Repercussions of the Fair Trade Commission’s Revised ‘Notification on Large-Scale Retail Businesses’

[ 12/9/2007 ]

The retail industry has been unsettled by the recently announced revision to the Fair Trade Commission’s ‘Notification on Large-Scale Retail Businesses.’ The FTC’s action follows an investigation into unfair trade practices at hypermarkets conducted since last year. The investigation found that the three leading companies—E-Mart, Homeplus, and Lotte Mart—received 470 billion won in sales incentives, equivalent to 4.8% of their total purchasing value, and employed approximately 28,000 dispatched promotional workers, accounting for 93.8% of their sales staff. The main elements of the revised notification are an expansion of the businesses subject to regulation and stronger sanctions. Previously, the notification applied only to department stores, hypermarkets, and TV home-shopping companies operating stores with a floor area of at least 3,000㎡. The revised notification adds a sales criterion, extending its application to businesses with annual sales of at least 100 billion won.  Accordingly, beginning next year, its scope will expand to include new retail channels such as online shopping malls, convenience stores, general merchandise stores, and SSMs, which were previously excluded despite their high sales because they did not meet the floor-area criterion. What the fashion industry is watching most closely, however, is the measure intended to prevent retailers from passing interior construction and promotional expenses on to tenant companies. Under the revision, if a tenant company completes interior work and is then required to relocate or withdraw from the store within two years without a special reason, the retailer must provide reimbursement or compensation for the actual expenses. It must also formally stipulate that it will bear a certain portion of the expenses for promotional events. This would require department stores and hypermarkets to fundamentally revise their business strategy of conducting MD reshuffles twice a year, drawing considerable attention from the industry. An executive at a women’s wear company said, “Rather than focusing on fragmented solutions such as expense reimbursement, retailers should approach the revised notification as an opportunity to improve the short MD cycles that create harmful department-store practices, including fabricated sales, excessive promotional spending, and copying.”   In addition, the revision prohibits, in principle, the sales incentives and sponsorship payments that retailers have frequently demanded from suppliers, and seeks to eliminate retaliatory actions against suppliers, including those related to contract amendments. It also calls for reasonable improvements to the standards governing permitted returns and significantly tightens the criteria for dispatching promotional staff and compelling suppliers to pay promotional expenses, practices regarded as some of the worst abuses by hypermarkets. Accordingly, retailers such as department stores and hypermarkets are struggling to develop new operating strategies that comply with the revision. This is because abolishing trade practices with tenant companies that have long been taken for granted—and specifying the relevant terms in contracts—feels unfamiliar, while faithful implementation of the revision will require preparations for substantial cost-sharing and financial compensation.   Among major retailers, Lotte Department Store has presented the most proactive response to the FTC’s revised notification. Lotte stated that it had already analyzed the factors contributing to rising costs for retailers and partner companies in 2004 and established a manual for improving trade practices, particularly those related to interior expenses as well as labor costs. According to the manual, under current department-store operating conditions, the appropriate minimum period for recovering interior investment costs is two years for medium-sized and larger stores, and approximately three to five years for smaller stores. Song Young-tak, head of the women’s casual MD team that developed the manual, said, “We have already been preparing by creating and implementing internal guidelines for interior and promotional expenses as part of the process of developing mutually beneficial policies, so the revision is unlikely to have a major impact even after it takes effect.” Lotte is also considering a fundamental revision to its MD strategy by reducing its MD reshuffles from twice a year to once a year. Hyundai, which has fewer department stores than Lotte’s 28 locations and does not operate discount stores, is adjusting the scale of next year’s MD reshuffles in consideration of the actual level of compensation required. It has also announced plans to expand channels for gathering feedback from partner companies, such as its recently declared ‘win-win partnership.’ Shinsegae is focusing on developing a medium- to long-term MD strategy that can be maintained for at least two years, as it plans to open several new department stores next year, including the Centum City branch. However, with the multi-store rollout of ‘Gap,’ introduced by its affiliate Shinsegae International, already confirmed for next spring, determining compensation measures for brands that will be forced to withdraw remains a concern.  Hypermarkets, where fashion accounts for a relatively smaller share of sales than at department stores, plan to apply the standards developed by their group-affiliated department stores to the fashion division while focusing on operating strategies for food and household goods, which will be more significantly affected by the revision.