Customer demand is finally back in positive territory, pressure on margins eases at last and costs continue to ease
The KPMG/Synovate Retail Think Tank (RTT) has unveiled its latest Retail Health Index (RHI) evaluation. The RTT, a group of leading industry figures, provided its regular non-partisan feedback on the retail sector’s health during its quarterly sitting, held on Tuesday 13th October in London. Quarter four represents the sixteenth quarter upon which it has deliberated since it was founded in February 2006, meaning that the metric now covers four years’ worth of data. The latest RHI scores cover both the quarter just ended, quarter three 2009, and its forecast for quarter four, the vital-for-retail Christmas quarter, 2009.
The RTT confirmed that the state of retail health in the UK in quarter three has now stabilised, as it had expected it would do this quarter, but it remains at its lowest level since the metric was launched. However the panel did see clear signs of improvement to the pressures on margins beginning to positively affect retail health towards the end of the quarter 3 and pointing the way to better health to come. After deteriorating for nine consecutive quarters, before levelling out, the panel was delighted to state that it expects that, at last, the state of retail health will improve in quarter four, albeit marginally. This is especially significant because it is just in time for the most vital trading period for retailers: Christmas. The RTT is anticipating that in quarter four, the RHI index will rise from 82 to 83 compared with the metric’s starting base of 100 in quarter one 2006.
Retail Health Index 2006 to date
The key points to emerge from the latest meeting, held on Tuesday 13th October, included:
- The RTT’s view back in July that the decline in retail health had bottomed out was confirmed. The panel was heartened that the data which they have access to showed a slow but steady improvement in retailers’ margins during the quarter. As a consequence, quarter three was very marginally better than expected, but not so much as to change the RHI score. Quarter three, along with the previous quarter, were therefore collectively the poorest state of health that the sector has seen since the RTT first met in April 2006. Pressures on margin had been the sole determinant of poor health in quarter three, with demand in neutral territory and costs under control.
- Whatever the results of its deliberations, the panel was at pains to make the distinction that what we are seeing is not the result of the ‘real’ economy and if we strip out actions of the Government such as the car scrappage scheme and quantitative easing we may well be seeing a very much bleaker retail situation. Nevertheless disposable incomes for many have improved in 2009 and along with them, confidence seemed to be returning, though serious concerns remain as to how long this will last.
- The panel also saw clear signs of a new gulf opening up between the ‘haves’ and the ‘have nots’ with two distinct styles of shopper behaviour beginning to develop and entrench. The ‘haves’, it seems, make fewer shopping trips and buy what they need with less desire to shop around except for reasons of fashion or brand. On the other hand, the ‘have nots’ are making a greater number of shopping trips, comparing prices and benefits and spending much more carefully.
- The previously identified trend of repaying borrowings rather than spending has now led some to feel that they are on top of personal debt and can extend their finances again, subject in many cases to reduced credit limits. Others are in far more tricky positions with regard to creditors, the fear of unemployment and actual unemployment. These concerns, as well as the attention of creditors for many, is holding back some spending.
- Large supermarket chains are beginning to reap the rewards of creating their own ‘discount store’ brands with foreign sounding or quirky names, many of which actually carry better margins for them than they can achieve from the well-established and heavily advertised third party brands. The promotional activity supermarkets have embarked on to promote these ranges as well as other high impact promotions involving discounted vehicle fuel or double loyalty card points have now begun to attract back formerly loyal customers who had briefly strayed into the discounters’ stores, and hands. Supermarket chains are also practising so-called ‘price engineering’ where pack sizes are reduced but prices largely maintained or increased less obviously.
- Larger retailers are continuing to manage their margins better than the small ones and able to accommodate changes better. In non food, retailers have passed on to consumers lower prices for some goods and prices in core goods are continuing to fall but albeit at a slower rate. With CPI inflation at its lowest level for 5 years, it is clear that retailers in some areas, particularly where demand remains sluggish, continue to absorb the price rises.
- The panel agreed that retail buying teams had adjusted their strategies well with their ‘restricted range’ buying policies and careful pricing. The falling value of the pound for goods sourced in dollars or euros continues to have some impact but retailers have had some success in negotiating with suppliers to offset the negative impact of the weakness of sterling and in many cases uplifts they have had to bear have been written into their pricing policies along with a buffer for when VAT rises in the new year. The panel predicts many retailers will hold prices at that time and are thus well placed to have a good Christmas and a good new year; a good result if they can pull it off.
- Members predicted that many retailers will run WIGIG (When It’s Gone, It’s Gone) campaigns leading up to Christmas to underscore their limited seasonal stock this year. In addition they will spread fear about the impending VAT increases, particularly for big ticket items. Consequently the RTT believes that this Christmas will not be like last, when subdued demand created large stock surpluses. If stock does run out this Christmas, retailers will simply bring forward their Spring ranges, in many cases.
- Voucher offers, mostly on-line and on social networking sites, so as to avoid ‘going to sale’ will be very evident leading up Christmas.
- While pressures on rents continue to help retailers, once again it’s a tale of two halves. Voids in the strongest shopping centres such as Bluewater, Metrocentre, Cribbs Causeway, Brent Cross and Meadowhall remain low but are much higher in some secondary shopping locations. Store sites made available by the demise of Zavvi and Woolworths in the best locations are now mostly let. The secondary and tertiary stock continues to be a headache for landlords and town councils alike and there is no doubt that fewer and fewer locations are attracting an ever larger proportion of shoppers (See RTT White Paper on the subject at: www.retailthinktank.co.uk).
- Looking forward to quarter four, a 5 to 2 majority of Members agreed that the state of retail health will be better than in quarter three. Retail health is forecast to rise by one point to an RHI value of 83 in quarter four, the same as in quarter one this year, when it was on the way down.
- Commenting on this trend the RTT said, “Everyone will welcome the fact that the deterioration in retail health has stopped for now and that we expect it to improve marginally in quarter four. This is very welcome news in the run-up to the key trading time of the year. If retailers can enjoy a regular Christmas, it will help steady the boat at the end of a very testing year.”
Detail of quarter four expectations
Demand
- The majority of RTT members agreed that the impact of demand on health will be positive in quarter four. This will be the first time demand has been positive since quarter one 2007.
- Many people have extra money to spend at the moment and this will find its way onto the high street in the next quarter and the boost from the Government’s fiscal policy will continue.
- Members agreed that those retailers which have survived the recession so far are in a very strong position to capitalise on the uplift in demand in order to have a good Christmas. It would appear that many retailers have also already made detailed plans for handling the expected VAT increase in January to 17.5% or even 20%, and if things work as planned trading should not be too negatively affected.
- The panel determined that the gap between food and non-food retailers was narrowing with the latter also now able to benefit from passing on moderate price increases.
Margins
- The RTT predicts that margins in quarter four will at last be in neutral territory meaning that now, not one of the three factors: demand, margins and costs, will be in negative territory and adversely affecting retail health. Retailers are planning for a Christmas with much tighter stock and inventory and where they will not have to sacrifice margin to the same extent as last year.
- However, it is expected that retailers will be running strong viral, guerrilla and word-of-mouth promotional campaigns in order to benefit fully from the anticipated up-kick in demand. As a consequence any discounting will be mostly unannounced in the sense of screaming ‘Sale’ banners and even where some retailers do go to ‘Sale’ early we should not expect heavy discounting or major bargains this Christmas. Discounted goods will likely be hard-to-shift or bought-in stock, only.
Costs
- Falling market rents have benefited retailers and will continue to have a positive impact on retail health in quarter four. Contractual rent increases are declining and are now often down to tiny percentages. Rate increases in the pipeline will however inevitably dilute any occupational cost savings on the rental side.
- Despite, or perhaps because of, the fact that many more young people are looking for jobs in retail, pay rises are slowing and one in four retail pay awards are freezes. Labour costs, will continue to be kept in check, helped by the minimal rise (1.2%) in the national minimum wage which came into effect on October 1st 2009 as follows:
- for workers aged 22 years or more: £5.80 up from £5.73 per hour
- for workers aged 18 to 21 inclusive: £4.83 per hour
- for workers aged under 18 (but above compulsory school age): £3.57 per hour
- Falling advertising costs will continue to help keep costs under control in quarter four.
- Rising fuel prices may have some effect in quarter four and some concern has been expressed about possible utility price changes.
Mark Teale, CB Richard Ellis, summarises the thoughts of the RTT: “The stronger than expected resilience of the retail sector that became apparent in sales figures earlier in the year, has been maintained. Volatility continues sector by sector, and region by region, albeit this volatility varies considerably by shopper demographic. Retailers ignore the widening gulf between ‘haves’ and ‘have nots’ at their peril. However, because we have been on a downward path for so long, some pent up demand is likely to be released in quarter four. All the usual family pressures look set to give a boost to spending at the end of the year.
“The impending VAT rise in January will give retailers an opportunity to push ‘buy now’ messages and have a positive impact on demand in the quarter. Margins will be better maintained, except where imperatives to beat competitors are paramount and stock levels will be tighter than last year so consumers should not expect a bargain-heavy Christmas. Those seeking a bargain-basement Christmas are likely to be disappointed. The few retailers likely to be panicked into full-on sales before Christmas are also likely to be those at highest risk of failing in the New Year.”
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:
Demand:
| Retail Sales Total retail sales across the quarter as measured by the BRC-KPMG Retail Sales Monitor actually rose by an average 3.7%, up from 3.4% in quarter two. Like-for-like sales rose 1.6% across the quarter; similar to growth of 1.7% seen in quarter two. Food and Drink continued to drive overall sales performance until September when non food sales outperformed food. The decline of 0.7% in quarter two in non food sales in total terms has reversed and non-food sales increased 3% in the quarter. |
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| Inflation The headline Consumer Price Index inflation measure has continued to fall to 1.1% in September, from 1.8% in June and remains well below its high of 5.2% in September 2008. Food prices were up 1.6% on September 2008 as measured within the CPI, down from 5.3% in June. However, the index of shop prices measured by the BRC-Neilson index reported a 0.1% fall in shop prices in September, with food prices up by 2.5% (well below the peak rise in food prices of 10% we saw in August 2008). The fall in shop prices in non-food has slowed reaching an annual rate of 1.4% in September (compared to a fall of 2.4% in December 2008), continuing to reflect the high levels of discounting on the High Street needed to drive demand. |
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| Consumer confidence The GFK composite consumer confidence index has improved further to -16 in September from -30 in March. Although on the face of it this shows an improvement in outlook, it most likely reflects recognition that prospects will not be quite as gloomy as first thought rather than renewed optimism about the future. |
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| Borrowings/Savings Unsecured borrowings, excluding borrowing on credit cards, is now falling year on year, showing a completely different trend to the historic long run average of 11% growth. The level of unsecured debt at around 26% of income remain high (although it has fallen far from its peak of 29%) and the serviceability of households’ overall debt measured through mortgage and unsecured interest payments as a percentage of income has continued to fall from its peak of 8.7% in the third quarter of 2007, to just 0.6% in quarter two (sources: Bank of England, National Statistics and Capital Economics). With interest rates now at historically low levels, disposal incomes are up on a year ago. However, much of this additional disposable income is being diverted into savings or reducing credit card debt rather than the spending, with the saving rate at 5.6% of income in quarter two, up from 3.9% in quarter one – it is now edging closer to the long term average of 7.3%. |
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| House prices The decline in house price has continued to slow and prices were flat on a year earlier in September, significantly better than the annual rate of decline at February of 17.6% which was the largest drop in the history of the series (source: Nationwide). Mortgage approvals fell to 52,300 in August, a 63.3% increase 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. |
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Unemployment
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Margins
| Exchange rates The pound weakened slightly against the $ and euro ending the quarter at approximately $1.59 and €1.09 respectively. This compares to average rates of $1.89 and €1.26 to the £ in the same quarter of 2008, making imports denominated in those currencies 13% to 16% more expensive than at this time last year. The impact of sterling’s ongoing weakness will impact clothing retailers most significantly, and the exposure to this is increasing as hedging contracts unwind over the coming months. |
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| Producer price inflation Inflation in producer prices (‘PPI’: the prices that retailers pay to manufacturers – source ONS) rose towards the end of the quarter, reaching an annual rate of 0.4% in September. But this was still below the high of 10% in July 2008 and was below the long run trend rate of approximately +2.6%. Food PPI inflation has fallen to 1.3%, down from 3.0% in June. |
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Producer price inflation – non food
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Costs
Rent
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| Utilities Annual gas and electricity price inflation rates have also continued to fall with annual price rises of 8.6% and 4.8% respectively in the quarter, compared to 23.5% (gas) and 7.6% (electricity) in the second quarter. We expect this downward trend to continue as significant price increases in 2008 annualise. The oil price crept back up to $75p.b at its high point during quarter three, from $68 at the end of June but remains well down from $140 p.b at the end of June 2008. It ended Q3 some 30% lower than at the same time last year. |
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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 3.8% including bonuses, above the 1.6% 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.
- 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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