home and Lifestyle market. Diversity mitigates the risk from existing and potential single-category

competitors.

(iii) Emergence of competitors in new channels:

The Harvey Norman® Omni Channel Strategy provides customers of franchisees with a diverse, consistent and

distinctive Harvey Norman® customer experience through a diversity of channels. The Harvey Norman® Omni Channel

Strategy integrates retail, online, mobile, and social channels. The online operations of franchisees in Australia and the

company-operated online operations in New Zealand have grown substantially. The digital platform creates new

opportunities for growth and new ways to embrace and engage with customers. Data analytics are an important

element of the Harvey Norman® Omni Channel Strategy, and are utilised to improve customer experience.

The Harvey Norman® Omni Channel Strategy sets the Harvey Norman® brand apart from other online and digital

competitors as the digital, physical complex and distribution channels are fully integrated, providing customers of

franchisees with a multitude of engagement options to meet their needs. The Harvey Norman® Omni Channel

Strategy, supported by the retail property portfolio of the consolidated entity, makes the Harvey Norman® brand a

strong competitor in the market.

(iv) Economic downturn in the property sector leading to softening property asset values, falling market rentals

and reduction of future capital returns on property assets:

With a property portfolio of $2.44 billion, the consolidated entity is exposed to potential reductions in property values

within the bulky goods sector. The consolidated entity has a selective and prudent acquisition and development

strategy and maintains high-quality complexes and a solid, dynamic, complementary tenancy mix in order to

maximise the profitability of the property segment.

(v) Counterparty risks of service providers:

This risk relates to the inability of service providers to meet their obligations. The consolidated entity closely monitors

and evaluates the performance of external service providers to mitigate counterparty risk.

(vi) Counterparty risk associated with the mining camp accommodation joint ventures:

Commodity prices are inherently volatile. The provision of services to the mining industry is inherently risky. The

consolidated entity has entered into joint ventures with counterparties to provide mining camp accommodation

services. The risk in respect of mining camp accommodation joint ventures includes the ability of counterparties to

meet financial and other obligations under mining camp accommodation joint venture agreements.

The consolidated entity closely monitors and evaluates the performance of counterparties of the mining camp

accommodation joint ventures by monitoring compliance with joint venture agreements; adopting a prudent and

conservative approach to the review of mining camp accommodation cash flows, including future cash flow

projections; and ensuring that an adequate level of security is maintained for any funds advanced to mining camp

accommodation joint ventures.

DIRECTORS’ REPORT (CONTINUED)

(vii) Compliance by franchisees with franchise agreements:

This risk relates to franchisees not operating their assigned franchise in accordance with the terms and conditions of

their respective franchise agreements. The consequences of non-compliance may include damage to the brand,

fines or other san
ctions from regulators, and/or a reduction in franchise fees received from franchisees.

The franchisor continually monitors and evaluates the financial and operating performance of each franchisee to

actively assess compliance with executed franchise agreements. Instances of non-compliance are promptly

addressed to protect the Harvey Norman® brand and/or intellectual property of the franchisor.

(viii) Information Technology (“IT”) security and data security breaches:

This risk relates to potential failure in the IT security measures resulting in the loss, destruction or theft of customer,

supplier, financial or other commercially-sensitive information including intellectual property. This has the potential to

adversely affect our operating results which would lead to lawsuits, damage the reputation of the Harvey Norman®

brand, and/or create other liabilities for the consolidated entity.

There are a number of key controls either planned or already in place, including an ongoing program of investment in

cyber security software; the implementation, maintenance and supervision of operational policies intended to

preserve the confidentiality and integrity of IT systems; regular independent audit and review of IT security; and the

ongoing review, practise and updating of a disaster/crisis management plan relating to IT systems.

(ix) Investment in agribusiness:

This risk relates to the recent volatility in the milk price and corresponding returns from investment in Coomboona

Holdings. The market price for milk has declined and the expected returns on milk production may be reduced

depending on production volumes. In addition, the future timing and development of the dairy to optimal scale may

be impacted by current trends in commodity prices.

The investment in Coomboona Holdings and the development of the corresponding agricultural assets is constantly

evaluated and reviewed to ensure appropriate commercial outcomes are achieved. Representation on the board of

Coomboona Holding ensures oversight of the investment and enables close monitoring of progress towards the

required operational and commercial objectives.