The health of the retail sector continued its slow decline in the opening months of the year, as soaring food inflation and greater use of promotions to attract footfall hit retail margins and profitability, according to the latest assessment by KPMG/Ipsos Retail Think Tank (RTT) members.
As retail data pointed to better than anticipated consumer demand in the opening quarter of the year, the KPMG/Ipsos Retail Health Index (RHI) fell by one point in Q1 23, with RTT members concluding retailers will have found it harder to achieve profitable growth in light of rising costs and tighter margins.
Margins continue to be squeezed with some retailers choosing not to pass on price increases to customers, in order to keep demand stable. While some costs such as commodities and freight have already started to improve, labour costs are the biggest challenge facing the sector, with wages rising to entice much needed staff and to avoid staff churn. Rising manufacturing costs are also challenging retailers, many of whom have exhausted cost cutting exercises.
Continued government energy support, the use of savings amassed through the pandemic, and a host of special occasions during Q1 23 helped keep consumer demand relatively strong for both food and non-food items over January – March. However, RTT members questioned whether this was healthy demand, or a result of increasing promotions both online and on the high street, as the sector fights hard to generate footfall.
With the grocery market accounting for around half of retail sector spend, rising food inflation, which is still running at 19.6% (but still lower than many other European countries), continue to have an impact on all areas of retail, putting a drag on consumer demand for non-essential spending. Failure to control rising food inflation is likely to cause a continued decline in retail health into the summer, according to the RTT members.
Commenting on the Retail Health Index, Paul Martin, UK Head of Retail at KPMG, said: “Demand from consumers held strong in the opening months of the year, but food inflation continues to have a huge impact on household budgets, with people spending much more to take home around 5% less goods. Retailers are fighting hard for every sale right now and with market share at risk, and stock rooms getting fuller due to wet and colder weather, we have started to see a number of retailers launch price cut programmes in a bid to entice consumers in, which will inevitably hit their profitability. The health of the sector continues to slowly decline against a backdrop of rising costs, as retailers struggle to create healthy demand, which not only sees their sales going up, but their profits going up also.
“UK consumers are resilient, and we are beginning to see the drag on real incomes from high inflation starting to fade, but much like the retail operators they are adjusting their spend and working hard to look at where they put their money. It’s a really mixed environment in retail right now. Whereas during the pandemic we had winning and losing categories of goods, we are now seeing winners and losers within categories, so even for example, in the grocery sector which is performing well, you have operators that are doing really well, and some that are really struggling.
“The retail sector has done a good job of fending off the challenges of the last three years, and it is testament to its strength that we haven’t had more casualties given the economic headwinds. It feels as if economic conditions are improving and providing inflation continues to fall and consumer confidence returns, we could see the sector rebound and rebuild as early as autumn.”
Food inflation is the wild card that could tip sentiment in Q2
Looking ahead the decline in retail health is considered by RTT members to continue in Q2 23 with the RHI falling again by 1 point to 70 points. With signs that the economy is starting to improve, there is some suggestion that the next few months could be the stabilisation mark, with conditions improving in the second half of the year.
The next quarter (April – June) will see a number of new challenges come into effect for the sector, such as the rise in minimum wage rates, rising household bills, the fading of government energy support and rising interest rates which could dent consumer spending. However, with year-on-year utility price inflation likely to fall sharply in April, which could see overall CPI inflation fall from 10.1% in March to 7.8% in April and with current wage growth sitting at 5.9%, RTT members believe that we could reach the key inflection point between wage growth and CPI inflation in Q2 23, which would boost consumer confidence.
However, the big unknown for the next quarter continues to be food inflation which is driving instability across the retail sector and a concern that higher food price inflation could be here to stay. Whilst commodity prices are now back at levels seen before the war in Ukraine, they will take several months to feed into supply chains in the UK. UK food price inflation, is expected to remain in double digits in Q2 23 meaning consumers will continue to spend more of their disposable income over the summer on groceries, possibly at the expense of non-essential spending. The RTT believe supermarkets will put more promotional activity in place over Q2 23 to keep consumers coming through the doors.
Joe Marshall – managing director, customer experience and channel performance, Ipsos Retail Performance, said: “Demand has been fairly resilient to the twin drags of high inflation and high interest rates as a result of faster wage growth and government energy support, which has supported nominal household incomes. However, as fewer people receive cost-of-living payments from April, pandemic savings start to dwindle and households devote a larger share of their incomes to interest payments, it is likely that the next few months will see retail health continue to deteriorate slowly as the consumer tank becomes empty.
“Whilst falling inflation in the wider economy could provide a boost to consumer confidence, soaring food inflation shows little sign of sharply falling in the next quarter and will be the wild card for Q2 23 having a significant knock on effect on non-essential spending. The grocery sector is the fastest growing part of the consumer wallet at the moment, so consumers are spending more of their money in the one area that is getting disproportionately more expensive. Having absorbed price increases to the detriment of their own margins, food retailers are now having to use significant promotional mechanics to drive footfall which will continue to impact profitability, in the fight to keep market share and is likely to intensify until food inflation starts to comes down.”
