UNCERTAIN TIMES AHEAD FOR RETAILERS
The decline in the health of the UK retail sector is predicted to accelerate in Quarter 3 2016, with all three drivers of retail health – demand, margins and cost – expected to turn negative for the first time since 2011. This follows a downturn in health in Quarter 2.
• The overall health of the UK retail market fell in Quarter 2 2016. Weak demand amongst consumers, reduced margins and rising costs following the implementation of the National Living Wage all squeezed retailers, resulting in a negative impact on retail health in the quarter.
• The RTT agreed that the decision to exit the EU was an unexpected blow to retailers, with uncertainty apparent in all areas of the sector.
• September is likely to be the key month on the near horizon, and although the ‘back to school’ mood of the consumer is hard to predict, the health of the retail sector is expected to drop even further in Quarter 3 as sales momentum runs out, price competition intensifies and higher costs continue to hit retailers hard.
• The RTT was keen to stress that Brexit isn’t the driving force behind the acceleration in the downturn, but it has had an immediate detrimental impact on consumer confidence. Members acknowledged though that Brexit isn’t all ‘doom and gloom’ and there will be opportunities for retailers. A weaker sterling will make the UK an attractive proposition for foreign tourists keen to take advantage of the weaker pound.
• The RTT expects more retailers to view internationalisation as a means of overcoming the lack of growth in the domestic market.
Following its quarterly meeting on July 12th 2016, the KPMG/Ipsos Retail Think Tank (RTT) has released its latest findings, stating that the health of UK retail fell in Quarter 2 2016. The RTT’s Retail Health Index (RHI) dropped one point to 83, the first time it has declined since Quarter 3 2014. Disappointing sales in April and June reflected flat demand and the National Living Wage came into force before productivity strategies had been implemented to lessen the damage to their cost bases.
Although consumer confidence continued to improve and the public’s personal finances were strong, with both employment and wages rising, there was no real uplift from the Euro 2016 tournament and the unseasonably poor weather hurt fashion retailers.
The RTT forecasts that the RHI will drop a further 2 points in Quarter 3 2016, and acknowledged that the general trend in recent months was already on its way down, and therefore, while Brexit was not the cause of this slow down, it could aggravate the existing issues that retailers are facing.
The three main drivers of retail health; demand, margin and cost, are all expected to work against retailers throughout Quarter 3.
Rising costs for retailers are expected to be the strongest driver of the health decline in Quarter 3, with sterling struggling in world markets making the importing of goods into the UK more expensive. Though most large retailers hedge funds six to18 months out, many of the smaller players don’t, leaving them exposed.
The National Living Wage has not only increased retailer’s wage bills, but further investment will be required to increase efficiencies in an effort to counteract the largest National Living Wage rise by 2020. The RTT discussed whether or not these rising costs would be passed onto the consumer, but it was felt that retailers would be looking to keep prices down and the additional costs would need to be largely absorbed by retailers and their suppliers.
There was also concern that energy and fuel inflation in the coming months would hurt retailers on multiple fronts, impacting not only on their costs, but also on consumer confidence as these are very ‘obvious and apparent’ price rises that effect people day-to-day.
The RTT debated at length how consumer confidence would be affected across the quarter. Wage and employment levels are still healthy and disposable income is rising, but as has been an ongoing narrative, a disproportionate amount of this money is being spent in the leisure and hospitality sector rather than in retail. The RTT agreed that it has never been more important for retailers to fight back and work hard to win more of the consumer’s wallet.
The RTT recognised that Quarters 3 and 4 would also be a challenging time for landlords who may need to renegotiate rent agreements in order to keep their estates attractive to retailers.
Retailers selling big-ticket items such as televisions and sofas, and goods at the discretionary spend end of the spectrum, are expected to be hit the hardest in Quarter 3. The RTT predicts that a softening of the housing market would have a knock-on effect on large purchases until the dust of Brexit had settled and people had a clearer view and understanding of what will happen next and what the impact will be for business.
The RTT predicts that if demand falls, retailers could well be forced into activating further discounts and sales to keep consumers spending in the quarter to come. The RTT suggested these could be prolonged and deep, which coupled with rising import costs, will squeeze margins even tighter.
If weaker demand materialises in Quarter 3, fashion retailers in particular will be forced into deploying heavier discounting programmes to stimulate sales and clear stock levels in advance of Quarter 4. Post June 23rd overseas markets look a lot more attractive and members expect further expansion plans to sell more outside of the EU, with the USA, China and Australia cited as natural targets. The confusion and unpredictable nature of the market also present opportunities for retailers already in strong positions, and in a similar way to during the last recession, some retailers could benefit from a ‘land grab’ and take a larger proportion of the market.
The RTT recognised that whilst overseas opportunities look attractive, there is also an opportunity for retailers to take advantage of their heritage and provenance of products if positioned correctly.
Dr Tim Denison, head of retail intelligence, Ipsos Retail Performance, said: “Uncertainty is one of the most damaging bête noirs in retailing, and the spread of opinions around the table speculating about the short term impact of the ‘out’ vote was symptomatic of the degree of uncertainty that exists in the sector. It is possible that if retailers can connect with consumers and portray a message of ‘buy now while prices are low’, we could see demand maintained throughout Quarter 3. But the reported decline in consumer confidence post 23rd June could threaten the resonance of that message.”
Nick Bubb, independent retail analyst, said: “Before the UK took the Brexit plunge, retailers
were already struggling with rising costs, squeezed margins and softening demand. The decision to leave the EU has now aggravated these issues with Sterling struggling and uncertainty creeping into both boardrooms and the mind of the consumer. The underlying issues that retailers are facing still exist, but there is now just a greater urgency required in addressing them.”
Jonathan De Mello, lead retail consultant, Harper Dennis Hobbs, said: “This looks set to be a painful period for retailers, as rising costs on multiple fronts will squeeze margins throughout Quarter 3. The National Living wage has already increased retailer wage bills – add to this rising import costs, petrol prices and energy bills, and if consumer confidence is hit due to uncertainty following Brexit, demand could also begin to tumble. We are potentially looking at a scenario when all three of the drivers for retail health, margin, demand and cost are working against retailers.”
Martin Hayward, founder of Hayward Strategy and Futures, said: “As the true effect of the referendum result settled in, I thought that we could potentially experience a ‘calm before the storm’ throughout Quarter 3 – as people took stock of the new reality before the divorce proceedings kicked in. However, now that a new Prime Minister is in place and Brexit negotiations may soon begin, I expect the knock-on effect of Brexit to flow down to the consumer at a much faster pace. However, the reality is that the real impacts of Brexit will take many months, even years to be clarified, so a calmer period will probably follow this initial period of unease, as the consumer realises the sky hasn’t fallen in.”
James Knightley, senior global economist, ING, said: “With a new Prime Minister and Cabinet now in place, we can hopefully see some stability and confidence creep back into the markets. Only time will tell how and when negotiations for Brexit proceed, but in the medium-term the plunge in Sterling is bad news for retailers, and although many will have implemented currency hedging, the cost of imported goods is going to rise. People’s personal finances look good for now, with wages and employment still climbing, however consumer confidence could drop as Brexit negotiations intensify, leading to people thinking twice before making purchases and instead saving for a rainy day.”
Martin Newman, CEO at Practicology, said: “Retailers in the UK may well first go through a process of consolidation as they take stock of the current political and economic climate. Those that then perform well and ride out the inevitable fall in consumer confidence will be the ones that have a clear vision and strategy in place – retailers must ensure that the core fundamentals within their business are robust. For instance, there will be opportunities that present themselves from such significant changes to the sector. Retailers may look to step-up the ‘Internationalisation’ of their business, looking for new markets outside of the EU to sell both off and online.”
James Sawley, Head of Retail & Leisure at HSBC Corporate Bank, said: “Pricing is going to be a big issue for retailers in the medium term, although most will be able to deflect the negative impact of a weak Sterling for at least the next 12 months having hedged against the Dollar. As these positions unwind there will unquestionably be increased costs that will either have to be absorbed or passed onto the consumer, and those retailers operating at the discretionary end of the consumer’s wallet may well have the hardest decisions to make. The UK retail sector is well accustomed to dealing with changes in the economic landscape and the knock on impact on consumer behaviour within the countries in which they operate and retail leaders may well look to other markets and other avenues for opportunity and growth.”
Mike Watkins, head of retailer and business insight, Nielsen, said: “The Brexit vote left consumers in a state of shock and it will have had an initial impact on consumer confidence. Historically, August is a holding month for retailers with many people abroad or looking to save money upon returning from holidays. This may amplify the weak demand we have seen in recent weeks due to the unseasonable weather and could intensify with the uncertainty of Brexit still in the air. However, the success retailers have in a normally buoyant September could well be a better barometer for ongoing performance over the following six months and looking further ahead, whatever changes are made by policy makers that impact disposable income.”
Note to Editors:
The RTT panelists rely on their depth of personal experience and 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
• David McCorquodale – KPMG
• Martin Newman – Practicology
• James Sawley – HSBC
• Mike Watkins – Nielsen
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.
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 judgments 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.