Inflation: instilling a new sense of retail bravery?
This week’s Retail Note addresses the issue of inflation and presents the somewhat contrarian view that it is not necessarily all bad for the retail sector.
7 minutes to read
Key Messages
- Inflation remains stubbornly high (CPI 8.7% in April 2023)
- Receding very slowly, despite annualisation
- ONS suggests grocery inflation of 14.4%; non-food 6.4%
- Retail inflation lagging raw input cost declines
- Growing accusations of retailer “profiteering”
- Hard to substantiate given decline in most retailers’ profit performance
- Sea-change in retailers’ mindsets
- Fear of consumer push-back previously a constraint on wider brand investment
- Retailers increasingly competing on a non-price-based playing field
- Customer remains king
- But customers value brands more than anything else.
Surely only the most myopic, die-hard optimist could see anything positive in the stubbornly high inflation figures? Optimism is something I’m rarely accused of, but on this occasion, I may just be that person.
The negative impacts of inflation are not so much well-documented as completely done to death. While maybe not quite as apocalyptic as our friends in the media would have us believe, the negative impacts are still very real. And the retail sector is both front and centre of this – at the full mercy of input and energy price hikes and simultaneously a mediating force as to how this is distributed to the consumer. Perversely, both a victim and perpetrator.
Challenging as the inflationary environment has been, it has also had some surprising by-products for retailers themselves. In the most general of terms, it has had a galvanising effect, sweeping away any vestiges of complacency (such as any were left post COVID). On a more tangible level, it has led to retailers reviewing their pricing stances and reverting to what was previously known as “honest pricing”, although there is now a certain irony in that, as I will go on to discuss. But with this shift has come a welcome drive to establish brand equity – operators electing to fight it out on competitive credentials other than price.
This new-found bravery in the face of adversity is also starting to manifest itself in other ways too – retailers taking a much more pragmatic view on the financial dynamics of online retailing, increasingly imposing more realistic delivery tariffs while also taking a harder line on the other margin-sucking issue of product returns.
Retailers were previously too scared to break rank. Inflation has arguably turned that on its head. And, I would argue, for the better.
Inflation vs deflation
Inflation is a good thing. Discuss.
For the retail sector, it most definitely is. But low inflation (<2%) is obviously a lot healthier and more manageable than the double-digits we have seen over the past year. But both are preferable to deflation, which is far more damaging to retailers than is widely acknowledged. Because it is perceived to be good for consumers, this tends to dominate the narrative.
In very simple terms, in times of deflation retailers have to run much harder to stand still. They have to sell more of the same just to make the same money. It is absolutely no coincidence that the retail market struggles most when in deflationary territory.
Of course, there are a myriad of mechanics and push and pull factors that underpin price movements. In the current climate, many of these are “external” to the domestic retail scene, UK retailers are largely pawns rather than kings or queens. This is not always the case. Previous deflationary periods in retail were often self-inflicted by retailers, who became far too embroiled in a vortex of discounting and promotional activity and/or were too scared to pass on any inflationary pressure to the consumer.
To preempt the obvious response from consumer champions: what’s wrong with retailers slashing prices, running loads of promotions and generally giving shoppers bargains? Surely that can only be a good thing? With a retail hat on, the assessment is very different. Unless a retailer’s very business model is based upon low price (think Aldi, Lidl and Primark), price is a very blunt instrument upon which to compete. Value is a much more multi-dimensional thing than price - and much more multi-faceted basis of competition. Although purveyors of low prices, Aldi, Lidl and Primark have many more strings to their respective bows than just price.
Retailers blindly running blanket promotions and offering seemingly never-ending discounts obviously has a very negative impact on gross margins. Even more damaging than that, it undermines retailers’ brand equity – becoming synonymous with constant sales/discounts is a difficult cycle to break. Above all, it sends out the message that a retailer is not confident in its own brand. And if a retailer isn’t confident in its own brand, why on earth would a consumer be?
Consumer champions may need convincing, but I would go as far as to say that brand devaluation has been one of the key structural failings of the retail sector over the last 20 years. One of the drivers behind this has been retailers being too scared to pass any inflationary pressures onto consumers for fear of being ‘out of sync’ with the market and losing precious sales as a result. Lowest common denominator retailing, if you will.
That was then. This is now.
“Honest pricing” not necessarily “profiteering”
Probably more by default than design, retailers’ mindsets have changed. Such have been the inflationary pressures on input and energy costs that retailers have had no choice but to pass them onto consumers in some shape or form – they simply could not absorb them themselves.
The result? Probably not as disastrous as they would have thought when under the strait-jacket of price conformity. As the monthly retail sales updates have shown, consumer demand has proved surprisingly resilient. Volumes may have declined (i.e. consumers may have bought less) but values (i.e. total spend) have remained firmly in positive territory. Not a perfect scenario by any means, but it could have been far worse. Price increases have been passed onto consumers and rather than push back, consumers have reacted accordingly. Shopping behaviours may have changed, but consumers have not simply stopped spending.
High inflation has therefore ushered in a return to “honest pricing” – retailers trading at full price, rather than relying on promotions and discounts. But is pandora’s box now open and there is no impetus for retailers to ever lower prices? This is increasingly becoming the narrative and “honest pricing” is now deemed to be anything but – “profiteering” and “greedflation” two buzzwords we are going to see a lot of in the coming months.
To be honest, it was only a matter of time before the finger of blame was pointed towards retailers, particularly the grocers. With raw material prices now receding, any lag in retail pricing was always going to be amplified. But “profiteering” seems a very hollow accusation set against the fact that all of the major grocers, without exception, have taken a significant hit to profitability over the past year. Juggling price increases across such a vast SKU count while keeping the customer satisfied has been a challenge of Herculean proportions. Retailers have had to rely on the full armoury of their brand, rather than just price.
Those that cite the major grocers’ profits in absolute (£) terms in their “profiteering” accusations are sadly somewhat adrift in their grasp of economics. Retailers are not charities, they are commercial businesses. Commercial businesses need to make a profit. Need I go on…
Other manifestations
This change in mindset is also manifesting itself in other ways. There are other examples where retailers are more inclined to break rank than they were before.
Online is another area where retailers have traditionally been running scared of being “out of sync” and suffering as a result. Retailers have generally been reluctant to pass the true costs of online fulfillment to customers, for fear of being out of step with the competition. Slowly but surely, this is changing with retailers gradually raising prices for both click & collect and delivery services. Retailers are also increasingly grasping the nettle that is abuse of returns policies. Previously, the fear of a consumer backlash prevented them from doing so.
In very general terms, retailers are slowly regaining their confidence, without fear of consumer pushback. That is not to say that the customer isn’t king – he/she always will be, but price is far from being the only consideration in driving purchasing decisions. Retailers are slowly rediscovering the importance of their brand and are investing accordingly – both financially and strategically.
Far better to see retailers competing on the basis of brand than engaged in a price-based race to the bottom. Yes, the macro-environment is incredibly tough and the cost-of-living crisis a very real thing for many. But price is not the only retail response.
To answer the exam question: Inflation is good. Deflation is terrible. High inflation is not good – but some good can come from it. And increasingly is.