RTT_Whitepaper_2010_01_16_WhatAreTheProspectsForUKRetailIn

– Looming economic factors could cause a “retail relapse” warns Retail Think Tank-

Part I:  Executive Summary

Introduction

Many could be forgiven for thinking that the worst effects of the recession are over, following better news for the industry lately.  The KPMG/Synovate Retail Think Tank’s (RTT) latest Retail Health Index, which recorded an improvement in retail health over the last quarter of 2009 and predicted it to continue into quarter one of 2010, strong figures from the BRC-KPMG Retail Sales Monitor for December 2009 and positive trading updates from a number of retailers suggest a better year ahead and a recovery sooner than many anticipated.

However, in its latest white paper, the RTT discusses the prospects for UK retail in 2010 and warns there are dark clouds gathering on the horizon which could create more turbulence for the sector and cause a “retail relapse.”

The economy: the defining factor for retail in 2010

There are many unknowns ahead: the prospect of higher interest rates, another fall in house prices, more unemployment and tax rises could hit the UK in 2010, bringing to an end the resilience of retail spending and the start of a period of retrenchment.

Helen Dickinson of KPMG says: “Because retail is so heavily dependent on consumer sentiment and individual consumers’ personal financial situations, which, in turn, rely on the economy, the sector is affected very quickly by economic events.   Unfortunately the current situation is more of a bumping along the bottom of the recession cycle than real recovery from it and the delicate confidence that has recently returned could very easily be shattered.”

The main catalyst will be the government’s economic policy after the election, so there is no room for complacency within the retail sector this year.

Vicky Redwood of Capital Economics says: “The most obvious cloud on the horizon is the looming fiscal squeeze.  Following the general election, whichever party is in power will have to take drastic action to cut public sector borrowing.  Even if most of this takes the form of government spending cuts, rather than tax rises, consumers will still be affected by public sector job cuts and pay freezes.”

If tax increases are the favoured route of the government, a potential rise in the rate of VAT to 20% or an extension in its scope would affect retail spending.  But a far greater impact would be a rise in interest rates, affecting personal disposable incomes, which is predicted by some to happen before the end of 2010.

“A mini-reflationary bubble has been created,” says Nick Bubb of Arden Partners.  “But that has to burst eventually and the ‘phoney recession’ that we had in 2009 will turn into the real thing at some stage this year.”

Anticipating and responding to the changing habits of consumers

The recession has modified shopping attitudes and retailers must continually address this.  Consumers are becoming more multi-faceted – and difficult to understand.  We will see consumers trading down in some circumstances while at the same time trading up to some brands that truly deliver premium quality.  They will regularly cross channels and expect consistency of proposition and service in each, as well as wanting more social interaction with those stores they frequent.

According to Synovate the number of shopping trips made by consumers is expected to fall by 3% on 2009, while different groups of consumers – “gainers” with reduced mortgage payments and “losers” who have suffered unemployment – will have different priorities.

Tim Denison of Synovate says:  “With the clouds of uncertainty looming, the gainers will not necessarily spend freely, while the losers will be inclined to stick to buying basics, avoiding extravagance and becoming more promiscuous as they become time rich and cash poor.  Shopper actions will, however, present retailers with great opportunities: the potential for more first time shoppers means they might not just win new customers today but possibly real loyalty tomorrow.”

Value retailers, who have outperformed the market since the downturn began, will continue to do so.  Supermarkets will continue to take market share in the non-food sector, particularly given the number of smaller, weaker players which will continue to leave the market.

Consistent growth will come from the Internet and through multi-channel retailing.  Richard Lowe, Barclays Retail & Wholesale Sectors comments: “Businesses should be reviewing their routes to market and how they can most effectively and efficiently meet their customers’ needs with great product at the right price.”

Focusing on business strategy

The successful retailers will be those who continually adapt to the changes in behaviour and lower levels of demand by finding new and innovative ways to exploit what few opportunities are available.

The focus on cash will remain critical again this year and retailers must continue to improve their oversight and integration of costs, cash and forecasting – particularly as the multi-channel model becomes more important.  Retailers will need to ensure they have sufficient banking facilities in place which will require continual re-evaluation should trading fall below plan. Close management of currency exposures will also be crucial.

Cost saving initiatives which many retailers implemented last year will need to be reviewed regularly as costs will have inevitably started to creep back up again.  Margins, the most influential driver of retail health in 2009, will also need close attention and the RTT predicts that successful retailers will be those that find innovative ways to do this.

For retailers with expansion plans, contraction in property development activity means that finding desirable sites will be difficult.  Mark Teale of CB Richard Ellis says: “Far from presaging a looming over-supply problem, the sharp concomitant contraction in development activity pretty well guarantees the emergence of primary/good secondary stock shortages.”

If growth plans include international expansion – new or ongoing – retailers will need to be aware of how their target markets are performing.  John Dawson, Universities of Edinburgh & Stirling says: “China, Brazil and possibly India provide the largest opportunities while those which are proving less lucrative will be abandoned.  On the other hand, domestic retailers will need to closely observe the activities of foreign retailers entering the UK which will provide additional competition.”

Conclusion

The sector has responded well thus far but the problems anticipated when the downturn began have not gone away, they have merely been postponed while the economic situation plays itself out.  With such an unpredictable backdrop to contend with, the RTT sees major challenges ahead for the sector and its overall state of health.  As the RTT has pointed out in a past White Paper, each post war recession has had a considerable impact on retailing best practices, efficiency gains and depth of customer understanding. This one will be no different.

Part II:  In detail – RTT members’ predictions for 2010

Vicky Redwood, Capital Economics: “A sluggish recovery”

The UK economy is starting 2010 on a relatively hopeful note. The recession finally seems to have ended at the end of last year and the risk of a renewed crisis in the banking sector has receded significantly. House prices have now risen by almost 10% from their trough, while even employment is rising again.

However, it is unlikely to be an easy recovery. The most obvious cloud on the horizon is the looming fiscal squeeze. Following the general election, whichever party is in power will have to take drastic action to cut public sector borrowing. Even if most of this takes the form of government spending cuts, rather than tax rises, consumers will still be affected by public sector job cuts and pay freezes.

Meanwhile, the news on the housing and labour markets has been encouraging, but a relapse in both is possible. House prices are still overvalued. And with productivity having slumped, a sharp pick-up in hiring by firms looks unlikely.

Finally, consumers have so far made little inroads into their mountain of debt. As they pay off at least some of this, spending is likely to suffer. The household saving rate has risen to above its long-run average, but there is no reason why it cannot increase further.

The upshot is that this economic recovery is likely to be rather more sluggish than those seen in the past. What’s more, what economic growth we do see is likely to be driven by the exporting sector of the economy, which has been boosted by the lower pound. In contrast, the consumer sector is likely to lag behind. Even though the overall economy should manage to expand by 1% or so this year, real consumer spending will struggle to rise and could even fall again.

Nick Bubb, Arden Partners: “The bubble will burst after the election”

A mini-reflationary bubble has been created, but that has to burst eventually and the “phoney recession” that we had in 2009 will turn into the real thing at some stage this year. Clearly a catalyst for that may be the election expected on May 6th as the new Government will have to quickly make some tough decisions on taxes and public spending to get that huge public sector deficit under control. And VAT at 20% in July is a distinct possibility. But the bigger catalyst for the inevitable, but long-awaited, retrenchment in consumer spending is likely to be the first upward move in interest rates.

The stockmarket has called the macro-outlook well so far. The general retailers were a startlingly good early-cycle play in 2009, but much of the near 50% outperformance it saw versus the 25% rise in the All-Share Index last year was banked before the autumn and more recently it has begun to flag and to discount a tougher 2010 ahead.  By contrast, the less cyclical food retailers were shunned by investors as being way too dull and defensive last year, despite reporting pretty benign trading and the food retail sector underperformed the overall market quite badly in 2009 (rising by a paltry 12.5%). But defensive stocks and therefore the food retailers may find that their time has come in 2010…and in 2011.

Finally, although most non-food retailers will be busy going nowhere in 2010, it will be an important year for the big specialist retailers of entertainment in the High Street. There may very well be cyclical factors at work in the recent sharp decline in the game console market, but for both Game Group and HMV, the stockmarket has decided that the structural decline of the physical market for games, books and music caused by digital downloading will very quickly overwhelm the efforts of both companies to adapt and prosper.  The severe de-rating of Game and HMV seems harsh, but the stockmarket tends to get these things right, so both companies will have to work very hard to get both consumers and investors more on their side this year.

Helen Dickinson, KPMG: “Low growth here to stay”                   

The market scraped marginal growth in 2009 and I see a low growth environment as here to stay.  The combination of a weak economic outlook and a changing consumer means the industry is at a key inflection point as it re-aligns itself to a new reality.  What growth there is will be absorbed by online.  Like-for-like sales will thus dip in and out of negative territory on a monthly basis.  Non-food will continue to decline and deflation will remain, although now more firmly focussed on electricals reflecting technological advances, as other non-food sectors can no longer sustain falling margins as input prices come under increasing pressure.

The consumer will be more multi-faceted – and hence difficult to understand – trading down to outlets that offer better value and up to other brands that truly deliver premium quality, regularly crossing channels (which are no longer seen as separate),  making fewer shopping trips and sharing experiences with others as the power of social networking increases.

To succeed, retailers need three things: Flexibility; Visibility; and Sustainability.  They must improve oversight and integration of costs, cash, and forecasts across the business.  The focus on cash over profit will continue.  Many will revisit the cost saving initiatives implemented last year as costs will have started to creep back up – which is particularly prevalent in retail.  There will be a decline in the number of in-store product ranges available as retailers target their customers’ wants and needs more accurately.

The gap between winners and losers will continue to grow.  Company voluntary arrangements will increase as further capacity is shaken out and banks will be more willing to swap debt for equity in sustainable businesses.  Transaction activity will pick up, whether stock market floats or private equity buyers re-entering the market, but it will be focussed on the strong retailers who demonstrated their resilience over the last two years,

Richard Lowe, Barclays Retail & Wholesale Sectors: “Retail – a cautious growth sector”

I spoke last year about the importance of cash with this being a key feature for 2009 which will remain so in 2010.  Throughout 2009 retailers have evidenced excellent trading skills and have paid particularly close attention to both stock and margin management.  It has been through strict retail disciplines and a close eye on costs that has led many through what has been a difficult year.

The outlook for retailing in 2010 is equally uncertain with a number of factors including the recent increase in VAT back to 17.5% and forthcoming General Election having a strong bearing. We have seen increased consumer confidence in the latter part of 2009 which has driven stronger demand although this remains fragile.

The key to securing funding is to have a robust business plan and detailed financial projections for the coming year.  These should be prudently reviewed in the light of the prevailing economic conditions and sensitised should trading fall behind plan to ensure that there are sufficient facilities to allow your business to trade through.

Whilst the dollar and euro rates have improved for importers since early 2009 the close management of these currencies in particular and therefore a business’s gross margin is key.  Your bank should be working closely with you to both achieve and where possible exceed your budget rates and support your business in providing timely information.

2010 will undoubtedly be another challenging year although I do see continued and consistent growth coming from the Internet and most importantly through multi-channel retailing.  Businesses should be reviewing their routes to market and how they can most effectively and efficiently meet their customers’ needs with great product at the right price.

Tim Denison, Synovate: “The year of the battle for both hearts and minds”

Given the negative indicators in the economy, some still laying in wait down the road, it’s difficult to believe that meaningful consumer confidence will bounce back quickly, if at all this year.

The recession has already modified our shopping attitudes, producing “gainers” and “losers”. With interest rates low, many are benefiting from lower mortgage repayments. With the clouds of uncertainty looming, the gainers will not necessarily revert to spending freely. For the growing unemployed, the low paid, as well as OAPs – many dependent on falling interest on investments – the losers will be inclined to stick to buying basics and avoid extravagance.

Society’s changing circumstances, for both gainers and losers, will continue to affect our shopping behaviour into 2010. Some retailers have, perhaps, confused habitual shopping for loyalty. But as we become more rigorous in watching our spending, so more of us will review where we shop regularly and question our routines. Some recession losers may become more promiscuous, as they become more time rich and cash poor, shopping around, pursuing both bricks and clicks to find the bargains. Others will experiment with regular switching between a choice set of retailers, making more frequent comparisons of their offers. Few are likely to stick to the status quo without reviewing alternatives. This alone presents all retailers with significant challenges.

Shopper actions will, however, also present retailers with great opportunities: the potential for more first-time shoppers means they might not just win new custom today but possibly real loyalty tomorrow. Synovate forecast that up to 3% fewer shopping trips will be made this year, making the significance of every shopper interaction just that bit more important. Success will stem from constantly delivering ‘every day great experiences’ and, in doing so, building trust.

This will be another testing year for retailers; sleepwalking shoppers will be a thing of the past. More conscious and cautious behaviour will be exercised, making 2010 the year of the battle for both hearts and minds.

John Dawson, Universities of Edinburgh & Stirling:  “International markets have post-recession potential”

A feature of the recessionary period in many countries has been a strengthening of the already strong retailers. Coming out of technical recession these firms are likely to be looking for growth opportunities in new markets. The retailers that have been weakened by the recession, whether in UK or elsewhere, are likely to become acquisition targets for the strong firms. There is therefore a likelihood of increased international expansion by strong firms during 2010. Some foreign retailers have already signalled strong intentions to expand in the UK, for example Best Buy in electricals and Clas Ohlson in homewares.

By the same token strong UK retailers are likely to ramp up their international activity over the next year. Tesco and Arcadia have already indicated plans in this respect and it is likely that others will follow. With a slow recovery in the UK the potential for growth by UK retailers is greater in markets outside Europe.

For retailers already having a substantial international presence, the maturing of international retailing as a strategy promises a more focused approach. This is likely to mean rationalisation and pulling out of non-performing markets to focus development on the more successful markets in order to achieve returns to scale in each market and increased benefits of sharing knowledge across markets. The days of  a ‘collecting countries’ approach to internationalisation are largely over with consolidation in a few markets likely to take place even more strongly in 2010.

With year on year growth not having fallen below 2% for emergent markets, even in the depth of the recession in developed countries, China, Brazil and possibly India provide the largest market opportunities. But in these three countries there is not a single market, but in reality several quite distinct markets each with its own particular character. Exploiting the opportunities again will require a focused approach to building a substantive international presence.

One of the long term impacts of recession will be an increase in international retailing not only by UK retailers but also by major foreign retailers entering the UK.

Mark Teale, CB Richard Ellis: “Property Markets Tighten”

Predictions that many retail majors would collapse into administration during 2009, triggering a shop property market meltdown, proved wide of the mark. Only a handful of significant players got into serious difficulty (and there were few surprises). Reports of soaring vacancy rates during the year also sent jitters through the market. In practice, vacancy proliferation, as in previous recessions, has largely occurred in poor secondary and tertiary markets. Vacancy growth in the primary/good secondary space occupied by mainstream chain retailers has proved much more muted.

Indeed, far from presaging a looming over-supply problem, the sharp concomitant contraction in development activity pretty well guarantees the emergence of primary/good secondary stock shortages. The expansion plans of many large unit retailers dependent on shopping scheme development have meanwhile been left in tatters. The frenzied cherry-picking of the Woolworths portfolio provides some measure of the continuing hunger for large, well-positioned unit space, even during recession. Almost 60% of the 800 Woolworths stores were let or under-offer within 6 months of the branch network first coming to market: a remarkable speed of take-up for such a large portfolio.

While speculative development activity looks set to remain sluggish for a number of years, the picture on the grocery front could not be more different. Grocers are taking advantage of the dearth of speculative finance to gear-up their own expansion programmes. Grocery pipeline levels are increasing very rapidly as a result. On the retail property investment side, it began to improve significantly in second-half 2009. Retail property yields hardened across the board, finally triggering a return to positive annualised returns. Central London in particular has performed strongly, bucking national trends.

The big unknown, moving into 2010, is the likely impact of post-election economic policy on retail property. Lending for speculative development will inevitably remain constrained:  expansion activity too. Although supply is tightening, if consumer spending is significantly undermined, the rental weakness that has dogged the property market for the past 18 months will inevitably persist.  A significant resumption in growth still looks some way off, albeit yields look set to continue hardening during the first half of 2010.

RTT White Paper January 2010-1.pdf

Date Published: 1/16/2010 5:20 PM

Note to Editors:

The RTT panellists rely on their depth of personal experience, sector knowledge and review an exhaustive bank of industry and government datasets including the following:

Members of the RTT are:

  • Nick Bubb – Independent Retail Analyst
  • Dr. Tim Denison – Ipsos Retail Performance
  • Jonathan De Mello – Harper Dennis Hobbs
  • Martin Hayward – Hayward Strategy and Futures
  • Maureen Hinton – Conlumino
  • James Knightley – ING
  • Richard Lowe – Barclays Retail & Wholesale Sectors
  • David McCorquodale – KPMG
  • Martin Newman – Practicology
  • Mike Watkins – Nielsen

The intellectual property within the RTT is jointly owned by KPMG (www.kpmg.co.uk) and Ipsos Retail Performance (www.ipsos-retailperformance.com).

First mentions of the Retail Think Tank should be as follows: the KPMG/Ipsos Retail Think Tank. The abbreviations Retail Think Tank and RTT are acceptable thereafter.

The RTT was founded 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.

Definitions:  The RTT assesses the state of health of the UK retail sector by considering the factors which influence its three key drivers.

  1. Demand – Demand for retail goods and services.  From a retro-perspective, retail sales, volumes and prices are the primary indicators.  When considering future prospects, economic factors such as interest rates, employment levels and house prices as well as others such as consumer confidence, footfall and preferences are used
  2. Margin (Gross) – Sales less cost of sales; the buying margin less markdowns and shrinkage.  Cost of sales include product purchase costs, associated costs of indirect taxes and duty and discounts
  3. Costs – All other costs associated with the retail operations, including freight and logistics, marketing, property and people

The Retail Health Index – how is it assessed?

Every quarter each member of the RTT makes quantitative assessments of the impact on retail health of demand, margins and costs for the quarter just completed and a forecast of the quarter ahead.   These scores are submitted individually, collated and aggregated in time for the RTT’s quarterly meeting.  The individual judgements on what to score are ultimately a combination of objective and subjective ones, drawing upon a wide range of hard datasets and softer qualitative material available to each member. The framework follows the example of The Bank of England Agents’ scoring system on economic intelligence provided to the Monetary Policy Committee.

The aggregate scores are combined to form the Retail Health Index (‘RHI’) which is reviewed at that meeting and occasionally revised after debate if members feel it appropriate.  The RHI tracks quarter on quarter changes in the health of the UK retail sector and as such provides a useful and unique measured indicator of retail health.  The index ‘base’ of 100 was set on 1 April 2006.  Each quarter, it assesses whether the state of health has improved or deteriorated since the previous quarter.  An improvement will lead to a higher RHI score than that recorded in the previous quarter, and with a deterioration leading to a lower score.   The larger the index movement, the more marked the shift in the state of health.

The RHI has two main benefits.  Firstly, it aims to quantify the knowledge of the RTT members in a systematic way.  Secondly, it assesses the overall state of health of the UK retail sector for which there is no official data.

For media enquiries please contact:

Max Bevis, Tank PR

Tel: +44 (0)1159 589 840

Email: max@tankpr.co.uk

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