The discussion for the KPMG/Synovate Retail Think Tank’s (RTT) latest white paper followed one of the toughest years of trading UK retailers have experienced for many years.
In early 2009, at the time of the RTT’s quarter 1 meeting, the economic outlook was extremely challenging for retailers with an increasing number of insolvencies in the sector, declining sales and pressure on margins.
Unfortunately, these conditions seem set to continue for much of the retail industry in the short term. This led the RTT to debate the ways in which different influences on retail are likely to shape the sector in the months ahead.
In discussing this, the group concluded the following:
- 2009 will be a cathartic year for UK retail. The industry will ‘keep the best but lose the rest’;
- Trading conditions will remain difficult at least into 2010, with discretionary spending affected the most;
- Non-food retailers will be hardest hit and suffer further falls in profits. However, the food sector will be a safe haven for investors;
- The economic backdrop will continue to deteriorate, led by rising unemployment, while Government policies are unlikely to generate a recovery over the next year;
- The mantra ‘cash is king’ will be more crucial than ever;
- Relationships with suppliers will become more critical;
- The current conditions will help create a rebirth of service excellence; there will no longer be any excuse not to take an interest in customers;
- There has never been a better time for overseas retailers to invest in UK retailing, due to the availability of cheap acquisitions and available property;
- Excellent opportunities exist for strong retailers to acquire prime quality sites;
- The property pipeline has contracted so the impact on the High Street in this recession will be less marked than in the 1990s.
2008: What really happened in retail?
As context for the year ahead the RTT looked back at 2008. The group agreed that the downturn took a little longer to happen than it expected, triggered by the financial crisis, rather than the converging economic issues the RTT had been observing for some months, such as unsustainable levels of personal debt, falling house prices and the rising cost of living.
At the beginning of quarter 1 2008 the RTT’s own Retail Health Index (RHI) stood at 100; twelve months on the panel’s assessment had fallen by 14 index points to 86.
2008 – Quarter 1
Christmas 2007 was followed by a number of downbeat trading statements and the RTT’s first meeting of the year found that all three drivers – costs, demand and margins – were negatively impacting the health of the sector. Rent inflation had not slowed, while utility and fuel prices were spiralling, meaning that retailers were juggling rising cost bases along with pressures on margins and the start of a shift towards lower demand.
This trend continued into the spring when the RTT acknowledged a further deterioration of the three drivers concluding that retail health, as measured by the RHI, had fallen to 98 at the end of the quarter. From a demand perspective, this was borne out by the BRC-KPMG Retail Sales Monitor (RSM) for March reporting the first fall in like-for-like sales for two years, though at the time the RTT stated “retail has caught ’flu, not pneumonia”.
2008 – Quarter 2
At its summer meeting, falling demand had become the dominant force driving retail health and the deterioration in the state of health began to accelerate; the RHI fell by 3 index points to 95. The panel noted the increasing importance of the divergent performance of food and non-food retailers. Food price inflation, one of the major economic themes of 2008, finally began hitting consumers’ spending power, particularly impacting non-food discretionary spending.
2008 – Quarter 3
Into autumn, the financial crisis increased fears of unemployment and the news that the UK was on the brink of recession, with a contraction in the economy of 0.5 per cent in quarter 3, continued to dent consumer confidence. In late October the RTT found that retail health had continued to decline at the same rate in quarter 3, with the RHI falling a further 3 index points to 92.
2008 – Quarter 4
By the final quarter, demand was under increasing pressure and the declines in total and like-for-like sales accelerated. This, combined with the negative influence of margins gathering pace, caused the RHI to fall a further 6 index points to 86. Throughout 2008 discounting became the norm, peaking with an unprecedented amount of activity before Christmas, a time when retaining margin until the last possible moment has traditionally been the order of the day.
The run up to Christmas saw the Government implement a reduction in VAT to 15% in the Pre-Budget Report, in an attempt to get consumers shopping again. However, this had little impact given overall discount levels and created extra work for retailers at their busiest time of the year.
The close of the year also saw the number of insolvencies in the retail sector increasing – the collapse of Woolworths ahead of Christmas brought home the severity of the situation for many.
The year ahead – what does 2009 have in store for retailers?
With the backdrop of trading in 2008 in mind, the RTT highlights the key actions that it believes retailers should be taking this year, and concludes with the ways in which this will influence businesses and shape the industry in the future.
Closely observing the economic picture…
The economic backdrop is impacting the consumer and will continue to do so, with Government policies unlikely to generate a recovery over the next year. The group members share the view that there is no ‘quick fix’ and expect to see consumer spending fall both this year and next, hitting areas of discretionary spend such as high ticket consumer goods, furniture and home improvement the hardest. Although food, commodity, oil and input prices have come down from their heights of mid-2008, the benefits are being more than offset by the slump in sterling which is placing pressure on margins and will force many retailers to re-think their sources of supply.
Vicky Redwood of Capital Economics said: “The economy is going from bad to worse. As the UK experiences a recession that is set to be worse than that of the early 1990s, consumers are in for an extremely tough year.”
Soaring unemployment was the big story of last year and at the start of 2009 the number of people claiming unemployment benefit passed the one million mark, with predictions that it could end up double that number, while those who keep their jobs may well have to accept pay freezes or even cuts. At the same time house prices have, according to Vicky Redwood, “20% or so further to fall if they are to return to something resembling fair value”, while the credit crunch will continue to restrain both mortgages and unsecured consumer borrowing.
Richard Lowe of Barclays said: “Hopes by many commentators at the beginning of 2008 were high that this crisis would be largely contained within the financial system. However, this was not the case with an uncertain economic outlook resulting in falling house prices, increased unemployment and a significant reduction in consumer confidence. The result has been consumers paying down debt and increasing their overall savings.”
Nick Bubb of Pali International added: “We face a systemic banking crisis and history shows that the economic recessions that these cause take over 4 years to resolve because Government monetary policy is so ineffective. This recession will be U-shaped, not V-shaped.”
It’s not all bad news through. The squeeze on consumers’ incomes from the rise in food and energy prices is now easing significantly with falling agricultural commodity prices pulling down food prices. Oil and petrol prices have plummeted (although they are rising again lately) and consumers should also benefit from utility price cuts later this year.
Meanwhile, the RTT noted that the response from policymakers to the recession has been far swifter and bolder than in the past. Interest rates worldwide are heading towards zero and the UK Government is introducing a range of policies to help the banking system. Vicky Redwood adds: “These measures should stop the current recession turning into a full-blown depression. But they will not prevent a substantial contraction of both consumer spending and the overall economy this year.”
…And the City
Following 2008, which saw the general retail sector stock market index fall by around 50%, 2009 began with a ray of hope: that the surprisingly strong High Street spending spree over the New Year shows that the Government’s attempts to slash mortgage rates and VAT are making some consumers better off and that the worst fears about the depth of the downturn may have been overdone.
Nick Bubb of Pali International comments: “Unfortunately, the light at the end of the tunnel simply seems to be a big train approaching and the New Year spending spree more of a ‘blip’, caused by an unusually helpful calendar and weather, rather than a new trend, which will be paid for by some very tough weeks to come.”
Bearing in mind the economic backdrop, non-food retail profits have a lot further to fall, particularly in the ‘big-ticket’ household goods sector, so it is “difficult to recommend the purchase of any general retail stock at this point”.
But the food retailers may be a different story and their premium stock market ratings will be underpinned by the safety and security that they provide investors, with food spending and supermarket freehold valuations holding up relatively well and food retail gross margins being under much less pressure than all the PR hype about price cutting would lead us to believe.
Nick Bubb added: “The big risk is that the benign level of food price inflation that the supermarkets enjoyed in 2008 will turn into price deflation but for food at least, this may turn out to be the dog that didn’t bark in 2009.”
Treating cash as king
The RTT agree that cash will be king more than ever and businesses will need to continue to manage this very closely through careful and consistent management of expenditure and working capital.
According to Helen Dickinson of KPMG: “Cash is now a top priority, yet many retailers are not very good at forecasting cash and most have a poor track record of bringing down working capital. With the squeeze on credit, this inability to accurately forecast cash will be a critical challenge for many. Also, my experience is that most businesses implement cost reduction programmes, as they are currently doing, only for costs to creep back over time. Retail is especially susceptible to this.”
Controlling cash flow and the supply chain will be of significant importance for the sector, with the management of currency volatility a key determinant of business profitability in 2009.
Retailers have, over recent years, been sourcing a larger amount of their stock from overseas, the result of which has been to introduce increased currency risk into their businesses. It is key that banks support their customers through the budget planning process so they can deliver on those all important budgeted exchange rates.
Richard Lowe said: “It is critical at this time for retailers to have a partnership approach with their bank, ensuring both are working very closely together.”
Adapting business strategy in a changing market
The RTT discussed how retailers’ strategies might change in the year ahead and agreed that we will see a swathe of re-financings for retailers needing to rebuild their balance sheets. There will be a number of high-profile distressed disposals, with opportunistic buying of businesses by those with the finance in place.
For the stronger brands in better financial shape investing in growth where possible will be the order of the day, as recession presents a great opportunity to take market share as the good get better and potentially bigger, whilst the weak will not survive.
Helen Dickinson said: “The winners will be those that do two things – relentlessly pursue their clear vision of who their customers are and what they want and have the flexibility to innovate and make changes to their business to respond to those changing customer needs.”
“Retailers may never be the same again,” added Tim Denison of Synovate. “Following top-to-bottom reviews of their businesses nothing will be left unquestioned nor remain sacrosanct. Carrying less stock and refreshing product offers more often will put new focus on buyer-supplier relationships. Liquidating slow-moving stock more quickly and frequently will become increasingly common practice. New emphasis may also be seen on local sourcing, bolstering range dynamism and variety, guarding against weak exchange rates and fulfilling green ambitions.”
Responding to the changing habits of consumers
According to Synovate, footfall is due to drop by 2.3% this year compared with 2008. Consumers were spooked by the crumbling of the banking system and will take time to recover their confidence, while job security and credit access will influence their desire and willingness to spend.
Predicting how shopping habits may change in the year ahead, Tim Denison said: “There may be fewer purchases and smaller basket sizes, but some will decide to shop and spend less often, so valuing trips more than they have done over the last decade. Their price knowledge will become more accurate and whereas buying on credit used to be de rigueur, we may now see a revival in the art of saving-up-to-afford-to-spend, something not seen for a generation.”
And it is not just in consumer attitudes and behaviours where noticeable changes may be seen. Shoppers’ expectation of more enjoyment from fewer experiences should trigger a paradigm shift in the industry with a potential re-birth of customer service excellence. With fewer people out shopping, store staff should take a more active interest in their customers: serving with a smile, priding themselves on excellent product knowledge and assuming responsibility for lifting conversion rates.
‘Me too’ is no longer good enough, meaning that retailers will need to recognise and exercise their source of competitive advantage, be it based on superior position, skills or resources.
And following unprecedented levels of discounting in 2008, cut price retailing is becoming the expected norm. Nick Bubb said: “Consumers will not buy Christmas gifts in November because they will remember all the discounting that took place ahead of Christmas last year.”
The global picture
The slowdown in the world economy will impact upon the way international activities of retailers develop in 2009. The slowdown will affect international sourcing volumes with a possible lowering of shipping rates and the investment that retailers are making in foreign markets.
Professor John Dawson of the Universities of Edinburgh & Stirling said: “UK retailers have been active in foreign markets with their store operations in both food and non-food sectors. The slowing of growth in consumer spending in emerging markets and likely declines in mature markets pose a strategic conundrum for these international retailers. Whilst opportunities will certainly still exist in emerging markets, should firms make investments with a long term view that these markets will return to strong growth or should attention be focused on making sure performance is solid in their UK operations?”
The RTT agrees that the answer may differ by sector and presence in emerging or mature markets. Emerging markets may continue to be attractive in the essential food sector but we may well see withdrawal by non-food retailers from both emerging and mature markets outside the UK. Any plans for new market entry, for example in India, may well now be put on hold with some non-food retailers even pulling out of India in response to a perceived over-investment in shopping malls.
Foreign retailer activity in the UK is also likely to differ by sector with likely continued expansion by non-UK discount food retailers and a re-thinking of operations, and certainly expansion by foreign clothing, electrical and other specialist retailers. But there is always the possibility that UK retailers will be seen as cheap acquisitions for a foreign retailer willing to invest for a longer term upturn.
Looking for property opportunities
Unlike the early 1990s, when a large amount of the shopping floorspace committed during the 1980s boom was delivered following the onset of recession, pipeline contraction this time around began to occur in the first half of 2007, well before any significant weakening in consumer spending growth set in. With completions now in freefall, UK shop property markets entered recession largely free of the sort of post-boom supply overhang burden present in the 1970s and 1990s downturns.
Mark Teale of CB Richard Ellis explained: “Stock shedding by distressed retailers will release some primary and good secondary stock. Some 4,000 units – equivalent to 0.5% of GB stock – has been predicted by some commentators, providing a rare opportunity for stronger players to selectively grab High Street market share, albeit bearing in mind there are over 2,700 chain retailers operating in Great Britain – so not as big an opportunity as it might at first sight appear. “
However, because the supply tap was turned-off relatively early on, the scope for non-food retailers to acquire high-productivity speculatively-built modern stock is likely to prove much more modest than in past recessions.
On the property value side, all-retail capital values have fallen 26.1% year-on-year. High street shops, shopping centres and retail warehouse capital values have fallen 22.9%, 26.3% and 27.7% respectively. The fall in open market rents seen over the last quarter 2008 is expected to continue into 2009.
As with lease periods and ‘upward-only’ rental reviews in the past, demand weakness is once again focusing attention on contractual terms. The long-run quarterly rental payment dispute has now come to the fore, but how prevalent contractual changes become, and what stock is affected, will depend upon the way demand trends over the next year or so impact on the relative strength of occupier and landlord negotiating positions.
Conclusion: 2009 – A brave new world for retail
The RTT’s deliberations concluded that 2009 is set to be a ‘brave new world’: an extraordinary year set against a unique economic backdrop where casualties will invariably capture the headlines. However, these casualties will not necessarily tell the whole story.
The year ahead will undoubtedly be challenging but the RTT points out that there are many winning retailers in the economy. As businesses have failed – and may continue to – there is much turnover to be won by their competitors in the sector, if they have the right strategy and proposition.
Whatever happens throughout 2009 though, the RTT agreed that the retail landscape will look very different in 12 months’ time.
Date Published: 2/2/2009 5:30 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
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.
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