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

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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 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.”

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 12 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 retail 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, 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.

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, Newman pointed out that following the outcome of the EU referendum, retailers have been putting capital expenditure decisions on hold. Meanwhile 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,” Knightley added.

Against a backdrop of higher prices in the wake of inflation, 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 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,” Martin added.

Dr 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. 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, 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. 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 Dr Denison. Meanwhile, 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 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. 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. 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, 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 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,” Watkins concluded.