KPMG/Ipsos Retail Think Tank warns of a costly quarter ahead for retailers

The health of the UK retail sector is expected to dip in Q2 2016, as retailers bear the brunt of soaring costs. The National Living Wage, a weak sterling, continued investment in channel shifts and rising petrol prices are expected to significantly outweigh improving consumer demand.

  • The overall health of the UK retail market improved in Quarter 1 2016, following strong sales in January and February. Retailers faced a tougher time towards the end of the quarter in March, as the early Easter fortnight failed to deliver any boost in demand for food in particular, and weather conditions conspired against the likes of the DIY and outdoor sectors.
  • The RTT agreed that although retailers were actively developing plans to absorb the cost hike of implementing the National Living Wage, much of the result of this work would not been seen until later in the year, and the health of the sector in Quarter 2 would suffer as a consequence.
  • Retailers are expected to be able to maintain margins throughout Quarter 2, through smarter pricing and moving towards EDLP frameworks - now favoured by consumers.
  • The uncertainty of the EU Referendum has yet to make its way from the boardroom to the consumer, and as such demand continues to keep the state of retail health more buoyant than it would be otherwise.

Following its quarterly meeting on 11 April, the KPMG/Ipsos Retail Think Tank (RTT) released its latest findings, stating that the health of UK retail improved in Quarter 1 2016. The RTT's Retail Health Index (RHI) resumed its upward trajectory, climbing a point to 84, after its flat performance in Q4 2015. It now matches the retail health of five years ago thanks largely to a rise in demand.

A strong performance throughout January carried through into February. However, March was a let down, with the unseasonal bad weather and an early Easter resulting in a disappointing last two weeks of the quarter. As has been a common story in recent months, demand continues to be the positive shining light for retailers. Employment statistics and wage growth are both robust, and as savings continue to fall, the public has more disposable income to spend.

Nevertheless, the improvement is expected to be short-lived, with the index falling back to 83 over Quarter 2 as retailers are hit hard with rising costs - this despite the stronger demand expected to endure in Quarter 2. Members warn that the battle ahead continues to be about steering consumers away from the current trend of spending in the leisure rather than retail sector.

The RTT commented that money was being spent in the DIY sector and with the 'white van man', as people moving house are spending on renovating their properties, and if they're not moving they're also spending money on doing them up. It also believes that food retailers should get a bump in demand of up to 1%, as three home nations will be taking part in the Euro 2016 football tournament, the majority of which falls in Quarter 2.

A combination of the mandatory introduction of the National Living Wage adding 5-7% to average wage bills, rising petrol prices adding to fulfillment costs and an 11% drop in sterling's value since November - detrimental to new hedging deals, are all expected to subdue retail health over the next quarter.

The RTT acknowledge that in order to combat the rising wage bill, investment in productivity and efficiency is the key driver for sustained progress. However, this will take time to implement, and the imminent cost shift is deemed significant enough to outweigh rising demand - impacting negatively on retailers in the coming quarter.

Margins are expected to come under pressure too in Quarter 2, as the weak pound is already causing retailers pain, and this will only intensify in the coming months. RTT members agreed though that retailers have reshaped their pricing and discounting strategies to reasonably good effect; while they have not given margin away, they have not been able to make it up. The rise in supplier insolvency levels is testament to the hard bargaining that has been going on. The RTT believes that retailers should be able to balance out the external financial pressures and maintain margins throughout Quarter 2.

The RTT believes that uncertainty of the upcoming EU referendum will be causing unease and uncertainty at a boardroom level, but during Quarter 1 it seemed this had yet to filter down to the consumer – people seem to be still happy to spend rather than save. However, as the campaigns themselves heat up over the coming 10 weeks and the press coverage intensifies, the uncertainty may begin to creep up on the consumer, and then onto the high street.

David McCorquodale, head of retail, KPMG, UK, said: "Whilst it is apparent that retailers costs will be hit hard in the upcoming months, I do think that this is a short term dip and one that will be righted in due course. Retailers have known about the National Living Wage for a long time, and have been planning for ways to take it out of the equation. I don't expect price rises to be first on the agenda, especially in the food sector – rather, I suggest we will see an increased level of investment that drives productivity and efficiency across businesses."

Dr Tim Denison, head of retail intelligence, Ipsos Retail Performance, said: "Nobody believed that this year was going to be an easy one. We can take heart from the fact that the year has started relatively brightly, especially given the strong comparator of Q1 2015. Dark clouds of uncertainty are threatening the health of the sector over the coming quarter over which retailers will have little control, and much may depend on staycations, football and the weather as sales levers in the coming months. The money is still there for them to spend, but the level of negativity will shape demand in Quarter 2."

Jonathan De Mello, lead retail consultant, Harper Dennis Hobbs, said: "The economic fundamentals are strong, and should create the framework for consumer demand to continue to thrive for the next quarter at least. Whilst retailers themselves are in general robust enough to succeed, insolvency rates in their suppliers have started to rise – which in turn could mean retailers could start to reach their limit in terms of squeezing margins. Alongside rising costs due to the National Living Wage, there has been an apparent rise in the number of retailers opening stores in traditional market towns. While they can specifically target high volumes of their target demographic, the high rents that are charged could see substantial increases in their business rates following a rate revaluation that is directly linked to rental fees."

Martin Hayward, founder of Hayward Strategy and Futures, said: "As has been an ongoing story for a while now, retailers are still struggling to fight for their expected share of the public's growing disposable income. As the leisure and recreational sectors continue to grow, retailers will have to adapt in order to compete. The public want more from their shopping experience. As the internet reduces much shopping to a world of efficiency and price, there is a great opportunity for retailers to enhance this with more experiential and enjoyable offerings across other channels"

Maureen Hinton, group research director, Columino, said: "Consumers are at last seeing growth in their disposable income and are more willing to spend, but they are still looking for bargains, which is why price and margin management are key factors for retailers in driving sales and profit. Furthermore retailers face the challenge of turning the tide on the leisure sector which has been growing much faster than retail over the past five years as consumers prefer to spend money on more experiential pursuits, such as holidays, dining out and recreational activities."

James Knightley, senior global economist, ING, said: "Consumer spending is continuing to do well, however with the pound struggling and petrol prices not set to stop rising anytime soon, we could start to see people easing off at the tills. This may not come as soon as Quarter 2, but should be a key consideration as the year progresses. There is a secondary factor to consider as well, in that retailers themselves will incur rising fulfillment and shipping costs as the result of rising petrol prices. Retailers are already starting to feel the currency weakness, and this will only intensify over the coming months."

Martin Newman, CEO at Practicology, said: "Retailers started the year well, with January proving fruitful amongst the non-food sector. But as the weeks rolled on, progress began to slow, culminating in a terrible Easter fortnight. Fashion retailers were hit particularly hard, with the unseasonal weather again proving tricky to navigate, only further evidence that investment must be made in creating more trans-seasonal ranges that bridge the gap and accommodate for the predictably, unpredictable British weather."

Mike Watkins, head of retailer and business insight, Nielsen, said: "We are now eight years from the start of the global economic crisis and four years since we exited recession. Currently UK consumer confidence is now as good as it gets, and evidence suggests that the current consumer cycle may be coming to an end. Many shoppers also had rising disposable incomes last year but are still looking to save money. So something of a 'perfect storm' may be happening in terms of different external factors working against the retail industry. Shopping behaviour has changed and there is no turning back the clock, as shoppers are now digital and more demanding. The business models of many retailers need to evolve faster as technology is the new disrupter with the capacity to significantly change consumer expectations."

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