Retail Think Tank April 2023

• The cost of living crisis is still creating challenges for retailers – but there are reasons to be optimistic.
• Post-pandemic access to physical retail has driven consumer appetite, and the big industry players are reconfiguring their store portfolios to optimise their physical presence.
• The RTT questioned the viability of the online-only retail model, suggesting that most retailers would succeed by refining their omni-channel offering.

After years of speculation that online retail would cannibalise bricks-and-mortar stores, the high street is making a comeback – driven by the cost of living crisis, and a post-Covid appetite for real-life experiences.

The retail sector is emerging from a turbulent winter – characterised by its own high costs, rising interest rates, strikes in other sectors, and inflation hitting consumer spending power.

Even with the government’s support packages for households, including the energy price cap, retailers have seen volumes dwindle and profitability dented as households focus on buying essentials and trading down from more expensive lines. 

At the first quarterly meeting of the KPMG/Ipsos Retail Think Tank (RTT) this year, members agreed that the road ahead was likely to be rocky in Q2 – however, going into the summer months, there are reasons to be optimistic.

They suggested the sector is potentially reaching an inflection point with inflation set to slow as energy prices stabilise, while the historically low unemployment rate and fast wage growth should bolster consumer confidence.

This is expected to provide a boost for retailers with physical stores, who have long had to watch their market share being eaten up by online-only players with no costs related to physical stores and overall lower cost of capital benefitting customer acquisition.

Now the tide is turning, as pent-up demand for in-person experiences after the pandemic is driving people to shops and leisure attractions. Meanwhile, value retailers, who often don’t have unprofitable online channels to service, are benefitting from more cost-conscious consumers opting to shop with them.

But the RTT stressed that retailers will still need to significantly invest in technology to refine their omni-channel offer – delivering not only exceptional experiences for shoppers but also driving down the cost to serve, especially while high levels of inflation continue.

Grocers, in particular, are taking a hit on margins as they absorb the cost of rising food prices and increase promotional offers to retain market share. The risk is that high food inflation could dampen overall consumer demand elsewhere in the wider retail sector.

Mike Watkins, Head of Retailer and Business Insight UK – NielsenIQ, said: “The economic challenges haven’t gone away and even when inflation slows, food and energy will still cost significantly more than two years ago which means shoppers will remain cautious about what they are spending. Food inflation is going to be the wild card for Q2 as it is not easy to call the peak and, if it remains higher for longer, it might impact the non-food and hospitality sectors as many households will still struggle to balance the books “

The buffer of savings some consumers built up during the Covid  lockdowns has been eaten away by inflation, both in terms of its value due to rising inflation and because they’ve had to dip into them.

Explaining more, Ruth Gregory, Deputy Chief UK Economist, Capital Economics, said: “If we are right in thinking that pandemic savings are now less powerful, households will no longer be as able to use those savings to support spending, so real consumer spending may evolve more in line with real household disposable income.”

The performance of the sector is reflected in the RTT’s Retail Health Index (RHI), which dropped one point in Q1 2023, as rising costs continued to hit profitability.

However, all signs suggest the summer months will bring improvements as inflation continues to ease, employment remains high and retailers receive a boost from spending during the Coronation Bank Holiday.

It would be easy to think the cost of living crisis would push consumers seeking out rock bottom prices even further online – but that doesn’t seem to be the case. In fact, it seems that the market is rebalancing after the pandemic.

The RTT agreed that retailers with only a physical presence, particularly the discounters, were currently at an advantage compared to those having to subsidise unprofitable online channels.

Paul Martin, UK Head of Retail, KPMG, said: “If we go back to August 2019, we saw online growth dip to below 10%. Now, we’re in the same place again, albeit the market has grown by 50% overall. We’re seeing equilibrium in the sector, with online penetration lower than  predicted during Covid. In fact, online penetration for non-food sales has dropped every month in Q1 of 2023. When compared year-on-year – non-food online penetration has fallen from 40.7% in March 2022, to 38.4% this year.”

The RTT also suggested that physical stores were more appealing to budget-conscious shoppers. Nick Bubb, Retailing Consultant, Bubb Retail Consultancy Ltd, said: “The big conundrum is how far the cost-of-living crisis has stimulated the return to store shopping, with the most hard-pressed consumers finding it easier to control their spending and check for price promotions in-store, rather than online.”

While the barrier to entry might still be lower for online-only retailers, they’re currently grappling with growing warehousing costs, including a rise in business rates, competition from ecommerce giants, and consumers who want a change from non-stop digitisation.

James Sawley agreed that the balance was tipping back towards physical retailers: “Some of the big winners are the discount stores who’ve achieved growth without being able to transact online. The pure-play ecommerce model has become increasingly challenging following the collapse of some big names. They have high supply chain and marketing costs, and it’s often a race to the bottom on pricing.”

At the same time, the RTT pointed out that while ecommerce brands are being acquired by physical retailers, investors are also eyeing up city centres, looking to transform existing spaces into a mix of retail and leisure attractions.

Jonathan De Mello, Founder & CEO, JDM Retail Consulting LLP, said: “Online retail has become too much of a crowded space in the post-Covid world, which has sparked a sea-change in physical retail. Big names in the physical retail world are snapping up online brands, and sometimes investing in entire shopping centres. There’s demand for former department stores, office and residential buildings, which can be repurposed as entertainment emporiums with shops and leisure attractions, like cinemas and mini golf. Online retailers, on the other hand, are not only fighting for spend from physical and other online stores, they’re also seeing their costs rise due to the hike in business rates on warehousing space. While online pure-plays will pay much higher business rates, physical retailers will benefit from lower rates across many locations.”

Members of the RTT were in agreement that the improving fortunes of the high street is being driven in part by a continued shift in consumer behaviours after Covid lockdowns forced shoppers online.

James Sawley, Head of Retail & Leisure, HSBC UK, said: “Humans are inherently analogue and there is some pushback on the increasing digitisation of our lives. My bet is that younger people who lived through the lockdowns will want to go shopping.”

This return to a more social customer experience represents a major opportunity for retailers which are prepared to invest in their physical presence.

Martin Hayward, Founder – Hayward Strategy and Futures, added: “The recent focus on online sales has been an own-goal for physical estates and now that consumers are starting to reassert their needs, there is a huge opportunity for investment in stores, inventory and staff.” 

Even if shoppers flock to the high street, the RTT believes that the appetite for convenience driven by technology won’t go away. While it might not be cost-effective for the discounters to start investing in online channels, most other retailers will need to refine their omni-channel models so they can serve customers better at every interaction.

Maureen Hinton, independent retail analyst, said: “We are social beings and, post-Covid, there is a big opportunity for physical retailers to win more customers. However, this does not mean online is finished  – the pandemic converted many agnostics to the channel and boosted online in sectors such as furniture where penetration was low. It’s about getting the balance right and offering the convenience of the omnichannel experience that consumers now expect. The challenge is how to do this profitably.”

Moreover, consumers are becoming less concerned about what channel they use but how well it meets their needs at the time.

Joe Marshall, Managing Director, Customer Experience and Channel Performance, Ipsos Retail Performance said: “The line between online and offline is blurring. Customers want to pick the channel that best meets their needs – it’s become very fluid. For omni-channel retailers who get it right, the future is positive. It’s more challenging for those who’re fixed to one channel.”

In the grocery sector, members agreed that retailers would need to strike the balance between offering different ways to shop and building customer loyalty. Mike Watkins said: “As consumers seek out different ways to shop for groceries, the challenge for the big supermarkets is to retain the loyalty of shoppers’ spend at their stores and limit the loss of sales to other store-based retailers. Whilst at the same time, maximising the longer-term growth opportunities in omni-channel and multi-mission retailing which are being driven by demographic and lifestyle changes.”

Members discussed whether retailers could subsidise less profitable channels in order to deliver an omni-channel experience. They concluded that it was possible – but only if it was underpinned by digital transformation across the whole business.

Paul Martin commented: “Whereas the big ecommerce platforms can prop up multiple channels, other retailers have to be smarter in order to avoid a race to the bottom. They can still subsidise different channels – but they have to fundamentally change the cost structure of the business and use more automation across the supply chain, including last mile. It’s interesting to see Switzerland discussing the option of nationalising last mile delivery due to there being too many delivery vehicles on smaller roads. Geolocation analysis needs to be more accurate too so retailers can see exactly which channels will deliver the best ROI.”

Members agreed that digital transformation is still siloed in different departments – and horizontal transformation across the business is needed to ensure that each one works seamlessly together.

Miya Knights, Director, Zendu Contracting Services Ltd and Publisher, Retail Technology Magazine, added: “Margin optimisation and omni-channel are the key areas that retailers will need to concentrate on. At the moment, they don’t have the data to orchestrate their strategy successfully. They need to have the right technology to understand customer preferences, location, warehouses – with their systems identifying the most profitable segments and locations. They also need to be able to see that opening a store could generate, say, three times more sales volume compared to online.”

The RTT believes that stores can have a ‘halo effect’ by delivering value beyond the sales generated in store, as long as they’re located in the right areas. Consumers haven’t lost their love of technology, but they may use it in a different way. Using store mode on apps, for instance, is a way to deliver seamless in-store experiences, so people are less tempted to use their mobile to compare prices or make purchases with competitors online.

Miya Knights said: “The UK is one of the most voracious online shopping nations in the world and how consumers use apps in physical stores is important. Many of them will use their phone to pay, and retailers could encourage certain behaviours with a store mode on their app. Whatever channel consumers choose, retailers need to give them the confidence that they are buying the right thing first time, in order to drive sales and reduce returns.”

Members of the RTT are quietly confident that the health of the retail sector will improve towards the end of Q2 and continue on an upward trajectory over the summer months. Retailers and investors recognise the appetite for in-person experiences and are developing new destinations, tipping the balance away from online retail.

The extent to which retailers invest in different channels will depend on their model. There’s still room for online-only retailers, particularly niche ones, while some of the most successful discounters have avoided, or removed, home delivery completely. Most retailers, however, will tread a middle ground with an omni-channel offer, using technology to drive behaviours in-store rather than pushing people to make purchases online.

What’s clear is that digital transformation across every part of the business will be critical to realising this omni-channel ambition and competing with ecommerce giants. Consumers might be looking for in-person experiences but that alone won’t drive success.

Retailers must therefore be data-driven in their decision-making. With good-quality analytics, they’ll be able to see which channels are the most and least profitable; where cost-savings could be made and whether it’s worth subsiding less profitable channels. Moreover, every store opening must pull in consumers with the promise that they can interact with a brand via whatever channel best meets their needs at the time.

The stage is now set for retailers to strike back against their pure-play rivals as the summer months draw people out of hibernation. In an ever-changing sector, they’ll need to act quickly – maximising their data to identify emerging opportunities and refining their omni-channel models to improve customer experiences.