Fall in Customer Demand Will Hurt Retailing in Quarter Four
The KPMG/SPSL Retail Think Tank (RTT) – the group of leading industry figures which provides a non-partisan guide to retail sector health – has unveiled its latest Retail Health Index (RHI) ratings for the quarter just ended (quarter three) and its forecast for the next quarter (quarter four). The ratings are based on the Members’ review of a comprehensive industry database and their discussion during its quarterly sitting, held on 14th October.
The output chart below tracks the change in retail health quarter-on-quarter and shows that the health of UK retail has slipped for the seventh quarter running and is now at its lowest level since the group first met in early 2006. The base period for the metric (when the index value equals 100) is quarter one 2006.
Retail Health Index 2006 to date
The key points to emerge from the latest meeting, held on October 14th 2008, included:
- Looking back, the overall state of health slipped a further three index points to 92 in quarter three, doing slightly better (by one index point) than the panel had predicted three months ago. In effect this meant that the decline in retail health continued at the same rate in quarters two and three, rather than deteriorating any quicker as the RTT had feared in July. As the chart shows, this still represents the poorest state of health that the sector has been in since the RTT first sat in April 2006. However, for the fourth quarter running all three key drivers (demand, margin and costs) contributed negatively to retail health, despite retailers fighting hard to survive and prosper through the long dog days, and extended Sale campaigns, of summer.
- Looking forward to quarter four, Members agreed that the outlook looked less favourable, issuing its most pessimistic set of retail health predictions yet. It believes that the state of retail health will deteriorate in the next quarter (quarter four) to an RHI value of 86, representing an accelerating rate of decline over quarter three. Commenting on this trend the RTT said, “Despite the encouragement that quarter three was not quite as bad as we had feared, retail, like other sectors, is in difficulties and most significantly the anticipated further fall in customer demand will hurt retail in quarter four. Depending on what happens to inflation, which looks likely to ease, we are possibly looking at year on year falls in the value of total sales.
- The RTT believes that the recent stock market and banking collapse has clearly affected the real world of jobs and consumer spending and shaken financial security, despite the likelihood of more interest rate cuts.
- Although the RTT blames the projected worsening rate of decline in health most specifically on a further deterioration in demand and margins, the RTT is at pains to point out that it is not all bad news; it believes costs have now stabilised and retailers will benefit from a slight relief on the costs front in quarter four.
- RTT members agreed unanimously that demand will weaken considerably in quarter four, although some are more pessimistic than others. The panel still sees a split between the fortunes of food and non-food retailers with non-food retailers feeling the brunt of weakening demand. However, the panel is in no doubt that the quarter ahead will be tough even for food retailers as volumes will continue on a downward trend. The RTT feels that with the latest unemployment figures showing some 1.7 million out of work, a rise of 164,000 in the three months to August, the biggest rise for seventeen years, fear of unemployment will further hit consumer confidence and levels of demand.
- Retailers will suffer even more heavily than in Q3 from declining margins. Last quarter the panel believed many retailers did not needlessly sacrifice margins to stimulate demand and judged it well. However, the fear is that they may now have reached the limit of how far they can push suppliers and still attract customers at prices that protect margins. The RTT believes that non-food retailers, in particular, will have to be more aggressive on price and that the road towards quarter one next year is already red-lit. Last year’s voucher promotions, e-mail campaigns, one-day sales and other, yet to be announced, incentives to buy, are likely to be tactics that are out in force early as we head towards Christmas. The panel also predicts that Christmas 2008 will be a return to basics, becoming more about children than adults, with adults likely to defer buying presents for each other until the Sales.
- Inflation, increased staff costs and lay-offs in China will very likely affect the prices that retailers will pay for the goods sourced there, as will the maturity of more favourable currency hedge deals with the pound continuing to be weak against the Euro and to a lesser extent, the Dollar.
- Amidst the gloom, though, there is some light for retailers. The RTT expects the growth in, and negative impact on health of, costs will begin to decline in quarter four. The reduction in the price of oil, the renegotiating of many quarterly rent demands to more favourable monthly ones, mainly for new premises, and falling rent inflation as well as an additional 1.5 million square feet of retail space joining the market in quarter three/four will all contribute to a lessening of the effects of costs.
- The RTT notes the impact of rising labour costs have now been absorbed although the exodus of many thousands of foreign EU workers back to whence they came may still hold some challenges to retailers’ costs. The panel still feels that better training of staff is, in difficult trading conditions, more important than ever and noted that due to expansion even the leaders in this arena may have been tempted to skip or rationalise their normally stringent training regimes. Such actions, the panel cautions, are likely to be extremely counter productive. The RTT also warns that it is at head office rather than store level that the main threat to jobs exists.
Professor John Dawson of Universities of Edinburgh and Stirling summarises the thoughts of the RTT: “It’s important to state that despite the somewhat negative predictions, we are not harbingers of doom. Yes, some smaller, weaker, just plain unlucky or poorly financed retailers will fail in the coming weeks and months. However, those wily retailers who constantly monitor and modify their entire operations, both online and in store, will come out of this difficult period fitter and stronger. Quarter four will definitely be the quarter where consumers will make or break retail businesses trading through a steepening downturn and those that fail will not only ensure radical changes to our high streets, but leave fallow clearings in the retail forests where new ideas, new products and new retail gurus will flourish.”
The RTT panellists rely on their impressive depth of personal experience and sector knowledge and also considered the following:
Demand:
| Retail Sales The average growth in total retail sales across the quarter as measured by the BRC-KPMG Retail Sales Monitor was 1.4%, down from 2.5% in quarter two. However, like-for-like sales fell by 1.1% across the quarter and have been lower than a year ago in six of the past seven months. Food and drink remains the only sector to show sales significantly up on a year ago. Clothing and footwear remain poor and furniture and homewares are well down. |
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| Inflation The headline Consumer Price Index inflation measure rose to 5.2% in September, the highest since the series began in 1997. Food and electricity and gas were the largest contributors. Food prices were up 12.7% on September 2007 as measured within the CPI. However, the index of shop prices measured by the BRC-Neilson index reported a 3.6% rise in September, with food prices up by 9.1%. This highlights that although there is considerable debate about the true rate of inflation hitting consumers’ pockets, it remains the driver behind any growth seen in total sales. Going forward, we see the impact of inflation beginning to ease. |
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| Consumer confidence The GFK composite consumer confidence index improved to -32 in September from -36 in August. Although on the face of it this shows an improvement in outlook, this survey was undertaken up to the middle of September when the financial crisis really took hold so will not incorporate any changes in expectations as events have unfolded. GfK undertook an additional survey later on in September, which showed confidence unchanged at -36. People’s expectations are now well below the trough seen in the early 1990’s. |
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| Borrowings Year on year growth of unsecured borrowings has risen in the last quarter by 6.8% and remains well below the long run average growth of 12%. However, the serviceability of households’ overall debt debt measured through mortgage and unsecured interest and principal debt payments as a percentage of income remains at over 20%, the highest since data began in 1987 (sources: Bank of England and National Statistics and Capital Economcis). The 0.5% interest rate cut is a welcome boost. But not all lenders have reduced standard variable rates by the full 0.5%. And it will take time for lower mortgage payments to feed through into spending anyway. |
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| House prices House prices have fallen by 12.4% over the year to September, the largest annual rate in the history of the series. (source: Nationwide). Mortgage approvals fell to 32,000 in August, a 70% decrease on a year earlier. From the peak in property values in summer 2007, expectations of 20-30% price falls over the period to the end of 2009, early 2010 are now the norm. |
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| House prices House prices have fallen by 12.4% over the year to September, the largest annual rate in the history of the series. (source: Nationwide). Mortgage approvals fell to 32,000 in August, a 70% decrease on a year earlier. From the peak in property values in summer 2007, expectations of 20-30% price falls over the period to the end of 2009, early 2010 are now the norm. |
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| Unemployment Levels of unemployment have started to creep up over the quarter and are expected to rise significantly as the impact of the global financial crisis hits the real economy. The RTT believes that the fear of unemployment, irrespective of actual unemployment levels, is one of the most significantly factors likely to have a detrimental impact on demand going forward. |
Margins
| Exchange rates
Over the quarter the $ and Euro strengthened against the £ and ended the quarter at approximately $1.78 and €1.27 respectively. This compares to average rates over $2 for the £ and €1.48 to the £ in the same quarter of 2007. The impact of sterling’s appreciation will impact clothing retailers most significantly although many will have covered this exposure in the immediate term. |
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| Producer price inflation Producer price inflation (‘PPI: the prices that retailers pay to manufactures – source ONS) fell to 8.5% in September down from 10% at the end of the previous quarter but still well above the long run trend rate of approximately 2.5%. For Food, PPI inflation has broadly stabilised at around 13.5% in the past two months, and should soon start to drop as the fall in commodity prices feeds through. It therefore appears that we are past the worst and the challenges around needing to pass on price increases while remaining competitive will begin to alleviate. |
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| Producer price inflation – non food Output prices for non-food have also fallen slightly to 5.4% from 6.7% in June which was the highest since 1982. However, inflation in the prices that retailers pay for goods remains higher than the increase in shop prices, again highlighting the detrimental impact on margins. |
Costs
| Rent Retail rents broadly stagnated across the quarter compared to a year earlier based on CBRE’s monthly index. This is down from the annual rate of 1.5% for quarter 2. |
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| Utilities Annual gas and electricity price inflation rose to 30%and 20% respectively in the quarter, up from 17% (electricity) and 10% (gas) in quarter 2. However, the oil price of $93 at the end of September is down from $140p.b at the end of June (although it remains 16% higher than at the end of September 2007). |
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| People costs There are no current statistics available for retail average earnings – the latest figures from Thomson Datastream for August show an annual change of 3% including bonuses, slightly below the 3.2% rate for the overall economy. Therefore people-costs will be lower down the agenda of critical issues than it was last year. |
Date Published: 12/1/2008 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.
- 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
- 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
- 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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