Initial post-Brexit resilience.gives way to the inevitable dip in consumer confidence
We witnessed resilient retail sales figures in the three months after the UK's historic vote to leave the EU, confounding expectations that there would be a sudden slowdown in consumer confidence as they re-evaluated their household budgets. A backdrop characterised by historically low interest rates and inflation sitting well below the Bank of England's 2% target, helped to suppress any reservations consumers were harbouring about the impending pressure on household finances.
However, November and December's figures were disappointing , with retailers having to resort to deep discounting to drive volumes. Despite this, the 0.4% volume decline in the three months to January was the first fall in three years (according to the ONS). These indicators clearly demonstrate that consumer confidence is being tested as they adopt a more cautious approach to spending as inflationary pressures are now clearly beginning to be felt at a household level. The bad news is that this is only the beginning and consumers are yet to feel the full brunt.
Retailers can mitigate cost pressures but not indefinitely
Retailers' profits margins are facing significant pressure from the double whammy of sharp rises in both input (as a result of Sterling's post-referendum collapse) and operational costs. Looking ahead there is little further respite, with the latter being impacted by increases in both the National Living Wage and the Minimum Wage, alongside further rises in both fuel and utilities, heaping further pressure on retailers' logistics / distribution infrastructures and store estates. The controversial business rates revaluation, scheduled to take effect in April, will see retailers in London and the South East pay significantly higher rates.
So what does this mean for consumers , and does it affect some retail sectors more than others?
Higher ticket, discretionary purchases are typically first to face the axe from consumers' budgets. When consumer confidence is fragile, there is an increased likelihood of deferring large projects such as a new conservatory or an extension , which will impact home improvement retailers. Home-focused retailers who are extremely reliant on imported, dollar-denominated, goods (electricals and furniture in particular) will also be feeling the effects of the sharp rise in factory gate prices, accentuated by Sterling's post-referendum collapse. This will be more pronounced as many currency hedging contracts unwind throughout 2017.
Other sectors such as food and clothing, typified by (increasingly) shorter supply chains, intense competition and slim margins, will find it harder to prevent increasing prices for consumers. According to the latest ONS inflation report clothing & footwear prices fell 4.2% between December 2016 and January 2017, largely attributable to very aggressive and unsustainable discounting across the sector. This is a short-term, seasonal effect which we expect will reverse rapidly throughout the year.
Focus on the consumer & fine-tune the proposition
As political events unfold throughout the year and consumers potentially further rein in their spending, it is up to retailers to play their A-game and fine tune their propositions to ensure they create more compelling reasons for consumers to part with their hard-earned cash, more frequently.
Whilst the retail basics should not be underestimated (since many a UK retailer has fallen foul of failing to address them , think BHS, Banana Republic and Staples), they represent only a one piece of the jigsaw.
Retailers need to ensure they have a comprehensive understanding of the entire customer journey , and investment in digital will be fundamental for this to succeed. The cliche seamless omni-channel experience has never been more relevant, where retailers create a unified experience for the customer regardless of which channel(s) they use from consideration/evaluation through to final purchase. Consistent customer engagement will be essential to help develop a deep understanding of what consumers want, how they approach their purchase and by delivering it in the way and at the time they demand.
Amidst the challenges lie several opportunities
2017 brings a number of challenges for retailers resulting in a turbulent market backdrop, which threatens to unceremoniously discard those retailers that fail to step-up to the challenges they face. Those that do succeed will be the ones that are agile in their decision-making and consistently engaging with their customers.
We expect all of this to result in a healthy level of M&A activity across the sector. Private equity will continue their trend of investing in fast-growing specialist retailers who focus on distinct market niches. Trade acquirers will become increasingly active in sale processes for strong online retailers, lured by their technology and deep understanding of customers through big data and analytics. Finally, International acquirers may view the current uncertainty surrounding the economy as an opportunity to invest in UK retail, reinforcing the long term positive outlook for the sector.