Outlook for the retail sector in 2015
NEW: OUTLOOK FOR UK RETAIL 2017. Our Outlook for UK Retail 2017 report is now available to download.The outlook for retail spending in 2015 looks set to improve with the combination of low inflation, reviving growth in earnings and resilience in the labour market ensuring that households’ real disposable incomes improve over the course of the year. A fall in the price of non-discretionary items such as food, petrol and energy bills should boost spending across other parts of the retail sector. The outlook for inflationary pressures faced by retailers looks set to remain low in the coming months. Lower import and producer prices suggest that there will be further scope for lower consumer prices – especially in fiercely competitive areas such as food, clothing, footwear and consumer electronics. Commodity prices, in particular oil, remain at low levels and the full impact of the downward pressure is yet to filter through the supply chain. Headwinds could come in the form of a slowdown in the housing market, which is likely to dent consumer confidence, and the inevitable hike in interest rates will hold back disposable income growth. We estimate that rate rises this time around are likely to impact households more than previously given around 65 per cent of mortgages are directly linked to Bank Rate. Any rise is likely to be more powerful than at the time of the last hike when there were only around 38 per cent of mortgages linked directly to Bank Rate. (To read about the impact of interest rate rises on consumer spending, please click here).Taking both the “push” and “pull” factors on consumer spending into consideration, Retail Economics still believes that spending could rise to between 2.5 per cent - 3.0 per cent in 2015 from current levels of around 2.0 per cent. However, we believe that 2015, being an election year, politics will play an increasingly important role although there is a higher degree of uncertainty. Key Factors influencing retail spending in 2015Growth in Real EarningsThe strength of the labour market has surprised most economists, none more so than those in the Bank of England involved in devising forward guidance! The recent reduction in labour market slack and the tentative recovery in productivity bodes well for a wider recovery in real earnings growth throughout the economy. In October, we saw the first rise in real incomes for over 5 years as inflation falls and incomes slowly rise. Given the outlook for inflation remains benign, we expect real incomes to rise throughout 2015. Saving and CreditProviding the economic recovery remains broadly on course, the prospect of households dipping into savings, saving less and acquiring further lines of credit seem likely. Rising house prices have provided a strong base for consumer confidence and households’ willingness to save less and spend more has prevailed. As credit conditions have also eased, and we think will continue to do so, we expect the household savings ratio could fall to lower levels and debt levels rise. The combination will support further consumer spending in 2015. General ElectionThe current government is unlikely to push further austerity measures forward this year irrespective of rising national debt levels and the ammunition this provides the opposition. The priority for government will be putting money in the pockets of households which bodes well for the first half of the year. However, there is a risk that there will be another hung parliament which will lead to a period of uncertainty. The composition of the next government will have a significant bearing on where the brunt of austerity measures fall for the remainder of the year. Interest Rate RiseCurrent expectations of an interest rate rise suggest summer 2015. The initial impact is likely to be felt through lower levels of consumer confidence as households begin to feel increasingly nervous about their exposure. However, we think sense will prevail and the MPC is likely to accept elevated levels of inflation in the economy if aggressive hikes begin to choke off recovery. In addition, the outlook for inflation remains benign which is favourable for a gentle and protracted rise in Bank Rate to more normal levels.The inside of retail While the underlying macroeconomic factors provide the backdrop for the retail sector in context of the wider UK economy, significant challenges remain inside of retail as the pace of structural change accelerates in 2015. This strategic retail transformation will be a formidable challenge for many retailers. The influence of digital technology will dominate tactical and strategic decision making across the industry. Retailers’ traditional business models will come under increasing pressure as old legacy systems are no longer fit-for-purpose and the customer journey becomes increasingly complex to measure and understand. Business models that thrived just five years ago will need to be ripped up and replaced with a short and more focused strategy fit for today’s digital consumer. The focus for retail will be on a: * Improved offer – more proprietary* Better experience – showrooming, convenience and seamless multichannel experience* Stronger brand – distinguished from large distributor modelNone of which is new and in many cases this is back to the basics for retailers but never has it been more important in this new age of retail where consumers are all empowered. Gone are the days of “caveat emptor” (buyer beware) as the new age is “caveat venditor” (seller beware). We also view the adoption of tablets, as a medium to purchase, to grow aggressively while the influence of smartphones on the purchase making journey will increase. As more powerful devices and better connectivity converge, consumers who browse on mobile in-store and purchase online will become more common place. Retailers will need to embrace this behaviour and focus on points of differentiation outlined above – excellence in offer, experiential retailing and strong brand. Click and Collect will continue to grow in popularity throughout the year as retailers improve and expand their offer. We view this purchase chain to be influential in 2015 but as delivery and delivery options and methods (such as lockers and pick-up areas) improve, the focus for pick-up is likely to shift to more convenient out-of-town and local collection points.The economics of retail is changing fast and this will accelerate. For many retailers, this shift in buying behaviour is a zero sum game. Total sales growth will remain flat with digitally influenced sales growing at the expense of pure store sales. The challenge for many retailers is the radical overhaul of aging business models in order to cope with evolving consumer habits. The grocery sector, in particular, is undergoing significant structural change. Increased competition from international retailers, especially in the food sector (Aldi and Lidl), will force retailers to pass on the benefits of lower costs to consumers. A number of large grocery retailers have already outlined their aggressive investment in lower prices. In addition, online grocery, the popularity of convenience, less waste and changing consumer habits is disrupting the industry. (Read more about structural changes in the grocery sector here: http://www.retaileconomics.co.uk/insights/structural-changes-in-the-retail-grocery-sector.asp) Retail is becoming less profitable. This trend will continue as costs of labour and property rise and competition intensifies. Any savings gained from cheaper imports and ‘cost of goods sold’ is likely to be passed on to consumers in a new world of price and service transparency. This will lead to further margin compression throughout the industry. While the challenges in the retail sector are formidable, there lies a significant opportunity for those retailers that provide a seamless omnichannel experience and react fastest to the changing dynamics of consumers.