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Retail Think Tank

Retail growth will stagnate overall in 2017, warns KPMG/Ipsos Retail Think Tank

Very limited retail growth in 2017, as any growth in non-discretionary retail will be clawed back by a decline in discretionary spend

• On average 5 – 8% increase in retail prices in 2017, albeit varying across categories of retail

• In light of increasing commercial headwinds, more retailers will leverage technology, consider multichannel or restructure

December 2016

 

Political uncertainty fuelled by Brexit, events in Europe and a new US President, mean retail growth in Britain will stagnate in 2017 according to the KPMG/Ipsos Retail Think Tank (RTT).

The RTT members predict that in the current political environment and with UK consumer price inflation set to rise to 2.5 – 3% next year, any growth in non-discretionary retail – including food and grocery – will be offset by a decline in discretionary spend, resulting in an overall retail growth figure of 0.5% in the year.

RTT co chairman and UK Head of Retail at KPMG, Paul Martin, said: “From a macroeconomic perspective, 2016 was a positive year with the UK delivering what is set to be an impressive 2.1% growth in GDP. However, the year is not likely to be remembered for this fact but rather the UK’s decision to leave the EU; the election of the new President of the United States, and the repercussions these events may entail for the years to come.”

Indeed, “you could argue that the ‘Great British’ consumer has broadly ignored the results of the Brexit referendum, with consumer spending continuing to grow over the final months of the year”, he added.

James Knightley, Senior UK Economist at ING, said: “The strength of the economy following the Brexit referendum has surprised many, but we must remember that Article 50 is still to be triggered. Scheduled to happen before the end of March, it will coincide with Dutch elections and possibly Italian elections, whilst French Presidential election campaigning will be in full swing.”

With the coming year awash with political uncertainty, Jonathan De Mello, Head of Retail Consultancy at Harper Dennis Hobbs said the outlook for 2017 could be summarised as one of concern.

Rising consumer price inflation, increased costs to retailers, diminishing consumer and business confidence, as well as political uncertainty, were among some of the central themes worrying the RTT members most. Dr Tim Denison, Director of Retail Intelligence at Ipsos Retail Performance, highlighted that these will add: “…to considerable challenges already in train for the next year from the National Living Wage programme and the revisions to business rates.”

However, it was not all ‘doom and gloom’. Whilst sharing the RTT’s concerns, Martin Hayward, Founder of Hayward Strategy and Futures, stressed that: “The sky didn’t fall down in 2016, and it won’t in 2017.”

Meanwhile, Martin Newman, CEO at Practicology, added that: “The industry will undoubtedly have a tough ride next year but if retailers can be agile to respond, then there are opportunities to ensure that they at least survive, if not thrive.”

The impact of the changing geo-political landscape on UK retail:

The RTT members all recognised the vital role the political landscape in the UK and across Europe will play in shaping the health of the UK retail sector in 2017. James Sawley, Head of Retail & Leisure at HSBC, said: “With global interest rates at record lows and quantitative easing masking the traditional market signals, politics is the new economics in its ability to influence foreign exchange rates.” Meanwhile, Dr Tim Denison, suggested that: “politics had finally caught up with retailing” in the way in which shoppers and voters are both pushing against the establishment.

“For years now, shoppers have been voting with their feet, punishing the ‘safe and established’ retailers that became disconnected from their customer, bringing them to their knees or, worse, sending them to the cemetery. In 2016, the same thing happened in mainstream politics: politicians experienced first-hand the damage that public disillusionment can inflict on the establishment”, Denison added.

Maureen Hinton at Verdict Retail, provided some explanation as to the factors at play: “Retail expenditure will be stronger in 2017 than in 2016, but not because of increased consumer demand but because of price inflation. The higher price of imported goods following the EU referendum, and the fall in the UK pound, has been masked by currency hedging in 2016, but this starts to unravel in Q2 2017 and all retailers, struggling with cost inflation and squeezed margins, will be forced into passing on price rises to the consumer.”

James Knightley of ING explained further: “Despite the current period of relative calm ahead of Article 50 being triggered, businesses are wary. Surveys from the Bank of England and others are pointing to a sharp slowdown in both hiring and investment spending over the next twelve months. This is largely due to the perceptions that uncertainty will increase once the Brexit countdown clock begins. An intensification of UK-EU hostilities could result in more businesses sitting on their hands… and this may feed through into weaker consumer confidence.”

The RTT members all noted that up until now UK shoppers have pretty relaxed about the results of the Brexit referendum, with consumer spending on the rise over the final months of 2016. However, this may change as Brexit negotiations, and the changing political landscape across Europe, crystallise.

The impact of rising prices and wavering consumer confidence: 

As Mike Watkins, Head of Retailer and Business Insight at Nielsen UK, pointed out, 2016 marked “…another year of unpredictable retail growth and falling prices…and the winner has again been the shopper.”

Whilst consumers have benefited from deflated prices, Paul Martin of KPMG stressed that: “…we will see inflation rise, potentially up to 3% by the end of the year and in conjunction with continued foreign exchange fluctuations, prices will rise.” In fact, his conservative view was that this could amount to a 5-8% increase in prices over the course of 2017 – albeit varying across retail categories. This raises questions regarding how much of this increase would be absorbed by the supplier base, the retailer and the customer.

Retail margins have been squeezed for some time, not least of all with further pressure coming in the form of the National Living Wage programme and revisions to business rates due in the coming year.  Combined with less favourable exchange rates that have resulted in increased costs for retailers, it is inevitable that shoppers will need to absorb some of this pressure in the form of increased prices.

In anticipation of higher pricing next year, the home related and technology sectors might see purchases of big ticket items brought forward to the final quarter of 2016 as a result.

Maureen Hinton warned that: “…the main inflationary impact will be in food and grocery which accounts for 45% of all retail spend.” She also pointed to Verdict’s forecast that inflation in food and grocery will average 2.4% over the year – the highest since 2013 and highest in any sector.

An increased spend in this non-discretionary area is likely to be a drag on spending elsewhere. However, ongoing competition amongst the big players in the food and grocery sector will dampen potential price inflation.

Making reference to the ongoing price deflation experienced by the grocery sector, Nick Bubb, Retail Consultant, said: “The return of some modest food price inflation is not a bad scenario for the sector, assuming that it does not impact on volumes, so 2017 could well be a better year for the major players in food retailing.”

Perhaps acting as a silver lining for retailers, given rising costs elsewhere, a potential reduction in retail rents next year could ease some of the pressure on retailers in the coming year. Jonathan De Mello stressed that: “It is almost impossible to see how landlords can justify an upward only rent review in the context of the potentially substantial amount of retail business failures we could witness post-Christmas.”

In the context of consumer and business confidence, Martin Newman pointed out that following the outcome of the EU referendum, retailers have been putting capital expenditure decisions on hold. Meanwhile James Knightley added that: “a more cautious stance by British business may feed through into weaker consumer confidence”.

“Whilst consumer price inflation is set to rise, wages are unlikely to respond [and] job insecurity could become more of an issue at a time when rising inflation will squeeze household income”, James Knightley added.

Against a backdrop of higher prices in the wake of inflation, Maureen Hinton suggested that “… consumers will be ever more careful with their spending”, which for retailers will result in lower sales volumes and a need for retailers to be even more competitive.

How will the retail sector react?

As stressed by the think tank, next year will bring several reasons for optimism as well as driving a spirit of enterprise. In fact many participants earmarked the upcoming challenges of 2017 as an opportunity for retailers to be more agile in the ever-changing external environment. The key, according to Paul Martin, is to focus on “controlling the controllable.”

“For retailers, this means an on-going focus on transforming their businesses in light of the structural issues they are facing – embracing new technologies, becoming truly channel agnostic and placing their customer at the heart of their organisations”, Paul Martin added.

Tim Denison said: “The consumer-led digital revolution has brought about massive change to the retail world in the last few years. Technological innovation is now a core strand of business strategy in the retailer’s books [however], it come as at cost, as not all new technologies are winners.” He and the other RTT members stressed that the acid test in exploring new technologies is whether the value they add justifies the investment. This is particularly pertinent given that 2017 will see some technologies fall by the wayside.

Retailers can also leverage new technologies in their efforts to confront the challenges of the upcoming year. James Sawley suggested that: “As costs are set to rise in 2017, UK retailers will be identifying areas where operations can be streamlined, renegotiating with suppliers and investing in new technologies which can provided longer term cost-saving benefits.”

Focusing on the grocery sector, Mike Watkins flagged that: “The supermarket industry in particular has embraced simplification and cost savings but with notable exceptions, real innovation has been left for another day.”

Becoming truly channel agnostic will help retailers to overcome next year’s hurdles. Martin Newman said that growth of online retail was one of the ‘few bright sparks’ for the retail industry during the last recession but questioned whether it would save the day once again. He also suggested that “multichannel retailers will be looking much more at their cost of sale and the role of the store as the percentage of sales transactions completed online continues to grow.”

Retailing has become more complex given today’s variety of shopping channels. “Smarter and simpler retail is the future and we can expect leading players to adopt this thinking as a focus for some of their energy in the year to come”, said Tim Denison. Meanwhile, Mike Watkins reinforced this focus on multichannel, suggesting that: “There is no need to build new stores but instead build brand equity and ‘go digital’ before the technology titans transform how we shop.”

Structural changes are another area for consideration by retailers according to Paul Martin, however many of the RTT members suggested that this was perhaps harder now than it had been in previous years. Martin Newman, explained that: “There is much less fat to cut. There’s little low-hanging fruit with existing multichannel operations models, but it could be quite a different story if retailers are prepared to more fundamentally change how they do business”.

In an environment where competing on price is no longer enough to differentiate, the RTT pointed to an increased focus on customer engagement and experience as a means to ensure survival in the coming year. Martin Hayward suggested that: “2017 will be a great time for retailers to rediscover customer engagement. Yes, price and efficiency are important, but now always at the expense of human interaction, trained staff, provenance and an enjoyable experience.”

The mergers and acquisitions market could see more activity in 2017 according to some of the members. James Sawley said that: “M&A will continue to play its role in achieving scale, differentiation and diversification as we trade through the challenging period.” He also suggested that consolidation with the leisure sector is an expected trend, as retail spend increasing becomes cannibalised by spend on leisure activities.

The UK retail sector was also flagged as a rich hunting ground for foreign buyers, especially given the weaker sterling and its impact on valuations. The RTT noted that while inbound acquisitions fell in 2016 – following a particularly active year in 2015 – next year could see strong appetite in the UK retail sector from a variety of countries, including the United States.

Following the theme of globalisation, Martin Newman also pointed to international e-commerce, highlighting that: “strong UK brands have already been successful selling into the USA. Chinese consumers are accessible via marketplaces with the right support… [and] the Middle East is ripe for fast e-commerce growth… [as a] region where western brands are highly desired.”

Overall outlook for 2017:

Overall, the RTT believes that 2017 will undoubtedly mark a challenging year for retailers, political uncertainty, consumer price inflation, increased costs, wavering consumer confidence and demand proving considerable hurdles. “It will be the year when business models, balance sheets and nerves will be really tested”, said James Sawley.

Adapting to the new retail landscape that lies ahead will be vital for retailers looking to survive, or better yet thrive. Leveraging new technologies, exploring multichannel and undergoing structural change will all aid in the quest to be more agile.

Moreover, as retail prices rise in line with inflation, the new differentiator will be radical profit optimisation, transformation, customer engagement and innovation. “We may not see a retail revolution next year but we will certainly see the foundations for a new retail landscape,” Mike Watkins concluded.

 

Part II: In detail – Individual views of the KPMG/Ipsos Retail Think Tank members 

James Knightley, Senior UK Economist – ING

The strength of the economy following the Brexit referendum has surprised many, but we must remember that Article 50 is still to be triggered. Scheduled to happen before the end of March, it will coincide with Dutch elections and possibly Italian elections while French Presidential election campaigning will be in full swing.

Mainstream parties right across Europe are being challenged by anti-establishment/anti-EU movements and Britain could get caught in the crossfire. Incumbent governments trying to make “change” look as unpalatable as possible could, for example, offer dire warnings over what Brexit will mean for Britain. This could prompt an intensification in the war of words between the UK and EU officials. At the very least it means the UK makes next to no headway in Brexit negotiations until after German Federal elections in September.

Even in the current period of relative calm, businesses are wary. Surveys from the Bank of England (and others) are pointing to a sharp slowdown in both hiring and investment spending over the next twelve months. This is largely due to the perception that uncertainty will increase once the Brexit countdown clock starts. An intensification of UK-EU hostilities could result in more businesses sitting on their hands.

A more cautious stance by British business may feed through into weaker consumer confidence. Job insecurity could become more of an issue at a time when rising inflation will squeeze household spending power. The pound’s plunge is pushing up the cost of imports and is being felt most keenly in the price of food. Wholesale energy costs, typically denominated in US dollars, are up for the same reason, compounded by the rise in oil prices following OPEC’s recent supply announcement. Households and businesses are therefore facing higher utility bills and petrol costs.

As a result, headline consumer price inflation looks set to rise above 3% in the second half of 2017. Unfortunately wages are unlikely to respond given the caution being expressed within business surveys. This means that we could see a return of newspaper headlines warning of a “cost of living crisis”, which runs the risk of further eroding confidence and leading to weaker retail sales. Interest rates will not rise in this environment with the Bank of England leaving the door open for a further rate cut.

Dr Tim Denison, Director of Retail Intelligence – Ipsos Retail Performance

Politics has finally caught up with retailing! For years now, shoppers have been voting with their feet, punishing ‘safe-and-established’ retailers that became disconnected from their customers, bringing them to their knees or, worse, sending them to the cemetery. In 2016 the same thing happened in mainstream politics; politicians experienced first-hand the damage that public disillusionment can inflict on the establishment. The ridiculous is no longer unimaginable.

The fallout from Brexit and ‘Trumptrance’ will inevitably impact UK retailing in 2017, adding to the considerable challenges already in train for next year from the National Living Wage programme and the revisions to business rates. I’ll leave it for other RTT Members more qualified to consider how these changes to the political and economic landscape will affect market conditions in the sector.

The consumer-led digital revolution has brought about massive change to the retail world in the last few years. Technological innovation is now a core strand of business strategy in the retailer’s book, but it comes at a cost. Not all new technologies are winners. 2017 marks the tipping-point for some of these technologies, as Proof of Concept testing comes to an end. Rationalisation of the first flush of dig-techs will ensue among the likes of Wi-Fi tracking, iBeacon BLE, smart mirrors, video analytics, 3D printing, virtual and augmented reality and contactless payment. The acid test, of course, is whether the value they add justifies the investment. I expect to see some fall by the wayside in the year ahead to be replaced in the R&D incubation hubs by a new wave of exciting technologies such as Just Walk Out and Li-Fi.

With the opening up of new shopping channels, retailing has become more complex. Operations have become less productive for the retailer and more frustrating for the customer. There is a need to put rationalisation right at the heart of retailing in 2017, looking to make things easier and more rewarding for the shopper and the retailer alike. Smarter and simpler is the future and we can expect leading players to adopt this thinking as a focus for some of their energy in the year ahead. Fresh ideas from outside the sector should be sought, bringing radical change to conventional practices. Whilst some may have been dismissive of the new approaches brought to market testing by the likes of Amazon, 2016 has taught us that complacency can be ruinous and alternative thinking should command respect. Radical can be realistic.

Paul Martin, Head of Retail – KPMG

From a macro-economic perspective, 2016 was a positive year with the UK delivering what looks like to be an impressive 2.1% GDP growth – one of, if not the highest growth rate of any mature western economy. However, 2016 is not likely going to be remembered for this fact but rather the UK’s decision to leave the EU and the election of the new President of the United States, both grabbing headlines along with the repercussions these events may entail for years to come.

The UK retail sector has delivered a mixed performance in 2016 and the structural changes the industry is facing remain an on-going challenge. You could argue that the “Great British” consumer has broadly ignored the result of the Brexit referendum, with consumer spend continuing to grow over the final months of the year. This is very likely to change in 2017 and the sector will face much stronger headwinds. We will see inflation rise, potentially up to 3% by the end of the year. In conjunction with continued FX rate fluctuations, prices will rise. The question remains how much will be absorbed within the supplier base, by retailers and actually be passed on to the consumer. A conservative view at the moment is that this will amount to 5-8% price increases over the course of the year (understandably varying across categories).

Although geo-political issues will stay at the forefront of many people’s attention in 2017, for business the focus should be on controlling the controllable. For retailers this means an on-going focus on transforming their businesses in light of the structural issues they are facing – embracing new technologies, becoming truly channel agnostic and placing the customer at the heart of their organisations. Whilst this has to be the longer-term strategic objective, many companies will need to work much shorter-term profit improvement initiatives over the course of the year in light of increasing costs and weakening consumer demand.

Martin Hayward, Founder – Hayward Strategy and Futures

The sky didn’t fall down in 2016, and it won’t in 2017.

The rather hysterical reaction to a democratically agreed Brexit, mirrored to a degree by the Trump victory in the U.S. masks some very important lessons for retailers to understand about changing consumer attitudes to life, commerce, politics and shopping. Despite the enormity of the votes, these are still weak signals in the marketplace, but 2017 will be the year that they start to manifest themselves as fundamental changes in the consumer psyche.

Looking behind the politics, it is clear that the aspirations of the ‘chatterati’ and many international businesses could be drifting away from the aspirations of the mass population. Globalisation of politics, cultures and business is looking less appealing as some of the realities become clearer – many people don’t want to be nationless and equally don’t want to deal with nationless companies who have interesting takes on tax and employee benefits.

The digital economy is in many ways behind a lot of the changes, opening markets beyond their traditional geographic borders and driving ever more efficiency. On-line shopping is clearly popular, but the realities of what this new digital world looks like are starting to be better understood. It’s not much fun buying and reading books online so we’re starting to see e-books decline and real bookstores open again. Buying music online isn’t much fun, so performance concerts are becoming over-subscribed.

But we’re telling consumers that the new digital economy is the future, friction free and painless, with everything delivered to our door in moments. No need to go out ever again. The much lauded ‘gig economy’ is however sometimes just transferring decent pensioned jobs into minimum wage and contract free roles as companies like Amazon recruit warehouse workers to walk in circles and frequently subcontract deliveries to cash in hand couriers.

Many of these ‘new economy’ companies rely on a pool of low paid, off the radar employees to make the economics work. Interestingly, in the grocery sector where delivery is by real employees, the industry estimates that the supermarkets make a loss on every order – home delivery isn’t really economic. The dream of these new businesses is ultimately to have no employees at all and to deliver by drone and driverless vehicles at which stage they can dispense with their ‘non-employees’, but that is a way off.

But, the reality of ‘efficiency’ is beginning to dawn on consumers just as it did with cheap flights, where the budget airlines were forced to improve customer service, and just as it did with call centres which are now frequently being re-located back to the UK.

Despite the continuing economic pressure on some households, 2017 will still be a great time for retailers to rediscover customer engagement. Yes, price and efficiency are important, but not always at the expense of human interaction, trained staff, provenance and an enjoyable experience. Tesco’s turnaround this year has been as much about the staff in the stores as it has about operational issues. The tide is turning on having life delivered to your door, and returning to a search for meaning and enjoyment. Technology is great at taking out the bad friction from your operation, but make sure to invest in good friction to give customers a reason to want to shop with you, not just on price.

Maureen Hinton, Verdict Retail

Retail expenditure will be stronger in 2017 than in 2016, but not because of increased consumer demand but price inflation. The higher price of imported goods following the EU referendum, and the fall in the UK pound, has been masked by currency hedging in 2016, but this starts to unravel in Q2 2017 and all retailers, struggling with cost inflation and squeezed margins, will be forced into passing on price rises to the consumer.

However the main inflationary impact will be in food & grocery which accounts for 45% of all retail spend, so a main drag on spending in other sectors. Verdict forecasts inflation in food & grocery will average 2.4% over the year, the highest since 2013 and the highest in any sector. To compensate for these higher prices consumers will be even more careful with their spending which means lower volumes and an even more competitive sector. Indeed it is the competition among the big players in the food & grocery sector, and the extra pressure from Amazon’s entry, that will stop inflation being even higher.

The clothing & footwear sector will continue to face challenges in 2017 quite apart from inflation and yet more unpredictable weather. Mass middle market players will lose even more share to distinctive brands with differentiated product who have a much better understanding of the modern consumer. On the other hand luxury retailers and department stores such as Harrods, Selfridges and Harvey Nichols, will benefit from the increase in tourists taking advantage of the lower prices the weak pound offers.

The most resilient sector will be health & beauty. Our obsession with how we look and, particularly for an aging population, maintaining health, means that yet again health & beauty will produce the strongest growth at 3.7%.

In home related sectors and technology much of the big ticket spending will have been brought forward into Q4 2016 and the New Year Sales as consumers anticipated big price rises in 2017.  This factor and a sluggish housing market will slow down growth. Meanwhile Bunnings will start to push harder on lower prices as it re-brands Homebase, which will drive competition harder in the DIY sector.

The online channel and in particular, Click & Collect, will continue to outperform. However investment in fulfilment to keep up with consumers’ high expectations will place yet more pressure on profitability.  This combined with weakening consumer confidence as the Brexit negotiations begin will make 2017 another extremely testing year for retailers in the UK.

Martin Newman, CEO – Practicology

Through the last recession, the continued double-digit growth of online retail was one of the few bright sparks for the industry. With unclear Brexit plans impacting consumer confidence, retail is likely to feel as though it’s in recession during 2017; even if the economy as a whole does not meet the strict definition.

So will online retail once again provide some comfort to retailers?

Retailers have already put capex decisions on hold in the wake of the Brexit vote, and if sales over Christmas 2016 don’t deliver growth, then it’s likely that some will go further and swing back into cost-cutting mode.

What’s different this time is that there is much less fat to be cut. There’s little low-hanging fruit with existing multichannel operational models; but it could be quite a different story if retailers are prepared to more fundamentally change how they do business

Digital transformation is an inelegant way of describing fundamental change, but there are certainly plenty of retailers out there who could benefit from reorganising their businesses for the benefit of their customers and bottom lines.

In addition, I expect multichannel retailers to be looking much more at their cost of sale and the role of the store as the percentage of sales transactions completed online will continue to grow. Some in the industry have nagging doubts about the profitability of selling online, while others are more focused on the overheads of legacy store estates.

House of Fraser has just announced plans to bring more leisure and hospitality brands into its stores, and it’s likely others will review how their space is used.

Questions will also continue to be asked about discounting and the distorting effect of special Sale events. Peak trading patterns have been fundamentally altered by Black Friday (which has now turned into a week-long Sale event both online and offline). A downturn in consumer sentiment during 2017 will likely make it harder for retailers to pull out of the discounting tailspin many have steered themselves into.

However, it’s not all doom and gloom. International ecommerce, particularly with non-European markets, is an opportunity for retailers to become less dependent on UK consumers to hit their growth targets.

Strong UK brands have already been successful selling into the USA, and Chinese consumers are accessible via marketplaces with the right support. In addition, the Middle East is ripe for fast ecommerce growth and it’s a region where western brands are highly desired.

The industry will undoubtedly have a tough ride next year, but if retailers can be agile to respond then there are opportunities to ensure that they at least survive, if not thrive.

Mike Watkins, Head of Retailer and Business Insight – Nielsen UK

After another year of unpredictable retail growth and falling prices, the winner has again been the shopper. The supermarket industry in particular has embraced simplification and cost savings but with a few notable exceptions, real innovation has been left for another day.

Nielsen anticipates 2017 being a seminal year. The uncertain economic, political and not least consumer outlook has the potential to be a catalyst to further structural change, the like of which we have not seen since the global meltdown 8 years ago. Food retailers have to keep up with the evolution in shopping behaviour and focus on three levers for business growth.

Improving the overall shopping experience

Low price on its own does not differentiate. Good customer service is expected so retailers will need to use technology to enhance the complete shopping experience. Expect the increasing use of data to make offers that are personal, and digitally linked to both point of sale systems for purchasing and rewards and with mobile for awareness and activation.  This can then be supported with marketing messages that truly resonate with shoppers.  Look out for some step changes in subscription services and business models as the ecosystem evolves.

Lifestyle as well as location

Location has become less of a differentiator for food retailers. Smaller stores are better able to meet the ‘little and often’ shopping trend and encourage frequency of visit, which is going to be the path to growth. However, we still expect the board room agenda to include the reinvention of large stores, to make them a compelling destination for lifestyle product choices, leisure and experiences and customer services as well as grocery shopping. There is also a lot of selling space that can be used differently.

Multi-channel as well as multi-format

Making connected commerce a reality. Until recently, the big Supermarkets retailers have been reluctant to revisit non-food. However, with falling market share in food and drink which is the outcome of Discounter growth (which will continue in 2017) and the underlying shift of spend towards food service, the more fragmented non-food channel is back on the radar screen.  This time it`s different and there is no need to build new stores; instead build brand equity and `go digital` before the technology titans transform how we shop.

 We may not see a retail revolution next year but we will certainly see the foundations for a new retail landscape.

Jonathan De Mello, Head of Retail Consultancy – Harper Dennis Hobbs

If I could summarise my outlook for 2017 in one word, that word would be ‘concern.’  For many traditional bricks and mortar retailers Black Friday 2016 could be the beginning of the end, given retailing during Christmas has now become a two tier event – where shoppers bring forward their purchases to benefit from the plethora of discounts on offer for Black Friday, and then ‘panic buy’ the week before Christmas. The former benefits principally retailers with a considerable online presence, whilst the latter benefits those retailers that have a strong physical presence on the high street.

Black Friday has hit margins at a time when they should be at their highest level – many high street retailers in fact make up to 50% of their profit from Q4 – Black Friday essentially wipes a lot of this profit out. Whilst Christmas Eve, Christmas Day and Boxing Day should be strong for bricks and mortar retailers – given Christmas Eve falls on a Saturday this year – I fear that this will not be enough to make up for the impact of Black Friday on margin; particularly given that Black Friday this year was – as with 2015 – largely an online phenomenon.

Whether Brexit actually happens next year remains to be seen, but I fear that a number of bricks and mortar retailers will fail next year given a perfect storm of falling post-Christmas consumer demand, currency hedging running out (a large volume of retailers have hedges that run out in Q1 2017) and a significant increase in business rates. A reduction in corporation tax would be most welcome, but would be too little, too late in the context of reduced consumer demand and rapidly increasing costs.

One thing that retailers are unlikely to need to worry about is retail rents however – as it is almost impossible to see how landlords can justify upwards only rent reviews in the context of the potentially substantial amount of retail business failures we could witness post-Christmas. This applies to major retail centres too given the increase in business rates retailers will have to bear in such centres, despite transitional relief. The physical retail market is becoming increasingly polarised given the advent of online – with fewer stores needed than ever before – and landlords with large dominant retail assets have fared relatively well in recent years. However, rental growth – at least for the foreseeable future – is hard to imagine. Even on London’s Bond Street – with some of the highest retail rents in the world – there is more stock available than ever before.

2017 for many retailers, their suppliers and even their landlords is looking relatively bleak – many will need to make their businesses even leaner (if that is possible) and focus on store optimisation rather than expansion. The sooner retailers start this process, the better.

Nick Bubb, Retail Consultant

Thanks to the support from the slump in sterling since Brexit, the economy hasn’t fallen off a cliff at the end of 2016, but as the inflationary consequences and other effects slowly play out on the consumer the outlook for retailers in 2017 is poor.

A year ago, the Food Retail sector seemed beset by structural problems, with the discounters running riot, but 2016 has actually turned out to be a pretty good year for the sector on the stock market. The Sainsbury share price has been held back by uncertainty over the wisdom of the Argos acquisition, whilst Ocado has been under pressure, but the Tesco and Morrisons share prices have done pretty well (both c50% up), reflecting the recovery in their trading momentum, which has coincided with slowing momentum for Aldi and Lidl. Asda has been a big loser, but they have not launched the much-feared price war, in recognition that their problems are more deep-seated

The industry remains very competitive, but the growth of Online Grocery shopping and top-up shopping at convenience stores has not destroyed the appeal of the “weekly shop” at the supermarket/superstore. And the return of some modest food price inflation is not a bad scenario for the sector, assuming that it does not impact on volumes, so 2017 could well be a better year for the major players in Food Retailing.

By contrast, the General Retail sector was riding high a year ago, but 2016 has been a disappointing year on the stock market, with some particularly marked underperformance from Next, Marks & Spencer and Dixons Carphone. The latter has done nothing wrong, but the City is worried about the outlook for “big ticket” demand and gross margins. M&S has plenty of long-term problems in its Clothing business, notwithstanding the growth of its Food operations, whilst Next has not been immune to the difficult trading conditions in Clothing this year.

Online Clothing sales have sailed merrily on, however, and 2016 has been an “annus mirabilis” for Boohoo.com, just as it has been an “annus horribilis” for the beleaguered Sports Direct. Who would have thought a year ago that little Boohoo would end 2016 with nearly as big a market capitalisation (£1.5bn) as mighty Sports Direct?

M&A has been a growing theme in the sector, with Home Retail, Darty and Poundland all disappearing from the public arena. It will be very interesting to see how Argos and Homebase fare in 2017 for their new owners, Sainsbury and Bunnings respectively.

One sub-sector in the spotlight in 2017 will be Department Stores, with their heavy fixed cost bases, with House of Fraser evidently under pressure and new CEO’s keen to make their strategic mark at both Debenhams and John Lewis.

Fashion retailers will hope that “the weather” will be more helpful in 2017 than it was in 2016, but they will also worry that persistently sluggish sales reflect the fact that consumers increasingly want to spend their money in other sectors, a situation that is unlikely to be improved if sterling weakness feeds through into higher clothing prices.

James Sawley, Head of Retail & Leisure – HSBC

The year of 2016 was a game-changer for the UK and the retail sector, but 2017 will be the year when business models, balance sheets and nerves will be really tested. The largely unforeseen outcomes of the EU referendum, US election and most recently the Italian constitutional referendum have led to volatile market conditions; the effects of which will play out in retailers’ strategies for years to come. With global interest rates at record lows and QE masking traditional market signals, “politics is the new economics” in influencing foreign exchange rates, and if the last year is anything to go by, we must be prepared for almost every eventuality.

Uncertainty and volatility will continue to have negative ramifications for UK retailers next year, as tough decisions are to be made on pricing and strategy in order to deal with cost headwinds and stay one step ahead of the competition. In recent months we have seen mixed messages from retailers regarding how the FX burden will be distributed between customers, shareholders and suppliers. Some, like B&M, see it as an opportunity to win market share, while other such as Next are messaging price rises in order to protect margins. Others stand to benefit, luxury retailers and London-based department stores in particular will be optimistic of a boost in sales from an uptick in inbound tourism.

As costs are set to rise in 2017, UK retailers will be identifying areas where operations can be streamlined, renegotiating with suppliers and investing in new technologies which can provide longer term cost-saving benefits. As a result, I expect CFOs to act defensively next year from a balance sheet perspective, with risk mitigation being at the heart of decision making. With appetite for new space likely to remain subdued, strategically, M&A will continue to play its role in achieving scale, differentiation and diversification as we trade through this challenging period. 2016 saw a 10% increase in deals completed‎ by UK retailers including a greater focus on cross border transactions. U.S. and Dutch companies were the most popular targets and JD Sports and The Hut were the most active buyers, completing three material transactions each. Retailers acquiring leisure companies is one interesting trend which I expect to see gather pace as the lines between retail and leisure continue to blur.

In 2017 I expect the UK to continue being a rich hunting ground for foreign buyers, especially given the valuation benefit of weaker Sterling. The number of UK retailers being acquired fell in 2016, with inbound acquisitions down 16% year-on-year (2015 being an exceptional year). U.S. and South African companies have again come out on top as having the greatest appetite for the sector, as this year these 2 counties alone have snapped up 6 significant retail brands. Fashion continues to be the category in the highest demand as brands such as Whistles and Reiss fell into foreign ownership.

Despite the large volume of M&A, 2016 was a quiet year for the capital markets with only a handful of bonds issued and share listings. 2016 only saw 2 IPOs in the sector (Hotel Chocolat and Joules) compared to 4 in 2015 and 14 in 2014. The loan market continued to offer a stable and active home for retailers looking to raise funds for strategic events such as M&A, special dividends and recapitalisations. In 2017 I believe we will see more defensive financing activity with retailers looking to the loan and equity markets (public and private) in order to shore up balance sheets and give themselves more flexibility to trade through what will no doubt be an exceptionally challenging year from a cost perspective.

In summary, the banking community continues to closely monitor the structural changes in retail in order to manage risk, but also opportunity. While exciting discussions around product, technology, supply chain effectiveness and internationalisation continue to dominate my discussions with retailers, we must balance this with helping to ensure that our customers’ business foundations are solid during the year of 2017.

 

 

Members of the RTT are:

  • Nick Bubb – Retail Consultant
  • Tim Denison – Ipsos Retail Performance
  • Jonathan De Mello – Harper Dennis Hobbs
  • Martin Hayward – Hayward Strategy and Futures
  • Maureen Hinton – Verdict Retail
  • James Knightley – ING
  • Paul Martin – KPMG
  • Martin Newman – Practicology
  • James Sawley – HSBC
  • Mike Watkins – Nielsen UK

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

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 by KPMG and Ipsos Retail Performance (formerly Synovate) 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.