How sustainable are retailer business models given a sales trend linked to debt?

HOW SUSTAINABLE ARE RETAILER BUSINESS MODELS GIVEN A SALES TREND LINKED TO DEBT? The volume of retail sales has been on a steady upward trend of around 4 to 6 per cent since 1999. In textiles, clothing and shoes, and the household goods sectors - especially DIY which has seen substantial growth - volumes have increased significantly. Positive as this sounds, there has been a simultaneous decrease in the price of these goods in real terms. Retail sales volume growth has outstripped the rate of price deflation at the aggregate level, however there a larger number of retailers and, with this increased competition, retailers profits are being squeezed. Given the expected decline in retail sales in the short and long term and increasing competition leading to price stagnation if not further decline, how sustainable are retailer business models? Dr Brenna O'Roarty, Head of European Retail Research at Jones Lang LaSalle, explores the implications further. The level of retail sales achieved in 2001 is all the more surprising given the comparatively shaky year consumer confidence has experienced. Foot and mouth, a slowing global economy, recession in the UK manufacturing industry and 11 September could all be expected to have hit consumer confidence hard. In fact, although consumer confidence declined it was remarkably resilient given the circumstances and rebounded to above the avergae trend for the 1990s by the end of 2001. In terms of spend, retailing benefited from substitute spending that would otherwise have been spent on travel and tourism leading to the buoyant sales levels experienced. Low interest rates and therefore affordable debt have helped to drive consumer spending. At the same time, above inflation income growth, low mortgage interest rates and strong house price (equity) growth have provided reassurance to consumers. "Rising debt," says Dr Brenna O'Roarty, "is, on one level good news since strong consumer spending is a means of underpinning the economy in a low inflation environment when business confidence has weakened and, essentially, offers the potential to buy a way out of recessionary threats. In the current climate, increasing debt is still affordable but not sustainable as a means of fuelling consumption. Given how low interest rates are, most could live with an increase in interest rates. However unexpected it is worth noting that with the high volumes of unsecured debt (brought on by credit card debt and unsecured loans) if something does go wrong it is likely to go very wrong indeed." The outlook for consumption levels in the UK over 2002 suggests that current levels of sales growth are unsustainable. The impact of rising unemployment (albeit from an extremely low base), a slight deceleration on earnings growth and moderating house price growth will slow consumer spending. With the substitute retail spending now also being channelled back into leisure and tourism, there is less of the consumer cake for the retailers to enjoy. All of this points to slower growth for retail sales. With the relationship between sales volumes and profitability weakening as profit margins narrow, retailers have been focusing on managing the cost base as a means of improving margins. These costs comprise staff, stock, distribution and property costs. In the current low-unemployment economy, there is little opportunity to reduce staff costs and, while many retailers have been adept at sourcing cheaper goods from regions with a lower economic base, consumer pressure for ethical /socially responsible retailing limits further savings potential. Distribution and property are therefore key. Efficient and effective distribution and logistics operations can help to manage the cost base in two critical ways: by providing 'just-in- time' deliveries which help to: decrease storage space and increase sales space; manage stock and give flexibility to order more of popular lines and discontinue poor performers; reconfigure the distribution network for greater efficiency by creating one large-scale central hub facility serving local facilities, and so doing away with a middle tier in the distribution chain. Traditionally retailers used store expansion programmes as a means of increasing market share. However, opportunities for retailers to increase sales need to be managed against sales cannibalisation where they are, in effect, taking sales from their own outlets. Gap, for example, has seen problems in the US with store over expansion exacerbated by its Old Navy, Banana Republic and Gap formats all overlapping and competing for the same customer share. Presently, as consumer spending polarises in terms of where it happens between regional and local, and experience and convenience, retailers are following suit. This enables them to increase margins by reducing total costs of both property and staff. The total amount of sales space is not necessarily reduce, but acquiring larger stores results in a lower cost per unit area as retail space is priced to incorporate economies of scale. At the same time they increase sales through enabling a wider retail offer increasing the range and thereby basket sizes. Arcadia's reversal of fortune for the better is a good example of its recognition of the benefits of this property strategy. In conclusion, Brenna O'Roarty says, "While existing debt levels may be affordable, continued borrowing to fuel demand is not sustainable. At the same time we will continue to witness pressure on retailer margins through strong competition leading to price deflation and at best, stagnation with management of the cost base providing a clear means of enhancing profits. This will dampen any prospects of rental growth which is already under pressure, and expected to marginally outpace inflation in the short term. Moreover, investors are under pressure to reconfigure property holdings to meet retailer demand for large stores of between 500 1500 square metres. This is could news for investors/ retailers holding very large stores which can be reconfigured. However, with retailers demanding larger stores, shopping centre owners are experiencing a decline in total income as they convert smaller, and, per unit area, more expensive space into large stores. Given the profits growth this enables, strong demand for the right space is expected to generate an increase in the unit area cost of such space, thereby readjusting the cashflow in the medium term. " "In the longer term, the key to retail performance for schemes is in understanding and positioning centres to meet the needs of the local catchment population in terms of their shopping behaviour rather than by age and income alone. This is particularly poignant for those schemes falling between the stools of 'experience' and 'convenience' location and is neatly provided for through socio-cultural analysis which enables effective strategic positioning of the asset in terms of retail function (experience, convenience, value, lifestyle), tenant selection / mix and design." -ends- Notes to editors: Dr Brenna O'Roarty is Head of European Retail Research at Jones Lang LaSalle. She undertakes a research and development role, focusing upon the impact of technological, economic and social change upon market participant behaviour including retailer, developer and investor strategies, valuation and investment decision making, with a view to the development of innovative solutions. A full copy of the report is available through the Jones Lang LaSalle web site at www.joneslanglasalle.co.uk Jones Lang LaSalle is the world's leading real estate services and investment management firm, operating across more than 100 markets on five continents. The company provides comprehensive integrated expertise, including management services, implementation services and investment management services on a local, regional and global level to owners, occupiers and investors. Jones Lang LaSalle is also the industry leader in property and corporate facility management services, with a portfolio of approximately 700 million square feet (65 million square meters) under management worldwide. LaSalle Investment Management, the company's investment management business, is one of the world's largest and most diverse real estate investment management firms, with $22 billion of assets under management. For further information or comment, please contact: Dr Brenna O'Roarty, Jones Allyson Andrews/Charlotte Lang LaSalle Freeman, Head of European Retail Public Relations Department on Research +44 (0) 20 7399 5426/5616 +44 (0) 20 7399 5401 allyson.andrews@eu.joneslangla Brenna.O'Roarty@eu.joneslangl salle.com asalle.com charlotte.freeman@eu.joneslang lasalle.com or Ben Copithorne / Catherine Bostock, Camargue on +44 (0) 20 7636 7366 bcopithorne@camarguepr.com cbostock@camarguepr.com ------------------------------------------------------------ This information was brought to you by Waymaker http://www.waymaker.net The following files are available for download: http://www.waymaker.net/bitonline/2002/02/22/20020222BIT01020/bit0002.doc http://www.waymaker.net/bitonline/2002/02/22/20020222BIT01020/bit0002.pdf