20 July 2024, 14:14
By Furniture News Jul 21, 2022

Surviving the cost crisis

The last 24 months have been some of the most tumultuous and painful in recent memory for the UK retail sector. And now, just as retailers shake off the shackles of Covid-19 restrictions, they are facing a cost of living crisis that is already putting increasing financial pressure on their customers and their own operations. In April, the KPMG/Ipsos Retail Think Tank convened to discuss why this is happening, the key implications for retailers, and how its impact might be mitigated …

Why is this happening?

Despite being bruised by the Covid-19 pandemic, the retail sector delivered a robust performance over the winter, with the RTT’s Retail Health Index increasing one point to 75 in Q4 2021, and holding firm the following quarter. The sector actually ended Q1 2022 with a score equal to that before the pandemic, in Q3 2019.

Performance was driven by the non-food sector enjoying stronger-than-expected demand, with many people returning to offices across the UK, shopping for new clothes and seeking out experiential shopping activities. However, RTT members expect this demand to start to fall away as the cost of living crisis beds in and consumers are forced to tighten their belts.

The current economic situation brings with it swathes of challenges that are driving increases in retailers’ costs, but many of these only exaggerate issues that the retail sector was already facing: geopolitical uncertainty continues to reduce output and increase the cost of goods; supply chains are inefficient and require major restructuring; progressive Environmental, Social & Governance (ESG) agendas need implementing; and investment must be made into new technology to drive efficiency and insights.

As steep rises in energy prices contribute to inflation reaching a 30-year high, domestic economic conditions are putting pressure on households to cut back on discretionary spending. This surge in inflation will probably mean that real household disposable incomes will fall by more in 2022 than in any year since records began in 1955, as Ruth Gregory, senior UK economist at Capital Economics, explains: “It’s undeniably a worrying and troublesome time for UK households, and individuals will suffer the pain of the cost of living crisis, especially those at the lower end of the income distribution. 

“We expect inflation to peak at 10% in October, driven by a +30% rise in utility prices in October on top of the +54% jump earlier this month, an increase in food inflation from +5.9% in March to above +7.0% in the coming months, and constraints on the supply capacity of the economy continuing to bite.”

The UK consumer is set to bear the brunt of the crisis, but while real households’ disposable incomes will continue to fall this year, RTT members do stress that the economy is starting from a strong position in several areas.

Ruth continues: “Strong fundamentals in the labour market will go a little way to dull the effect on the economy as a whole. Low unemployment levels mean that a larger share of the population is receiving an income than at almost any time since 1975, and the demand from businesses for new workers is fuelling faster wage growth. Millions of households have amassed savings throughout the Covid-19 pandemic, and a drop in this saving rate at the start of 2022 shows that households are starting to draw on savings in order to continue spending.”

Economic pressure is not just impacting consumers. Retailers also started the year facing a rise in their own costs, as Jonathan De Melo, founder and CEO, JDM Retail Consulting, points out: “Retailer costs have risen significantly due to a combination of wage inflation, increased freight costs, the rising cost of raw materials, and a return to full business rates payments from April. 

“This impact has been felt across all sectors, but the electrical goods sector has been hit particularly hard, mainly due to exorbitant shipping costs, coupled with a global microchip shortage. Geopolitical events such as the war in Ukraine and the ongoing lockdowns in China continue to exacerbate the situation, limiting manufacturing and increasing the price of commodities.”

What are the key implications?

The implications of the current economic conditions on the retail sector are substantial, and will require swift action to mitigate the effects. The RTT believes increasing costs, price rises, a battle with other sectors for discretionary spend and changing shopper behaviour are already impacting on the sector.

Retailing consultant Nick Bubb explains: “The stockmarket looks ahead, and it is clear from the recent underperformance of retailers that investors are discounting a difficult period for retailing profitability, given the mounting pressures on consumer confidence and on operating costs. The overall stockmarket is broadly flat on a cumulative basis, so far in 2022, but the general retail sector is one of the worst performers, down over -20% in the year to date, with, for example, the Marks & Spencer share price down by over -40% and even Next down by -27%. 

“The food retail sector has held up a bit better, but even that is down by over -16% so far in 2022, with, for example, the share price of Sainsbury (with its heavy non-food sales exposure) down by -16%.”

Price rises

The urgency of the economic situation puts emphasis in the short term on reducing costs and driving efficiencies. James Sawley, head of retail and leisure, HSBC, explains: “At present, retailers are feeling inflation more than their customers. The cost of commodities, manufacturing, freight, shipping and labour are rising faster than consumer prices, and as such most of the pain at the moment is being worn by the retailers.”

Despite a conscious effort from large parts of the retail sector to absorb much of their cost increases, consumers are already feeling the effects of price rises at the tills, with GlobalData’s latest monthly trend tracker showing that 84% of consumers had noticed increases in their grocery bills. As costs continue to mount for retailers, RTT members expect further price rises throughout the year, in an effort from retailers to protect margins – this will likely be in conjunction with an effort to reduce product and packaging sizes.

The battle for discretionary spend

RTT members agree that after two years of Covid-19 restrictions and relative isolation, there is a desire from a lot of consumers to ‘go out and spend’. The cost of living crisis may be a dominant force on the news agenda, but high employment, increasing wages and bumper savings amassed over the last two years seem to be giving many people confidence (at least in the immediate term) to keep spending.

James goes on to say: “The challenge for retailers will be battling other sectors for their share of any available disposable income. The leisure and hospitality sectors are increasingly taking spend away from retailers as consumers are prioritising socialising over shopping – especially as the weather takes a turn for the better. There will also be high demand for foreign holidays in the summer as people look to get away, with the end of many of the restrictions and testing requirements. 

“Having benefited from a reduced level of spend in those sectors throughout 2020 and 2021, with all Covid-19 restrictions now lifted, the consumer is acting on that pent-up urge to socialise, and this is to the detriment of the retail sector.”

Changing consumer behaviour

The cost of living crisis is being felt across all sectors of retail, including in food, where consumers’ changing behaviour is already having a tangible impact on the grocers, as Mike Watkins, head of retailer and business insight UK, NielsenIQ, discusses: “Consumer behaviour in the grocery sector is already shifting, with the discounters seeing an increase in sales early in 2022, and I expect Aldi and Lidl to soon hit a new high of 20% grocery market share. 

“Alongside volumes of sales falling -7% in March (NielsenIQ Scantrack), shoppers are increasingly opting for private-label goods, as a conscious decision to save money on grocery shopping as part of their overall coping strategy when faced with rising household bills.”

It is clear that the squeeze on disposable income will impact on consumers in different ways depending on where they sit on the income scale, and as such consumer behaviour and spend will differ across retail categories, presenting them with a plethora of challenges.

Maureen Hinton, global retail research director, GlobalData, adds: “Consumers on lower incomes will be looking for value and cutting back on discretionary spending. This is good for budget retailers and supermarkets, but a cutback in volumes will make it challenging, as scale is essential to maintain low prices. 

“At the other end of the scale, those on high incomes will be less affected – though are likely to choose to spend more on travel and holidays. However, an increase in tourism and the access to physical shopping will boost sales for luxury and premium retailers whose customers are less impacted by inflation – though this is a smaller share of the market. It is the mainstream retailers who will have to give consumers a very good reason to spend with them, with price being a major factor.”

How do retailers mitigate the impact?

RTT members believe there are several different levers that retailers can pull to mitigate the impact of the current situation, including reducing costs and driving efficiencies, becoming customer-centric businesses, investing in technology and talent acquisition, and a short-term shift in focus regarding ESG agendas and associated messaging to consumers.

Reducing costs

Reducing costs will certainly be at the top of most retailers’ agendas, and the knee-jerk reaction of some may be to implement mass job cuts and store closures. While this will offer short-term respite, RTT members agree that this is an outdated way of thinking, which will only lead to poorer levels of customer experience and satisfaction, at exactly the time when retailers need to be proactive, focus on the consumer and encourage them to shop.

Martin Newman, The Consumer Champion, comments: “It has never been more important than it is right now for retailers to focus on building customer lifetime value and turning customers into fans. Lead with purpose and authenticity. Show you care. Show you understand. Walk the talk by reducing prices, and find other ways of adding value to customers when many are in such a difficult situation. This will generate goodwill and will be returned by customers through their lifetime value and advocacy for your brand.”

Customer-centric businesses

RTT members agree that retailers need to reassess their own customer base. By taking a closer look at what their customers value, retailers can then start to implement the forward-thinking change that the situation demands.

Paul Martin, UK head of retail, KPMG, explains: “Before strategies to cope with and combat the cost of living crisis are implemented, retailers have to first reacquaint themselves with the consumer.Retailers have enormous swathes of data on their customers – their buying habits, locations, product preferences, delivery schedules and levels of spend – all of this is crucial information that is at the fingertips of decision-makers. 

“The final piece of the jigsaw is investment to organise and understand this data on a grand scale. Without a clear picture of who they are selling to and what they want, retailers won’t be able to deliver the changes that are required to not only survive, but come out of the cost of living crisis in a stronger position, as customer-centric operations.”

Utilising this data will put retailers in a position where they can better create and sell products and goods that are more appealing to consumers. Peter Luff, MD of Ipsos Retail Performance, says: “Fundamentally, successful retailers sell products that are desirable to the consumer or show value for money. This has always been the recipe for success, but current economic conditions are squeezing people’s disposable spend and intensifying this requirement – increasingly amongst the middle-income earners. Driving quality and affordability into that middle sector will be key for ensuring demand remains robust in the coming 18 months.”

Investment in data and technology

Retailers must embrace the insights that can be gleaned from their customer data, so their decisionmaking can be dictated by the consumer. This will require investment in new technology and talent to organise and understand the data. In such a competitive employment market, talent acquisition could be expensive and time-consuming, resulting in many retailers looking to outsource the activity to external partners.

This investment in expertise will allow for successful retailers to be able to re-engineer their product lines to be smaller and more focused on what customers want to buy – this will likely include the sourcing of more goods and products from artisanal and local suppliers. Data-driven decision-making will also allow for more sophisticated and agile price and promotional management – something that will be a powerful tool as the cost of living crisis plays out.

The ESG agenda

The wider ESG agendas of retailers will likely take a back seat in the short term, with cost and margin pressures forcing many operators to focus less on environmental- and social-related topics, only investing time and resources into the must-do governance aspects of ESG. RTT members agree that this course of action could be a mistake, and instead, proactive retailers should be remodelling policies to link their ESG agendas with the cost of living crisis.

For example, UK retailers are aware that the re-engineering and optimising of supply chains to source goods more locally is a critical priority. Robust, near-sourced supply chains will help to create operations that are more resilient to external factors such as inflation or fluctuating shipping costs, as well as reducing the environmental impact of international logistics. Retailers should be looking to near-shore sourcing as a cost benefit to themselves, but also to support local communities and help reframe their ESG messaging to the consumer.

Despite what are, in the grand scheme of things, short-term challenges, RTT members stress the importance of retailers not losing sight of their longer-term ESG goals, which must remain a central focal point for the sector. Both the non-food and grocery sectors require strong leadership to kickstart the debate on reinventing processes and best practice in the sector. Communication with consumers will be vital in this process, as undoubtedly it will lead to increased prices – but operators need to explain why it is happening, and the wider societal and environmental benefits it will bring.

Business leaders have a short window of opportunity to take the lead on issues such as waste, CO2 emissions, home deliveries, water usage and packaging – otherwise their hand will be forced by governments, with regulations that will likely prove more costly in the long run.

An opportunity to right-size pricing?

RTT members agree that keeping prices low has to be a top priority, and at present many retailers are holding back on passing the bulk of their rising costs onto customers. However, for far too long, there has been a race to the bottom in terms of pricing across the retail sector. In the longer term, RTT members question whether 99p ready meals and £1 T-shirts are sustainable, and as such, many of the price rises that consumers experience could be permanent.

While there is a ‘window of opportunity’ in the coming 18 months for a wider re-structuring of pricing, Martin Hayward, founder, Hayward Strategy and Futures, warns that it is a long process to do this, and retailers will have to tread carefully: “It’s been apparent for a number of years that too much ‘stuff’ is far too cheap, and while a sector-wide recalibration in pricing structure to end the race to the bottom is needed for the good of the sector, society and the environment, now is not the time to start this implementation. 

“Consumers will not be sympathetic to steep rises in prices, and it’s a slow process to unwind the UK’s addiction to fast fashion and cheap food.”

Conclusion

The cost of living crisis has developed just at a time when the UK retail sector had cause for optimism, following two years of stop-start lockdowns. It is clear that the sector will not go unscathed, with rising costs expected to cause further retail failures in the coming months. However, most operators showed their mettle during the pandemic, adapting to rapidly changing trading restrictions and shopper behaviour, and RTT members believe the cost of living crisis is another challenge that the UK retail sector can meet head on.

The retail sector requires strong, data-led leadership at this time, and while there will be pressure to cut costs through redundancies and store closures, the RTT believes that the retail sector should instead look towards a more positive set of solutions. Investment in technology, improving operational efficiencies and creating more robust supply chains will help ease the current pressure and put the sector in a stronger position – so much so that the cost of living crisis may actually ignite the structural change that the sector has long required.

With increasing costs and falling consumer confidence, RTT members predict that this quarter will deliver the first negative Retail Health Index result since Q2 2020, at the start of the pandemic. The increased costs that retailers are facing are also expected to be a more permanent fixture, meaning margins will continue to come under pressure and price rises will have to be passed onto the consumer

As such, retailers will have to innovate and work hard to create and sell consumer-centric products, and they will need to be desirable to shoppers, or deliver great value for money. This starts by putting customers at the centre of decision-making, using data to identify what they really want and using that information to entice and persuade them to shop.

Retailers cannot afford to be negative, nor can they afford to stand still, concludes Peter Luff: “It will require investment, the latest technology and leading talent to deliver it, but at its core it’s very much back to basics for retailers – driving efficiency, shoring up supply chains and putting the consumers’ needs first. It’s also very apparent that the bright light of the cost of living crisis will quickly expose those retailers that fail to identify and answer the current needs of their customers.”

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