Retailers’ profitability challenged by inexorable rise of e-commerce, Deloitte report finds

The retail industry has faced many challenges over the last 20 years but rising cost pressure, lower pricing power and the need to invest in digital transformation will test retailers’ mettle in 2017, according to Deloitte, the business advisory firm. Analysis in a new report, The Retail Profitability Challenge, reveals how resilient retailers can turn the threats they are facing into opportunities that maximize returns.

Deloitte’s research involved looking at the profit and loss accounts of the UK’s leading 1,000 retailers between 2007/08 and 2014/15, revealed that profitability is declining. Between 2007/08 and 2010/11, average margins stood at 6.1%, however, by 2014/15, average margins had declined by 2.1 percentage points, to 4%.

The fall in profitability has coincided with a rapid growth of e-commerce within the last decade.  The share of total retail sales accounted for by online has grown from just 2.8% in November 2006 to 18.3% in November 2016. Changing consumer behaviour has caused this shift, with consumers choosing to shop more and more online, increasingly via their smartphones.

Ian Geddes, head of retail at Deloitte, explained: “The retail industry is undoubtedly going through a period of unprecedented change, and profit margins have never been under greater pressure. Retailers are already responding to these challenges, but the question is, are they moving fast enough?

“Successful retailers in 2017 are likely to be those that concentrate on genuine customer engagement, differentiation and innovation while improving productivity and keeping a laser-focus on reducing costs. In particular, it is likely that the evolution of the retail industry will see more specialisation in the market – our research has found that the most clearly differentiated retailers are often the most profitable.”

The perfect storm of cost pressures

Retailers are having to face up to five other challenges that could drag operating margins into negative territory in 2017. Deloitte calculates that the following five causes combined could generate a fall of between 3-5% in operating margins:

  1. Rising property costs – including business rates and rental costs
  2. Increased staff costs – introduction of the National Living Wage and Apprentice Levy
  3. Devaluation of sterling – depreciation of the pound since summer 2016
  4. Rising fuel and commodity prices –due to the increase in the price of oil
  5. Higher pension costs – increasing pensions liabilities due to falling gilt yields

Sectors including DIY, Health & Beauty, Mixed Goods and some Supermarkets could see operating margins head towards negative territory if no mitigating action was taken to address these*.

Dan Butters, restructuring services partner at Deloitte, said: “You can feel the storm coming but the effect on retailers will depend on a case by case basis. We know some retailers are already taking action, such as hedging currency in the short term, but many could become exposed to further FX volatility. These five substantial cost pressures, including increasing staff costs and, critically, business rate rises, cannot be taken lightly.”