The retail industry in the United Kingdom is going through a monumental shift in fundamentals – consumers are making more online purchases at the cost of brick and mortar stores, retailers are making more data-driven decisions, even behavioural data is examined to make better informed decisions. It is not by chance that the changes experienced by the industry have coincided with the most crucial issue plaguing the country – Brexit. The planned break away from the European Union (calling the decision and process ‘planned’ would tantamount to playing fast and loose with the word), has exposed the underlying weaknesses of the industry. But the year 2019 is going to be a very important year for the industry and can set the directions for years to come.
Despite many reports of its imminent slowdown, its annual sales totalled an astounding £358 billion, more than the gross domestic product of many of the countries, and with one in 10 people working in retail, it remains the single largest private-sector employer in the UK. Supermarkets such as Morrisons, Asda, Sainsbury’s and Tesco dominate the retail landscape, while Amazon is the leader in online sales. It now accounts for £4 in every £100 spent in the UK and has cemented its position amongst the top five, behind only to the supermarkets. According to market research firm GlobalData, technology retailers like Boots and Dixons Carphone have made into the top 10, which indicates the future landscape of the industry.
According to data released by the Office for National Statistics on Thursday, 18 July 2019 retail sales volume in June 2019 increased by 1.0 per cent as compared with May 2019, reflecting a significant upside surprise with much stronger-than-expected growth. This followed a decline in sales volumes in both May (0.5 per cent) and April (0.3 per cent) and differed with the weak June, Confederation of British Industry (CBI) and British Retail Consortium (BRC) surveys. On quarter-on-quarter, the second-quarter sales volumes grew by 0.7 per cent. However, it was less than the 1.6 per cent growth rate seen in the first quarter, benefitting from the particularly strong gain in sales, in March.
The strong sales data, which is widely regarded as an indicator of consumer spending, indicated that the consumption in the country has been more resilient than other areas of the economy, offering a glimpse of hope that the country may avoid the much-dreaded contraction in the second quarter. While the sales of household goods rose 1.9 per cent month-on-month in June, non-food sales were the major driver behind the volume gain as it rose by 1.7 per cent against the previous month.
However, questions were raised about the sustainability of the boost to gross domestic product growth from the retail sector as the growth in the sector was driven by home improvements and charity shop deals, and department stores continued to suffer. As compared to the previous three months, the quantity bought in non-specialised stores dropped 1.2 per cent, despite the apparent resilience of consumer spending. The latest decline was the largest in the past decade and marked the longest period without growth since the financial crisis as department stores last reported an expansion in the three months to September last year.
The shift towards the online world and away from physical shops are increasingly becoming evident from various figures published. This is sometimes colloquially referred to as the Amazon effect for its power to force through some serious changes in the industry. Retailers are increasingly accepting the complementary role of the store and online operations, wherein consumers increasingly order online and physical stores act as showrooms and outlets for click-and-collect sales and product returns. However, this risk is cannibalising the physical operations as more traditional retailers successfully expand their online businesses. Moreover, many retailers do not have the necessary financial power to operate both the operations and are thus are forced to close, leaving thousands of employees jobless. In the UK in the first half of 2018 alone, 2,700 stores were shut, costing 80,000 retail jobs.
Retailers are increasingly under pressure from the need to invest in digital transformation, lower pricing power and rising costs, which has strained the already stretched profit margins of the company. Companies are now facing new competitors who have different operating models and cost bases, at a time when the established companies are still competing with each other, with competition increasingly shifting towards the online space. The online sales grew at more than ten times the rate of in-store sales, and online sales as a proportion of all retailing were 18.9 per cent in June 2019. New companies are able to avoid cost pressures like the rising cost of the property as many are either online or operate businesses that have only a small number of stores. This trend reflects the changing consumer behaviour as more and more consumers are choosing to shop online, increasingly via their smartphones, which has dramatically reduced the barriers of entry to clothing and homeware markets.
The UK retail industry is facing rising cost pressures, including higher property costs, leading to demand by retailers to lower rents on unprofitable stores as struggling retailers seek ways to keep their businesses afloat. Many retailers argue that they would collapse if they could not secure company voluntary arrangements (CVA), but property owners have grown increasingly resistant as they feel they are being pushed into a corner by chains. Company voluntary arrangements is a form of insolvency that permits store closures and rent forgiveness deals, and according to PwC, the number of retailers that agreed CVAs doubled between 2016 and 2019. Real disposable income growth has been very weak for a good decade while many consumers now prefer to shop for big-brand toys online, leading to the demise of Toys R Us in the UK, which created considerable pressure and exposed the company with underlying issues.
As the labour market has strengthened to register a record low unemployment levels and the national living wage has risen in recent months, the companies have been facing increasing staff costs. Moreover, if the UK agrees for a hard-Brexit, the much-needed pool of workers from the European Union would be reduced, resulting in further straining on the profitability margins of the companies. Also, the threat of Brexit has resulted in a free fall in the Pound since the EU referendum vote. As the value chains are highly connected with the EU, the costs of importing goods have risen, which has further increased the input costs. The increase in input costs has been considerably more than the general inflation in the country. Commodity prices have also been rising, further straining the financials of the company.
Retailers have started to renegotiate leases at lower rates after they fail to protect their margins. Next PLC in its latest annual report announced that where leases have come up for renewal, it negotiated a rent reduction of 29 per cent and it expects similar reductions in the year ahead. Recently, the Housing, Communities and Local Government committee suggested that a review of the unfair business rates system which unfairly burdened the operators of physical shops and said that the government should consult on whether to outlaw upward-only rent reviews.
Helped by modest inflation and stronger growth in wages due to record-high employment, consumers have so far largely taken Brexit in their stride and have been more resilient than most other sectors of the economy, helping the economy at a time when many companies have been cutting back on investment. Although inflation-adjusted wages are still below their peak before the financial crisis, real earnings growth picked up only between mid-2018 and early-2019 as the country recorded its lowest unemployment since 1975. As annual earnings growth reached 3.5 per cent in the three months to February and inflation trended lower and fell as low as 1.8 per cent in January, real earnings growth reached 1.6 per cent in the three months to February, reaching its best level since mid-2016 and up from just 0.1 per cent in mid-2018.
However, there have been signs that the consumers are turning more cautious as the political crisis drags on, amid concerns that the improvement in consumer fundamentals is faltering, including slower employment growth. Although earnings picked up in May, annual real earnings growth was lower than its early-2019 peak of 1.6 per cent at 1.4 per cent in the three months to May, as annual earnings growth dipped to 3.2 per cent in the three months to April from a peak of 3.5 per cent in the three months to February. Moreover, even as lenders have started to cut back on the availability of unsecured consumer loans, the savings ratio is close to 50-year lows, and consumers would seek to avoid further expenditures given current uncertainties.
According to a report by the analysts Retail Economics, the online market could more than double its contribution to the retail market by 2028 and is expected to account for 53% of retail sales in 10 years. The companies agree that the industry is going through a readjustment phase, and personalised marketing and artificial intelligence will drive future online growth. This does not portend well for many companies, and they would have to continually reinvent themselves to survive under pressure from growing online competition.
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