Terrie Isaac and Justin Duffy talk to Paul Martin, KPMG’s UK Head of Retail, to discuss the key factors impacting retail in the context of the current global crisis. Paul has over 15 years of experience in consulting, market research and the consumer goods sector, and specializes in understanding global macro-economics and consumer trends. Based on his expert knowledge of previous recessions, Paul was able to provide a broad outline of the impact we should expect to see on the retail industry over the coming months and years.
BDA: Thanks for joining us today to provide the KPMG perspective on how you see the market moving. The instinct throughout this crisis has been for businesses to try and protect their cash flow. Are there any other key factors that you feel come into play when protecting business?
PM: I would highlight four key phases that businesses should be taking into consideration in the context of the current global health and economic crisis – react, resilience, recovery and the new reality.
The first phase was the ‘react’ phase, which we saw hitting the UK 10 days to a week before the lockdown measures were announced. It really depended on which side of the essential or nonessential retail equation you sat. If you sat on the nonessential side, cash and liquidity were front of mind during this phase, and connected to that was workforce optimization – do you take any of the government stimulus measures such as furlough, CBILS, CLBILS? There’s been a long list of fancy abbreviations, but for the retail industry, initially they fell between the small business scheme and the investment grade scheme. Thankfully, that has now been upgraded.
On the contrary though, if you sit on the essential side of retail, it was all about guaranteeing the resilience of your supply chain, product availability, and very importantly, the safety of both your customers and your staff.
BDA: Businesses have had to make some difficult decisions when it comes to their workforces, and we’ve seen how long-established relationships with suppliers have been affected. As we head towards a recession, what does ‘value’ really mean to the consumer now? We’re seeing brands discounting heavily and extending sales dramatically; what damage could that be doing to brands?
PM: There are six key drivers of consumption: being value, convenience, experience, choice, purpose, and finally, privacy and safety.
Generally, value rises to the forefront in economically uncertain times, and that will be no different going forward. If you look at the market share gains the discounters were able to deliver from the last financial crisis, it’s quite interesting to see on 1st January 2009 two value supermarkets had 3.7% market share. They now stand at 15% plus, so the value equation is going to be important, but – and this is a big but – the value retailers have historically always placed less focus on online.
We have seen online accelerate considerably in this context, but will there be other things that will be different? Value doesn’t always mean cheap, and that is a really important point. Massive markdown events, which we will see to a degree across the industry, will not be very helpful for the mid-market brands. We already have a challenge around pricing elasticity and margin management in the UK retail industry and if businesses - for understandable reasons - are wanting to clear stock once the lockdown restrictions are eased, going into mass markdown is not the answer. It will not wean the consumer off the drug that is discounts.
What’s been quite interesting is that KPMG’s consumer surveys in recent weeks have showcased that price promotions and special offers have really dropped off the top-five agenda. The focus has been much more around safety of product, availability of product and origin of product. Will price and promotion come back in a couple of weeks? Yes. But I do believe this is a great opportunity to reset the industry’s approach to markdown going forward.
BDA: You’ve touched on online briefly. As a result of the pandemic, it feels like consumers have almost been forced into changing their habits. Do you see the focus on online being a continued trend and will that lead to an acceleration in digital transformation for businesses, particularly at that value end of the market?
PM: Not just at the value end. I do believe that will happen across the entirety of the market. If we look at engagement pre-COVID-19 online sales had a medium penetration of 20% in the UK. Our forecasts pre-crisis highlighted that by 2025 it would likely reach 30 to 35%, and by 2030 it would reach a 50% penetration. I do think that has now been accelerated, and we’ll likely see penetration of 30 to 32% by 2023 and 50% by 2025 potentially.
Looking at China as an example, there was a 28% average penetration pre-crisis. During the pandemic however, online sales skyrocketed to 60% on average, albeit it is important to highlight that there was significant variation across the country. Even though things have calmed down, with various lockdown restrictions lifted, online penetration is still operating at 50% penetration.
Large parts of the consumer base in the UK – and indeed in other markets – will have interacted with the online channel for the first time, and in some cases on a much more regular frequency. These habits do stick and, even when the lockdown restrictions are lifted, people may still be nervous about the prospect of gathering in large crowds. Putting this further in perspective from a statistical point of view, KPMG recently posted April’s retail sales figures, in association with the British Retail Consortium, which showed that the online channel actually grew by 57%.
BDA: We’ve been quite fortunate in the UK, as have other developed countries, to have had access to strong e-commerce retailers. In less developed countries, where online retail isn’t so established and where lockdowns have been stricter, in some cases consumers coming out of isolation are ‘revenge spending’. Do you see there being any longevity to that, or is it something that will spike and plateau before returning to some sort of normality?
PM: I feel very privileged to have access to data from across the world in my position leading KPMG’s retail practice. Indeed, I speak with 20 to 30 different countries every week, and clear variations do become clear.
We have seen volumes in nonessential retail, specifically online, grow over recent weeks. We’ve also seen a very initial surge in spend in countries that have recently emerged from lockdown. However, very quickly this is returning to significantly reduced levels when compared to even the pre-COVID-19 period. There is pent up demand out there, so once people are able to go back to the high-street, some will do just that. Looking at the UK specifically, we have modelled spend across multiple retail categories, and even in 2021, we will likely still see a double digit decline in demand in many categories. What’s more, we don’t expect to get to pre-COVID-19 levels until 2022.
BDA: Do you think retailers should be concerned about consumers rushing back to stores, once restrictions are lifted, given they may not be able to replenish stock as normal due to delays in the supply chain?
PM: I think that’s less of a worry now. Lots of businesses are sitting on surplus stock, specifically in the non- essential categories, and more and more stock is arriving at British ports as we speak. The big problem is where do you put that stock? Distribution centres are full, as are stores.
Equally problematic, you’ve got the wrong seasonal stock in your store, so that is really a big headache for many businesses. Of course – and we’ve seen this widely published in the media – many of the non- essential retailers have canceled large proportions of forward-looking orders.
We’re seeing more and more businesses attempting to nearshore some of their supply, as well as also diverting some of their supply into multiple baskets. If you source from a single source or a single country, that’s obviously a high-risk strategy in the current climate.
There may well be spikes of COVID-19 over the next 6 to 12 months and, while we don’t necessarily anticipate another national shut down, it is likely that there will be regional spikes to be mindful of too. Retailers will naturally have to be poised and ready to deal with that, ideally remaining as agile as possible.
BDA: Do you think it will become increasingly important for businesses to become more agile, through ideas such as nearshoring, that may allow them greater flexibility and to react in a more fluid nature?
PM: As raised earlier, we believe there are four key stages for businesses to consider where COVID-19 is concerned – reaction, resilience, recovery and new reality.
Phase one, the react phase, endured for the first few weeks and most businesses have well and truly gone through that stage and are now in the second phase, ensuring resilience. They are operating business as usual albeit in a very different environment.
Businesses now need to be thinking about recovery and new reality, the third and fourth phases. These are not isolated phases; they are happening in parallel. Even though businesses are currently focused on improving resilience, they absolutely need to have their eye on recovery and new reality at the same time. Connected to this horizon scanning, business model and partnerships; the future of cost of doing business; purpose, and customer, must be looked at very closely.
Looking at business models and partnerships first, the traditional retail business model has been challenged for quite a few years now. In many ways there’s nothing new about some of the challenges on the high-street. If you look at the value chain in retail, it used to be as simple as: ‘you source great product, you ship product and you sell product’, but that’s become a lot more complicated in recent years. Look at the value chain and think of some of the additional components we now encounter, such as customer insights, process automation (including artificial intelligence). In many cases, as retail is a low margin sector, you’re not going to have the capital or the capabilities to deliver these transformative processes yourself, so you’re going to have to think about partnering. In some cases, that will entail partnering with big businesses and, dare I say it, even consider working with some of your competitors or smaller start-ups.
Turning to the future cost of doing business, cost base is going to have to go down by 20 to 50%, especially if you are a non-essential retailer. In essential retail, we may have seen a spike in demand and you’ll have seen several grocers reporting very positive top line growth numbers over recent weeks, but in most cases that is not translated into profitability. Indeed, the cost of retailing has only gone in one direction for the last couple of years, therefore the cost going forwards is just not going to be sustainable.
Purpose will also be key. Businesses that can show they have a clear purpose, and that they have behaved well in the current crisis, will be rewarded. The likes of treating customers, staff or the wider community well have all been closely watched. Conversely, we’ve already seen a number of organizations being put on the ‘naughty step’ for what has been deemed as bad behavior.
Finally, added focus on the customer will also be vital. Understanding your customer has never been more important. On one hand we see businesses that have true customer insight; those able to personalize their communications and their offers. On the other hand, many businesses do not have that capability today, and that will lead to the requirement of investing in a variety of technologies and capabilities to really enhance this crucial focus going forward.
BDA: A lot of businesses are trying to understand how they can use this as a catalyst for positive change, identifying lessons that can be learned. Who do you feel will be the big winners as we come through the other side of the pandemic?
PM: If I think about the future of the retail industry, I might even be as provocative to say it won’t be called ‘retail’ in 5 to 10 years from now. More likely, it will be called ‘consumer commerce’, as the distinctions we once knew become increasingly blurred. You’ll have the large technology businesses that happen to sell consumer products and services. You also have the businesses that are increasingly trying to become platform businesses too.
You’ll still have the national heroes, especially the supermarkets, but they will have to start thinking about broader buying alliances. By that I’m not referring to the buying alliances of old, where you would source own label products such as toilet paper at the cheapest possible price. You’ll need to use these new buying alliances as a research and development innovation hub, a buying hub, and as a skill and talent development hub. Most likely you’ll have to start thinking cross border to do that.
The fourth group of winners will be the value players, who are historically much more profitable. That said, they will have to fix the lack of online. That’s going to be a key component moving forward, as discussed. The fifth group are going to be ‘category heroes’ – often smaller businesses that have really built expertise in a specific niche and are world class in a specific subcategory. But if you look at the totality of that category, they often have less than 2% market share and therefore fly below the radar of some of the larger multinational players.
The sixth and final group of winners will be brands. You will see more and more brands cut out the middle person or use the first and second group, the platform businesses, to go direct to consumer. Some of those brands who have always struggled to build their own retail capabilities are now increasingly going to have to do that. For those that don’t fall into the buckets outlined above, it’s likely they’ll fail in the next five years or so.
BDA: The luxury space has been on a decline for some time now, do you think that players in this arena could be the major casualties of this period?
PM: Luxury is a discretionary category that has its challenges. Discretionary spend is going to be significantly under pressure over the next few months, if not years, but we are seeing certain luxury platforms that are quite well positioned to continue benefitting from this trend, so it’s always a really interesting one. I think even in some of the most challenged categories, you spoke about luxury, you could speak about womenswear, there are winners and there are losers, but you can’t write off entire categories.
BDA: When we do emerge from this situation, and when things do start to settle into whatever normal looks like, what do you think the key lessons will be that will be taken forward and applied to how we do business?
PM: I spoke about the four key trends: the business model, the cost of doing business, purpose and customer. None of those themes are new, but COVID-19 has really functioned as an accelerant in that context. That’s the key thing. Nobody can plan for an event like this, but at the same time, a lot of work that should have been done over several years has now been pivoted to the front of everybody’s agenda. If you don’t do it now, you won’t be here in the future.
BDA: Within risk management a lot of businesses would have been prepared for a whole range of events, but people were not expecting this to accelerate as quickly as it did.
PM: It’s always interesting and as an organisation, KPMG has been prominent in the restructuring arena, especially within retail. You generally see different waves of failures in the context of a specific event, such as a recession. You generally have a small number of immediate victims, as we’ve experienced over the last couple of weeks. Then, normally 3 to 6 months later, we have the next wave. I predict that will happen come September or October, when the furlough scheme has wound back and businesses must start covering the true cost of their operations. As we know in retail, the dependency on the Christmas trading period is exceptionally high for a few different categories. We traditionally see a wave of insolvencies post-Christmas, and we’ll probably see those three waves over the next 6 to 12 months.
BDA: Everyone is so focused on the immediate but, as you say, some businesses are so dependent on the Christmas trading period. It’s going to be a really interesting period, and the customers’ outlook on Christmas will also be interesting.