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Retail Think Tank

Retail Think Tank says decline in retail health is beginning to ‘bottom out’

Margin pressure is now the leading cause of the continuing fall in retail health though customer demand is also still in decline but costs are now largely under control

The KPMG/Synovate Retail Think Tank (RTT) has unveiled its latest Retail Health Index (RHI).  The RTT is a group of leading industry figures which provides a non-partisan guide to retail sector health ratings, based on the Members’ review of a comprehensive industry database (see below for examples). The ratings reflect both the quarter just ended, quarter 1 2009, and its forecast for quarter two 2009 following discussion during its quarterly sitting, held on Wednesday 15th April.

The chart below tracks the change in retail health quarter-on-quarter and shows that to the end of quarter one 2009 the state of health of UK retail, whilst still declining, was now declining at a slower rate.  However, the state of retail health did deteriorate for the eighth quarter running, dropping to 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 Wednesday 15th April, included:

  • Looking back across quarter one, the RTT concluded that while the overall state of retail health had slipped further , the decline was less steep than the panel had expected it would be in quarter one when it made its forecast back in November. Although this still represents the poorest state of health that the sector has seen since the RTT first sat in April 2006, the members of the RTT judged that the rate of decline was slowing and beginning to ‘bottom out’. Weak demand once again was the key determinant of the deterioration in health in quarter one. However, while still weak, demand was better than many had expected and better than that that seen in quarter four, reflecting the higher disposable incomes of many consumers, as mortgage costs and CPI inflation continue to fall.
  • Heavy discounting to stimulate demand, the maturity of existing exchange rate hedging and the falling value of the pound for goods sourced in dollars or euros, along with the reluctance of non-food retailers to pass on increased costs, all contributed to a further negative impact on health of margins. However, the RTT agreed that once again the impact on health of costs was positive in quarter one as retailers continued to benefit from reduced pressure on rents, stabilising energy costs, staff rationalisation programmes, a new anti-bonus/anti-sales-commission culture and other cost-cutting measures.
  • Members also noted the beneficial impact for some chain retailers of the capacity shakeout caused by the demise of certain retailers such as Woolworth’s and Zavvi.
  • Looking forward to quarter two, Members agreed that there were clear signs that the falling state of retail health was beginning to ‘bottom out’. Nevertheless the RTT was at pains to point out that this does not yet mean an end to the decline in retail health which they consider will continue to fall in quarter two by a further three points to an RHI value of 80.
  • Commenting on this trend the RTT said, “Thankfully we can now begin to see a slowing in the rate of the decline in retail health. Although demand will continue to suffer it seems that falling margins caused to an extent by global supply factors well outside most retailers’ control will begin to have a greater effect in quarter two. Psychologically, consumer confidence is still very fragile.”

Detail of quarter two expectations

  • RTT members agreed unanimously that demand will remain weak in quarter two, although most were considerably less pessimistic than three months’ ago. Disposable incomes are now considerably higher than a year ago for many consumers. However, the need to repay borrowings, save for a ‘rainy day’, and both the fear of unemployment and actual unemployment are holding back spending. It’s a fragile balancing act between these two forces as we look forward to the next quarter and rest of the year.
  • The panel acknowledged that there were significant differences between food and non-food retailers, with the former continuing to benefit from the ability to pass on food price increases. One member was particularly scathing of the current rash of price-cut TV commercials which failed to paint a realistic picture of price increases in basic foods, especially imported goods.
  • The RTT predicts that it will be in quarter two when margins overtake demand as the largest negative driver of the deterioration in retail health. Looking forward, the panel anticipated a widening and deepening of the public’s ‘haggling mentality’, where paying full price will more often become the exception instead of the rule in many non-food sectors, even for those more staid retailers which have established themselves for at least a generation as ‘no-haggling’ zones. The worm and the world have both turned, it seems.
  • The panel agreed that the obvious and somewhat less than exciting effects of the earlier 2.5% VAT drop have now all but disappeared and many of those retailers which were briefly ‘playing ball’ with the Chancellor and public expectation by reducing goods formerly priced at, say, £299 to a less eye catching £292.64 have now reverted to their former pricing policies. Whether these policies reflect true VAT savings is somewhat debatable, with the unchanged pricing policies of certain pound and ninety nine pence shops being of particular note!
  • Retailers are continuing to reduce stock levels, particularly in non-food, and the ability to manage stock and predict sales is improving for many, consequently reducing their exposure to the need for expensive-to-margin sales and promotions.
  • However, neither of the above factors will be enough to offset the effect on margins of higher goods input costs which are expected to rise again. Opportunities to pass them on to consumers will be severely limited. Also, with some retailers’ hedging arrangements beginning to expire, and more expiring as we head into summer and autumn along with the ongoing weakness of the pound against the Euro and Dollar, the downward pressure on margins will intensify.
  • In quarter two for the second quarter running, the only driver to have a positive impact on the health of retail is costs. However the RTT determined that more benefit was gained by retailers in quarter one than will now be seen in quarter two. The members were impressed with the speed and efficiency with which several leading retailers had reduced costs wherever practicable and with the fact that many are already seeing the benefits. However, having cut staff at head offices, distribution centres and at store level; built more flexible staffing systems; reviewed pension arrangements; cut marketing budgets; and further squeezed suppliers it may be that retailers’ cost-cutting options are about to become a good deal more limited.  Even the falling open market rents options are becoming played out.

Richard Lowe, Barclays Retail & Wholesale Sectors summarises the thoughts of the RTT: “In quarter one the impact of demand on retail health was the key downwards driver with margins coming a close second. However costs were brought firmly under control providing a slight fillip to most retailers’ bottom lines. Overall it seems that as hard as retailers fight on one front, say costs, pressures from elsewhere chip away at overall profitability. Although, having said that, once again food retailers are much better placed than non-food retailers. Looking forward to quarter two we see that the opportunities for retailers to continue the good work on costs will become harder to find, demand will remain weak but margins will be hurt worst of all – and largely by factors outside most retailers’ control. If there is good news, and there is some, it is that the decline in the health of retail is slowing and the bottom of the downturn may be in sight. However we all expect that the journey along the bottom of the U-shaped slump will be extremely bouncy and rough even for those retailers insulated to some extent by their food offers.”

The RTT panellists rely on their impressive depth of personal experience, sector knowledge and also considered the following:

Demand:

Retail Sales
Total retail sales across the quarter as measured by the BRC-KPMG Retail Sales Monitor actually rose by an average 1.2%, up from a 0.6% decline in quarter four. The fall in like-for-like sales was 0.7% across the quarter, an improved rate of decline compared to the 2.7% drop seen in quarter four. Like-for-like sales have been lower than a year ago in nine of the past ten months. Food and Drink remains the only sector to show sales up on a year ago increasing at 4.7% on a like-for-like basis across the quarter. The rate of decline in non food slowed from 7.3% in quarter four to 4.3% in quarter one.
Inflation
The headline Consumer Price Index inflation measure increased marginally to 3.2% in February, up from 3.1% in December and still well below its high of 5.2% in September. Food prices were up 11.4% on February 2008 as measured within the CPI. However, the index of shop prices measured by the BRC-Neilson index reported a 2% rise in shop prices in March, with food prices up by 9% (coming close to the peak rise in food prices of 10% we saw in August 2008). Shop prices in non-food have continued to fall but at a lower annual rate of 1.5% (compared to a fall of 2.4% in December), continuing to reflect the unprecedented levels of discounting on the High Street as well as the reduction in VAT.
Consumer confidence
The GFK composite consumer confidence index remains in the -30s but has improved to -30 in March from -37 in January.  Although on the face of it this shows an improvement in outlook, people’s expectations remain well below the trough seen in the early 1990’s, primarily due to concerns about job prospects.
Borrowings
The rate of year on year growth of unsecured borrowings, excluding borrowing on credit cards, continues to slow – it is now well below 5% and growth remains well below the long run average of 12%.  Although the levels of unsecured debt at around 24% of income remain high, the serviceability of households’ overall debt measured through mortgage and unsecured interest and payments as a percentage of income has continued to fall from its peak of over 8% in the first quarter of 2007, to 3.5% in quarter four (sources: Bank of England, National Statistics and Capital Economics).  With interest rates now at a historically low level, lenders are finally passing on some of this benefit to their customers.  However, much of this additional spending capacity is being diverted into savings rather than the spending, with the saving rate at 4.8% of income in quarter four, up from 1.7% in quarter three – but this is still well below the long term average of 6.5%.
House prices
House prices have fallen by 15.8% over the year to March, marginally better than the annual rate of decline at December of 16% which was the largest drop in the history of the series (source: Nationwide).  Mortgage approvals increased to 38,000 in March, but this is still a 44% decrease on a year earlier. From the peak in property values in summer 2007, expectations of 20-30% price falls over the period to end of 2009, early 2010 are now the norm.
Unemployment
Levels of unemployment have continued to increase over the quarter.  UK unemployment rose by 165,000 to 2.0 million between October and January, the highest total since July 1997.  The number of people claiming jobseekers allowance increased by 138,000 to 1.4 million in February, according to the Office of National Statistics.  Economic prospects and recent announcements point to a continuation in this trend over the coming months with 3 million expected to be unemployed by the end of 2009. The RTT believes that the fear of unemployment, irrespective of actual unemployment levels, is one of the most significant factors likely to have a detrimental impact on demand going forward.

Margins

Exchange rates
The pound steadied against the $ and Euro ending the quarter at approximately $1.43 and €1.08 respectively.  This compares to average rates of $1.98 for the £ and €1.32 to the £ in the same quarter of 2008, making imports denominated in those currencies 22% to 39% more expensive than at this time last year.  The impact of sterling’s weakness will impact clothing retailers most significantly, and the exposure to this is likely to increase as hedging contracts unwind over the coming months.
Producer price inflation
Producer price inflation (‘PPI’: the prices that retailers pay to manufacturers – source ONS) fell to 2.0% in February, continuing the downward trend from the high 10% in July 2008 and now below the long run trend rate of approximately 2.5%.  Food PPI inflation has fallen to 6.3%, down from 7.9% in December.
Producer price inflation – non food
Output prices for non-food have also continued to fall to 3.3% in March from 5.0% in December.  However, inflation in the prices that retailers pay for goods remains above the changes in shop prices – non food shop prices are actually falling – again highlighting the detrimental impact on margins.

Costs

Rent

Based on CBRE’s monthly index, retail markets rents across all retail are now falling when compared to a year earlier, for the first time since the early 1990’s. Standard shop rents were also down, but warehouse rents are seeing the highest falls.
Utilities
Annual gas and electricity price inflation rose to 33% and 18% respectively in the quarter, compared to 50.6% (gas) and 31.4% (electricity) at the end of quarter four. We expect this downward trend to continue as significant price increases in 2008 annualise. The oil price crept back up to $47 p.b from $36 at the end of December but remains well down from $140 p.b at the end of June 2008 and some 56% lower than at the same time last year.
People costs
There are no current statistics available for retail average earnings – the latest figures from Thomson Datastream for January show an annual change of 2.0% including bonuses, above the -0.2% rate for the overall economy.  A number of retailers continue to announce job cuts in order to control people costs while the top line remains under pressure.

 

 

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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