White Paper - September 2008: Does a downturn have to be all bad for the retail sector and its stakeholders?

Introduction

The recent deliberations from the RTT showed that the three indicators of the health of UK retail - demand, margins and costs - had fallen to their lowest level since the group's first meeting in early 2006.

At the same time, there is much talk of an imminent UK recession. So, if the current downturn turns into a recession, or even if it doesn't technically become one, what are the prospects for the retail sector? Is it a case of universal gloom for retailers and consumers alike?

Whilst the group is in agreement that a downturn or recession is never good news for any individual company struggling to meet the challenges that the new environment presents, the RTT debated what positives can come out of an economic downturn, both from retailers' and consumers' points of view.

Background

To put the current situation into context, the RTT examined previous recessions - the two most recent being during the 1970s and 1990s - and looked at the effects these had on the sector.

The 1970s

The 1974/5 recession was characterised by very high inflation and rising unemployment over a sustained period. The volume of retail sales fell for four consecutive years between 1974 and 1977 although there were some small quarter on quarter rises over that period.

Not only was there great concern over costs in the inflationary environment, but there was also a step change in the way that consumers reacted to this, requiring retailers to compete more strongly for the attention of consumers than ever before. Consumers were less willing to simply settle for what was provided by their regular retailers; 'shopping around' in order to seek out lower prices and better value. Rising car ownership gave consumers access to a wider choice of stores. On the back of tougher trading conditions, leading retailers began to actively 'market' their total retail offer, moving away from their sales-centric approach of before.

The development of early marketing strategies was inevitably focused around competitive price propositions. It was hardly coincidental that immediately following the recession, there was strong growth in discount food retailing, leading to the emergence of new chains such as Kwik Save. It was primarily through redefining relationships with their suppliers and taking control of the supply chain that retailers managed to drive down costs and with them, prices. This was the most significant legacy of the recession for the industry. Retailers also put renewed emphasis on driving up their national market shares, to gain further cost benefits from economies of scale.

The second main impact to retailing on the back of the recession was a move away from the concept of mass consumerism to a more tailored customer approach, whereby retailers looked to provide greater relevance to their customers in an effort to retain their custom. Retailers began collecting information about their customers through surveys and other means, to get to 'know' them better. For the first time, retailers began to view their role as one of marketer rather than intermediary and their stores as 'the selling machine' (Source: Gardner and Sheppard 1989), rather than the manufacturers' channel gate.

Better customer knowledge enabled market segmentation. Its consequences for retailers were; firstly, the ability to generate different store formats (targeting different customer groups) and ranges and, secondly, the launch of their own TV advertising and promotional campaigns, communicating directly with their shoppers for the first time.

The 1990s

This recession was against a different economic background, partly caused by a bubble in the housing market in the late 80's. In the early 1990s, economic policymakers were committed to keeping the pound in the Exchange Rate Mechanism (ERM), which prevented them from cutting interest rates as the economy slowed. As a result, interest rates continued to rise and it was only when the pound left the ERM late in 1992 that interest rates fell sharply. Therefore, this recession was much shorter than in the 1970s with retail sales volumes only falling in '91 while growing by less than 1% in '90 and '92 (Source: ONS Retail Sales Volumes).

The effects of the recession for retailers this time around were equally impactful and long-lasting; they were similar in their aims, but different in solution. Once again, the primary challenge for retailers was to reduce costs and prices, thereby addressing both the strain on the consumer's pocket and defending their competitive position. The main means of achievement was different to the early recession, focussing on 'process re-engineering' in the supply chain. Retailers looked afresh at the end-to-end supply chain, identifying where they could refine their processes, or increase their buying powers to make efficiency gains and cost improvements.

Retailers also examined how they could build closer relationships with their customers. Advances in technology meant that through EPoS (Electronic Point of Sale) systems they could begin to analyse transactional data in a way that previously had been impossible to do. To provide insight behind the numbers, retailers began to undertake qualitative research to better understand the motivations and attitudes of their customers. Strategic emphasis lay on retaining existing customers and maximising basket sizes, rather than looking to grow market share, which had already become concentrated. In 1995, Tesco's Club Card was launched. Though not the first such scheme to be launched, it was the first that could computer-analyse individual customer details with their spending patterns to offer real insight into buying behaviour and 'reward' their shoppers for their continued patronage.

In summary, the two recessions were different yet had some similarities; the first was characterised by price reductions and aggressive 'front door' price competition, whilst the second was more concerned with 'back door' cost reductions. However, what they both had in common was retailers reassessing their strategies and the acceleration in the rate of market concentration seen in the sector, in order to more effectively meet the evolving demands of consumers.

The current economic situation

Although policymakers do not face the constraints the ERM created during the recession in the 1990s, inflationary pressures are currently acting as a barrier to lowering interest rates this time round. The RTT considered current economic conditions and reflected on their effect upon consumer spending:

• Savings - the household saving rate is now lower than it was prior to the downturns in the 1970s, 1980s and 1990s. This might suggest that consumers face a tougher period ahead to get saving back up to more normal levels;
• House prices - these are even more overvalued relative to earnings than they were before, although this is good reason to believe that the equilibrium house price to earnings ratio has risen over the past few years;
• Unsecured credit - on a more positive note, even with the credit crunch, unsecured credit, whether or not this is a 'good thing', is far more accessible and widely available for consumers than it was in previous downturns, when financial markets were less developed and credit scoring less sophisticated. This will help consumers to borrow through a period of squeeze on their incomes.

Whether we will see a short lived downturn or a more prolonged period of stagnation or even stagflation remains to be seen. The RTT agreed that a short, sharp shock is preferable to a prolonged, slow decline. Some signs of the actuality of a short sharp shock are the recent demise of both Rosebys and Motor World and the near demise of MFI. But for a quicker recovery, we need to see some or all of the following; a sharp fall in interest rates; a cut in tax rates; a Government solution to the mortgage freeze and a sharp fall in oil prices, which would lower vehicle fuel and utility costs. Without these changes, the timing of a recovery looks even more uncertain.

Whatever the downturn's duration, we will emerge with a more sustainable platform for future growth. The credit crunch will cause a reduction in the number of overstretched consumers as they will be less reliant on borrowing, access to easy credit and growth of asset values such as property in order to fund their retail spending. However, for now and some considerable time, consumers will become even more discerning in their retail buying decisions and retailers will be fiercely competitive as they vie for a share of consumers' spending power.

What are the benefits/upsides of a downturn?

The consumers' perspective

In any period of economic change there will be some consumers who benefit or are less affected, particularly non home owners, the wealthy and those who have paid off their mortgages.

However, the overriding benefit for consumers is that they now have more power than ever before; retailers will have to become more market driven - even more focused on understanding the needs and wants of their customers - in order to survive.

The RTT noted the following likely implications for consumers:

Price/value proposition

• Price - competition will become more intense creating 'price wars', e.g. between the supermarkets;
• Promotions - genuine promotions will be implemented which are attractive to consumers.

The retail experience

• Product - enhancements to ranges will be made e.g. more relevant ranging as retailers look to concentrate on the proposition most appropriate for their customers;
• Customer service - could improve as retailers compete for the consumers' 'share of wallet' by trying to differentiate themselves from the competition;
• Environment - will become a greater focus for differentiation of retailers' offers, stores and websites.

The outcome is that a 'best of breed' will emerge, which is beneficial for consumers as it forces retailers to raise their game, with the strongest retailers in their sector emerging as the winners.

The retailers' perspective

Sectors

• Some sectors of retail perform well in a downturn:
  - Discounters do well in a recession and there are signs that Aldi, Lidl and Iceland are prospering, with all three recording sales growth this year;
  - DIY retailers could have scope for growth as people carry out their own renovations and improvements, rather than employ the services of builders, and improve existing properties rather than move, although this could be mitigated by falling confidence in house prices;
  - Retailers which cater for 'recession proof' and less economy-sensitive sectors such as teens, high net worth individuals, wealthy tourists etc.
• Growth of the internet. The downturn adds renewed emphasis for retailers to become 'truly multi channel' as a recession tends to accelerate trends which are currently in ascendancy, such as the rising popularity of online shopping. The group noted that rising fuel prices may also be accelerating this trend.

Infrastructure

• Productivity savings and efficiency gains. As in the last downturn the need to find cost savings will move higher up the strategic agenda. However, those who have been investing and innovating in this area will start to see benefits and achieve competitive edge. For example, innovation in logistics & supply chains with greater use of shared resourcing will create increased efficiency. Retailers are approaching this in a number of ways, including refining 'just-in-time' stock systems to minimise dead stock; operating shared transport and warehouse facilities as Alliance Boots does; or signing up to the 'speed-dating' sessions that IGD runs to facilitate shared transport. The inevitable end-stop will be shared space on vehicles, not just shared fleets.
• Rent structure change. There have been calls by the British Retail Consortium, as well as industry figures like Sir Philip Green of Arcadia, Simon Wolfson of Next and Lord Harris, Chairman of Carpetright, for landlords to collect rents on a monthly rather than quarterly in advance basis. Lease reform has been on the agenda of retailers for some time and this is the latest debate on the issue, prompted by increased focus on cash flow resulting from the credit crunch. Landlords are coming under increasing pressure for change and representatives of the BRC met with the British Property Federation recently for discussions. Indeed it is worthy of note that Hermes has just agreed to this in certain cases. However there continues to be opposition to any move to amend leases retrospectively, whilst the position on new leases will depend both on the negotiating strength of the parties and local market conditions.
• Banking point of view. Retailers looking for investment will become more realistic, their business case more compelling in order to secure required funding in a 'credit squeezed' market and this could help to create more sustained, stable business development.
• Better Dialogue. During difficult trading conditions, the need for retailers to maintain good communication with their banks becomes even greater and helps to create a 'no surprises' culture and better working relationships for the future.

Structural change in the sector

As highlighted above, recessionary environments have led to the acceleration of structural changes ongoing within the sector. To date, the main focus of structural change has been around seeking greater economies of scale and the development of new formats to meet the needs of different customer segments. The RTT members agreed that we would continue to see retailers focus their strategies around how to get the benefit of these.

However, we are now also seeing the effects of convergence of information and communication technologies, giving a new set of cost economies that will continue to be exploited by the retailer. For example, it is becoming easier for retailers to consider the internationalisation of their operations and to extend them into new areas of retail services, such as financial services, health services and specialist leisure services.

The development in information and communication also affects marketing activities of retailers. Retailers are now able to obtain and better use information on the behaviour of individual consumers, rather than only having information on the items in the store.

Whilst it can be argued that these structural changes, which will again lead to acceleration in the levels of concentration in the sector may not be beneficial, the positive outcomes will be that:

• Good retailers will get better, whilst the weaker ones will not survive; a case of 'survival of the fittest';
• Economies of scale. Getting bigger brings the added bonus of a reduction in costs (e.g. buying costs, energy costs, ability to negotiate with property owners etc) enabling retailers to invest more in understanding the needs of their customers;
• Overseas expansion. A domestic downturn creates the impetus to expand overseas, offsetting UK market pressures. Emerging markets become more attractive; e.g. M&S is expanding its interests in China and India and Debenhams is said to be looking to expand its presence in the Indian and Russian markets as part of plans to increase its international sales;
• Entry for overseas players. Britain becomes more viable for market entry, as space is released by distressed retailers that would otherwise not have come onto the market, a good example being Best Buy which is exploiting its new relationship both here and in the USA with CarPhone Warehouse;

Conclusions

The RTT acknowledged that there are undoubtedly casualties during and following downturns, as past events show, but it does not have to be all bad for all retailers, their stakeholders and customers.

British retailing over the last 30 years has changed fundamentally in its role in the UK economy. The degree of market concentration over 30 years has been intense. Since the early 1970s the structure of the market has changed to one characterised by larger retailers creating an increasingly concentrated market. Previous downturns have accelerated the rate of these structural changes.

Whether the UK is entering a recession or merely a significant downturn is a matter for the economists. Whatever its technical analysis, there is no doubt these are the toughest trading times for UK retail since the early 1990s, or possibly the mid 1970s, and retail will emerge more competitive than ever once the current storm is over.

The need for innovation becomes even more critical when the environment becomes uncertain and turbulent. One of the notable immediate outcomes of the 1970s recession was a retail sector more focussed on its price proposition to customers. The 1990s recession forced retailers to make step changes in the efficiency of their cost bases. However, both caused retailers to critically reassess their strategies to respond to the new market conditions and as well as accelerating structural changes in the sector.

The RTT concluded that the current downturn will lead to:

• A further shift in power from retailers to consumers as they compete for share of consumers' spending capacity;
• An enhancement of the retail experience as successful retailers strive to improve their understanding of their customers and target their ranges, service store and online environments to meet the needs of their customers;
• Increased globalisation of the retail industry;
• More efficient retailers. The current need for cost reduction programmes will create an opportunity for retailers to grow when economic conditions improve and steps taken by retailers now could help them reap rewards in the future;
• The emergence of new, ground breaking strategies will prove the key determinants for the future success of the sector.

-Ends-

Note to Editors:

First mentions of the Retail Think Tank should be as follows: the KPMG/SPSL Retail Think Tank. The abbreviations Retail Think Tank and RTT are acceptable thereafter. The RTT was founded by KPMG and SPSL in February 2006. It now meets quarterly to provide authoritative 'thought leadership' on matters affecting the retail industry. All outputs are consensual and arrived at by simple majority vote and moderated discussion. Quotes are individually credited.

The Retail Think Tank has been created because it is widely accepted that there are so many mixed messages from different data sources that it is difficult to establish with any certainty the true health and status of the sector. The aim of the RTT is to provide the authoritative, credible and most trusted window on what is really happening in retail and to develop thought leadership on the key areas influencing the future of retailing in the UK.

Its executive members have been rigorously selected from non-aligned disciplines to highlight issues, propose solutions, learn from the past, signpost the road ahead and put retail into its rightful context within the British social/economic matrix.

Members are:

Nick Bubb, Pali International
Prof. John Dawson, Universities of Edinburgh and Stirling
Dr. Tim Denison, SPSL
Helen Dickinson, KPMG
Richard Lowe, Barclays Retail & Wholesale Sectors
Vicky Redwood, Capital Economics
Mark Teale, CB Richard Ellis

The intellectual property within the RTT is jointly owned by KPMG (www.kpmg.co.uk) and SPSL (www.customercounting.com).

For media enquiries please contact:

Theo Chalmers, Managing Director, Verve Public Relations
Tel: 01908 275271 or 07932 004632
E-mail: t.chalmers@vervepr.co.uk

Rachael Halliday, PR manager, KPMG
Tel: 0117 905474 or 07747 102909
Email: rachael.halliday@kpmg.co.uk

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