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UK Retail 2016 Disruption, uncertainty and strategic change

February 2016

UK Retail 2016: Disruption, uncertainty and strategic change

UK retail is a crossroads. The margin vice is tightening, it looks like 2016 will be the last hurrah for consumer spending and disruptive forces continue to provide both challenge, but also opportunity. In this environment, we believe that retailers who can balance demands on cash — and still innovate and invest to embrace new trends — are most likely to emerge stronger. On Thursday 21 January 2016, an EY panel with a wealth of retail expertise held a webcast to discuss their views and ask participants for their insights into the trends that will shape the year ahead.

1UK Retail 2016 Disruption, uncertainty and strategic change

A note on ‘like-for-likes’Positive like-for-like reports from retailers this January appear to contradict weaker survey data, but we treat this data with some caution. There isn’t an industry standard for reported like-for-like sales, whilst private companies are not obliged to report their figures and will often only do so if they are positive — thus distorting the overall picture. Moreover, these figures only look at the top line with very little discussion about profitability or cash. For instance, most apparel retailers managed to report sales growth, but margins undoubtedly have suffered through higher markdowns.

► Weak Christmas trading again came in two humps, edging just into the black on a surge in online sales

► The margin vice is tightening, with profits squeezed by pricing pressure, online costs & the National Living Wage

► Disposable income levels should rise again in 2016, but this could be consumers’ last hurrah

► Consumer behaviour is changing rapidly, with the weekly shop giving way to ‘discountvenience’

► Deal expectations have shifted from IPO exits to ‘distressed purchases’ as more companies struggle to keep up

► Fixing core problems is important, but retailers need to innovate and be bold to lead their sector

The margin vice tightens …Wet and unseasonably warm weather certainly contributed to anaemic like-for-like sales growth at Christmas, but UK retailers face challenges that transcend our unreliable climate. The economic outlook remains supportive. EY ITEM expects consumer spending growth to remain at 2.8% in 2016, due to delayed changes to tax credits, steady wage growth and low inflation, which should help hold interest rates at 0.5% for most of the year. Meanwhile, the housing market remains buoyant, supporting both spending and confidence in household balance sheets. So, why isn’t increased consumer health translating into increased retail health? The most significant sector challenges identified by our webcast participants chime with our view that UK retailers are effectively in a margin vice with no sign of this pressure letting up in 2016.

Margin pressures from discounting and deflation are, unsurprisingly, regarded as the main challenge. We see this pressure as twofold: competitive forces from within the industry and the consumers’ increasing desire to grab a bargain. Neither situation looks likely to change in the near-term, which leaves retailers with the challenge of having enough agility to react

effectively. Christmas sales patterns once again underlined how discounting is still driving demand, with sales again forming the shape of a two — or even three — humped camel as shoppers held on for bargains during ‘Black Friday’, Christmas week and the post-Christmas sales. In food retail, the ‘big four’ grocers performed better than expected, but it is far too soon to talk about a sustained fight back. Margins remained the story at Christmas — as they did for the rest of the year. We start 2016 with renewed price wars and an expectation that discounters will continue to expand their market share from 10% to perhaps more than 15% by the end of this decade.

What will be the key challenges for retailers in 2016?

Margin pressures from deflation and discounting 38%

Impact of national living wage 20%

Threat from market disruptors 2%

Maintaining profitability as sales move online 34%

Competition for consumer pound 6%

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The Christmas period also underlined the increasing importance of a robust online offering. Online was one of the primary growth drivers this Christmas, with Black Friday sales up 32% on last year and one fifth of non-food Christmas purchases made over the internet. The online shift might have been amplified by poor weather, the Paris attacks and the desire to avoid the scrums of previous Black Fridays; but the long-term trend is hard to ignore — as is the impact on the bottom line of increasing online sales. Over a third of our webcast participants identified this as retailer’s main challenge in 2016 and there are several pinch points. In a recent EY survey, 40% of retailers said increasing online fulfilment is margin dilutive. The delivery ‘arms race’ will only add to this pressure, if retailers continue to shoulder most of the cost of the final mile. Investment also needs to increase to capture sales and avoid problems that have beset retailers in previous peaks. Seven of the top 10 online retailers in the UK still have bricks and mortar stores, which puts

The margin vice continues to bite

Black Friday dominated by online...

Online sales on Black Friday (Experian, IMRG)

Footfall over the weekend (Springboard)

... but digital problems still apparent.

32%

9.6%

15

£5.3m

1 in 10

Major retailer websites suffered loss of service

Major retailer websites suffered loss of service

Parcels missed their delivery date

Competitive intensity: fight for the consumer wallet

Price pressure: expectation and competition

Margins vs. the omnichannel model: mutually exclusive?

National living wage: the war for talent

this discussion in a omnichannel context. ‘Click & Collect’ reduces fulfilment costs, but again it requires significant investment to create a seamless and flexible service across all channels. The question of store footprint also remains paramount. We’re seeing more negotiations for much shorter, leases, as retailers seek to gain greater flexibility to adapt.

Along with rising business rates, the National Living Wage (NLW) will add to the margin challenge, with the Resolution Foundation estimating that 2016’s wage bill will increase by 0.5% — rising to 1.3% by 2020. Our individual conversations with retailers suggest this figure could be higher and we estimate that up to 38% of employees could be affected. The impact isn’t just on existing minimum wage employees, businesses will also need to adjust pay scales throughout their organisation to maintain morale and retain staff. The NLW also raises questions around productivity and automation and has brought the discussion around the retention of talent to a head.


… and are consumers enjoying their last hurrah?Only a few of our webcast participants attendees choose competition for the consumer pound as one of the most significant challenges in 2016 — perhaps because other factors seemed more pressing. But retailers are certainly up against serious competition, with consumers focusing more spendings on ‘experiences’ rather than ‘things’.

This competition looks set to become even tougher by the start of 2017, when pressure looks set to build on disposable incomes again. Next year, inflation and interest rates will likely move higher. In addition, the decision not to reform tax credits was only a stay of execution — the introduction of the Universal Tax Credit is likely to have a similar impact. As a result of all these factors, we expect consumer spending growth to fall to nearly 2% in 2017 and continue around that level. The slowdown could come sooner.

Consumers aren’t immune from market worries and recent turmoil could trim confidence. Moreover, although employment is growing, average earnings are starting to slip again. The National Living Wage might boost the lower incomes, but the situation looks less healthy in the middle.

With this backdrop, retailers have the challenge of grabbing what they can from the consumer wallet in 2016, whilst planning how they react to and plan for the new retail environment. The pace of change is unrelenting, with demand increasingly unpredictable and more seasonal. We expect to see even stronger peaks and troughs in the future, with the introduction of more events — like the Chinese Singles Day — to drive demand. This is an interesting, but challenging time.

Deal focus shifts away from IPO to distressThe views of our webcast participants reflect this more troubled backdrop for retailers, with ‘distress purchases’ expected to lead deal making in 2016. This isn’t the kind of market to trigger a clutch of post-Christmas administrations; but the tightening vice on retailers’ margins — and disposable incomes by the end of 2016 — could squeeze a few retailers to breaking point in the next 12 months.

What will be the main driver of UK retail sector deals in 2016?

Distress (opportunistic purchases of near insolvency) 34%

Private equity exits via secondary sales 16%

UK trade buyers acquiring as part of long term strategy 23%

Overseas investors into the UK 25%

Exit through IPOs 2%

Meanwhile, just 2% choose ‘exit to IPO’ as the main deal driver this year, compared with 27% in 2014 and 19% in 2015. Troubled equity markets could have influenced this response, along with mixed retail IPO performances and a sharp slowdown in

new issues. The expected post-General Election IPO recovery never materialised in 2015, with numbers of new issues dropping from 14 in 2014 to just three last year — two of which were niche online players. Instead the focus has shifted to trade deals. Foreign purchasers have led the sector’s M&A revival in the last two years– notably from South Africa and China. The UK market is difficult, but there are still interesting propositions for overseas investors looking for geographical diversification. UK retailers have been shyer, but recent bids suggest we may see more activity — particularly from companies trying to reshape their business or improve their use of space.

The unpredictable nature of the sector does seem to have deterred mainstream private equity investment, although attitudes are changing to allow longer-term views beyond the traditional three-to-four year span. Investors clearly have cautious confidence in the market, which suggests that outside of IPOs, there is a breadth of options available to sellers. We expect companies to keep their options open and not hang their hat on one route early on.


A disrupted futureIn this age of innovation, disruption is now a given. EY expects that 70% of today’s major organisations will attempt to reinvent themselves digitally, 40% will fail and just one third of today’s major corporations will survive the next 20 years. The retail landscape has totally transformed in the last 15 years and we expect this process to accelerate as technology development speeds up, becomes more user friendly and becomes part of the mainstream customer experience. The consumer has growing expectations, as a function of our 24/7 digital lives. Loyalty is scarce and shoppers are demanding competitive pricing and convenience shopping — a trend we call discountvenience. We can see the impact in the types of retailers emerging to lead the market, from the ‘pure play’ online and true omni-channel retailers — where the experience feels the same at every touch point, to those who truly understand their customer and respond quickly to changing trends. This includes the off-price value clothing retailers who increasingly provide accessibility to luxury

brands at scale and the fashion houses who lead the way with responsive, on trend ranges.

Much of what we see in response are initiatives to fix short-term problems, for example looking at space, price, technologies that support operations and connect with the community to drive relevance. All of this is important, but retailers will need to think beyond this to thrive or even survive in this environment. We believe that leading retailers will win market share by being bold about new propositions to engage the ever evolving customer. Being bold doesn’t mean expanding budgets; but it does mean acting fast, if necessary failing fast, making sure lessons are learnt for the next time and to keep going. We’ve identified five winning themes that today’s emerging leaders are developing. The most vital lesson for retailers is not to wait — because your competitors are innovating already.

Themes Trends

Blurring Physical and DigitalCreating a customer experience that is the same as every touch point with the brand

► Use of digital to increase basket size

► Growing proportion of mobile-based digital orders

► Growth of ‘online’ as primary shopping channel

► Shifting towards experiential selling/complimentary services

► Pop-up stores positioning their activity around holiday/events

Store as a Theatre

To pull people into stores, retailers need to create interactive experiences

► Greater interaction between retailers and CP companies

► Shift in fulfilment

► Growth of independent shipping services to homes

Home not Shelf

Creating innovative delivery solutions

► Ideation and innovation to win and retain customers

► Increasing own brand penetration

Solution and ProductCreating solutions to customer problems rather than simply selling a product as a commodity

► Trend towards a ‘segment of one’

► Differentiation in offering to high-value/loyal customers

1:1 Customer Relationships

Driving deeper engagement to the end to end offer rather than simply providing another loyalty card


Contact details

Jessica Clayton Partner, Head of Retail for Transaction Advisory Services

Tel: + 44 20 7951 6415 Email: [email protected]

Helen Merriott Partner, Head of Retail Advisory


Martin Carr Strategic Retail Advisor


Christian Mole Executive Director, Transaction Diligence


Chris Lundquist Executive Director, Digital Retail and Store Operations Lead


Julie Carlyle Partner, Head of UK Retail



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UK Retail 2016 - EY - EY - United StatesFILE/EY-UK... · UK Retail 2016: Disruption, uncertainty and ... year and one fifth of non-food Christmas ... identified this as retailer’s