Online tax will not level the playing field
COVID-19 Market Update – 03/08/2020
12 minutes to read
Introduction
This is the 15th of a series of weekly notes analysing the state of the UK retail market in the light of the COVID-19 pandemic. This note explores three key themes:
- John Lewis to convert stores to housing?
- Is an online tax an equitable counterpoint to business rates?
- Amazon to expand roll-out of Fresh
Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.
Key Messages
- Very few John Lewis stores likely to become housing
- Reform to the Use Class Order effective from 1 Sep 2020
- Likely to have a profound impact on town centre planning
- Major relaxation of Use Class transfer to aid repurposings
- Retail repurposings much more complex that widely credited
- Geography and values the key divides / barriers to viability
- Chancellor reportedly mulling an online tax to raise £2bn
- Online tax would hit multi-channel high street retailers hard
- Multi-channel’s share of online now larger than pure-plays/non-store
- Those that it is designed to help will disproportionately bear the brunt
- Questionable alternative to business rates
- Amazon Fresh to launch major assault on online grocery market
- Already a highly-competitive market, success not guaranteed
- Free same-day delivery would put more cost pressure on a profit-challenged sector
- Online grocery growth projections may be optimistic.
1. John Lewis to convert stores to housing?
John Lewis is looking at turning empty stores into privately rented housing. That seems to be the key takeaway from a communication to staff written by Dame Sharon White, the Partnership’s chairperson, in which she outlined ideas for the future direction of the business. Potential repurposing is a theme that has certainly been widely picked up in the media.
But more general and sweeping reform to Permitted Development (PD) Rights and Use Classes Order has largely flown under the radar. But this is potentially very significant and without it, many retail repurposings such as those being investigated by John Lewis may not come to pass.
From 1 September 2020, there will be a new Use Class (E) to include all current A1 (retail & shops), A2 (financial & professional services) and A3 (food & drink) Classes, alongside B1 (offices, R&D, light industrial), D1 (clinics, health centres, creches, day nurseries) and D2 (gyms & indoor activities). Potentially meaning far greater fluidity between existing classes.
Certain A1 shops (no larger than 280 sq m selling mostly essential goods and at least 1 km away from a similar store) have been allocated their own use class (F2), as have D1 Uses (F1), currently education, training, museums, exhibition space, public halls, places of worship, law courts. A4 (public houses), A5 (hot food takeaways) and D2 (bingo halls, cinemas, concert halls, music venues) transfer to Sui Generis from 1 September.
As planning reform goes, this move is very far reaching and it could potentially have a profound impact on the future of high streets. In very general terms, this represents significant relaxation of a system that was previously very rigid and a major barrier to asset repurposing.
For further detail on the changes and to discuss the potential implications for any property sector, please contact my planning colleagues Stuart Baillie (stuart.baillie@knightfrank.com, 020 7861 1345) or Nick Diment (nick.diment@knightfrank.com, 020 3866 7859).
Returning to John Lewis, how many stores are likely to be converted to privately rented houses? Despite the attention-grabbing media headlines, realistically very few. Perhaps a couple of department stores and the odd Waitrose, but not much more than that. Certainly not a significant proportion of either estate. For the simple reason that retail repurposings generally are much more complex than many perceive.
Over-supply is one of the clear structural challenges facing the retail market. Other property sectors (including residential) are under-supplied. What may seem a logical and straightforward transfer and transformation on paper may be anything but in reality.
Geography is a key divide. Retail over-supply is often at its highest in “down at heel” towns and areas where there may be limited residential demand. There is also the issue of inflated retail values - only in areas where there is some modicum of parity of values between retail and residential (broadly within the M25 and certain towns in the South East) will repurposing stack up financially, if the full costs of re-development (including demolition) are factored in.
Planning reform will lift some of the restrictions, but others will remain. There are undoubtedly opportunities to repurpose retail space to other uses and indeed, we shouldn’t be precious about preserving surplus or obsolete retail stock. But the fact remains that the window of repurposing opportunity is perhaps far smaller than many imagine.
2. Is an online tax an equitable counterpoint to business rates?
Chancellor Rishi Sunak is reportedly considering an online sales tax to raise £2bn a year and level the playing field between digital and high street businesses. Ideas being considered include the imposition of a 2% levy on online sales and a charge for online deliveries, according to The Times. Sunak aims for an online tax to generate a “sustainable and meaningful revenue source for the government” and “help embattled bricks-and-mortar retailers to compete”.
What is ostensibly a well-meaning measure to address an undoubted problem actually raises more questions than answers. Does the high street need intervention and support from central government? Absolutely, yes. Does the business rate system need reform and complete overhaul? Unequivocally, yes. Is an online tax the solution? Sadly, I don’t think it is.
In my view, the very last thing the retail sector needs is additional tax, in whatever form. For the very simple reason, it will negatively impact those that it meant to help.
The very notion of an online tax is built upon the very hackneyed concept of online and physical retail being two very separate entities, the former on the rise at the expense of the latter. The reality is very different, the two often work in tandem and as we often say, the future is not about online, nor is it about stores, it’s about both and how they seamlessly interact.
By extension, if an online tax is introduced, it will not just affect the likes of Amazon, ASOS and boohoo, but also Tesco, Next, John Lewis, M&S etc etc. Any high street retailer with a multi-channel business – which is pretty much all of them, barring a few exceptions e.g. Primark. Any business rates savings would be merely substituted by an online levy instead, a classic case of robbing Peter to pay Paul.
Some quantification on online vs multichannel: prior to COVID-19, online broadly accounted for 20% or retail sales, roughly split 50:50 between pureplay/non-store and multichannel. During lockdown, online’s share has peaked at 33.4%. Multi-channel has grown at a faster rate, possibly accounting for as much as 20 percentage points of the 33.4%. If an online tax were applied, high street retailers would actually bear the brunt of it.
But business rates remain a burning issue in retail. The issue has been temporarily kicked into the long grass as there is a holiday until next March, but thus far, there is no indication other than this as to how they will be reformed. Surely, the Chancellor cannot just flick a switch next March and we go back to where we were before?
As appealing as a total abolition of business rates may sound, realistically the tax books will have to be re-balanced somehow. From a personal point of view, ensuring that all large multi-national firms (dare I point the finger at the tech companies?) pay an equitable rate of corporation tax, which many patently don’t. And maybe realign taxation to address the top line rather than profit, which can be accounted for, doctored, reapportioned and offshored in so many different ways.
Or a delivery or even ‘green’ tax, as opposed to a more generic online tax? That not only raises the requisite tax but also addresses one of the unsaid (and, as far as I am aware, under-researched) facets of online retailing, namely its huge carbon footprint. In this day and age, it still perplexes me that people put sustainability so high on their agenda, yet willfully embrace retail channels and operators with dubious ESG credentials.
Of course, were an online tax introduced, multi-channel retailers would have to radically rethink both their pricing and accounting strategies. Having different price points online and in stores would be confusing for consumers and retailers would potentially circumvent this by harmonising prices and paying the differential rate of tax depending on the selling channel. A lot of online sales would suddenly be attributed to stores, the exact reverse of what we’ve seen for many years. To put the cat amongst the pigeons, how many retailers would then be pressing for turnover rents? A lot fewer than are now.
3. Amazon to expand roll-out of Fresh
A perfect pub quiz question: what is Amazon’s share of the overall UK retail market? A recent straw poll (incidentally conducted outside a drinking establishment) yielded answers ranging from 30% to 70%. Way out – to the incredulity of those canvassed, the actual answer is just 3-4%.
The reason for Amazon’s relatively low share of retail sales is that, until now, it has been a relative minnow in the UK grocery sector, which makes up nearly half all retail spending. Amazon Fresh has been around for a while (since 2016), but has been relatively low profile, almost as a rolling trial. Customers had to be subscribed to Amazon Prime, the range was limited and geographic coverage was restricted to London and selected postal areas in the Home Counties.
These multiple barriers to accessing the service have thus far limited the appeal of Amazon Fresh, but are slowly being relaxed. Firstly, the need for an additional Amazon Fresh add-on to Prime was removed in 2019, with customers allowed to simply pay per delivery. This week, the ante was upped further, with Amazon Fresh offering free same or next-day grocery deliveries in London and the Home Counties.
But certain barriers remain. Customers must still be Prime members and despite Jeff Bezos’ arrogant claim that it “was irresponsible to not be part of it”, Mintel estimates that only 45% of the UK population are. The range offered is limited to around 10,000 fresh, chilled and frozen food grocery products supplied by Whole Foods and Booths, as well as a raft of brand suppliers such as Britvic, Danone, Pepsi and Warburtons and Britvic.
How significant a move is this? The jury is well and truly divided. It is clear that Amazon Fresh is going beyond a trial phase and that infrastructure is going to be ramped up. But will this necessarily have other players in the market, both online pureplays (Ocado) and multi-channel operators (Tesco, Sainsbury’s, Asda) quaking in their boots?
My personal views are equally divided. I don’t subscribe to the view of many that Amazon is an indestructible force and that all it touches turns to gold. Whatever its merits and questionable growth potential (which I will go onto discuss), the UK online grocery market is already well-established and fiercely-competitive. The main protagonists are not just sitting ducks, waiting to be shot down by Amazon Fresh. It will definitely have its work cut out if it is to become a significant force in the grocery market.
On the other hand, when Amazon plays, it tends to play to win. And it has very deep pockets in deploying its hand. And, crucially, it operates to a different financial model than established retail businesses in that it seemingly doesn’t need to turn a profit in the same way - and this doesn’t seem to matter, even to shareholders.
I personally am not a fan the word “disruptor”, but that is most definitely what Amazon is. And if there is one thing Amazon is exceptionally good at, it is making its own agenda a defining force across the retail industry – where it leads, others think (rightly or wrongly) they have to follow. Will Ocado, Sainsbury’s et al now think they have to match Amazon Fresh’s pledge on rapid and free delivery, or will they have sufficient faith in the customer base they have built up and their superiority in other aspects e.g. depth of range, private label proposition and established track record?
Of course, if they feel compelled to keep up with the Amazon Jones’ this will have cost implications and impact on profitability – and profitability is still far from proven in online grocery. Ocado makes far more money out of being a service provider than it does selling food online. The multi-channel operators are very coy as to the profitability of online grocery, tending to regard it as part of their modern retail ecosystem and brand, rather than a business in isolation. If all associated costs were reallocated to online as a freestanding entity, it is highly unlikely to be profitable. If it is profitable at all, it would still be far less profitable than store-based business.
A contrarian view, but I remain to be convinced by online grocery generally, both in terms of its profitability and its growth trajectory. As I outlined in last week’s Retail Note, I don’t believe share gains made during COVID-19 are sustainable ones and I question that the pandemic has kickstarted a period of accelerated growth. Mintel are far more bullish in their assessment of online grocery, but even they are predicting that online’s share of grocery will top out at 9.1% for this year as a whole, before slipping back to 7.7% in 2021. Only by 2025 will it again hit the 9% mark.
Not as high growth as many predict and with an unproven record of profitability, it seems strange that everyone is so keen to grab a slice of this market. To be clear, it is not a market that is going to die a death anytime soon, but it seems a curious war to want to win. But, to be fair, just the sort of challenge Amazon relishes.
Of course, Amazon’s relatively low share of all retail spending belies its overall influence on the UK retail market. Plans to ‘disrupt’ the online grocery market through roll-out of Fresh, a key factor behind John Lewis’ strategic challenges (a worrying trend of dancing too much to a competitor’s tune), but at risk of a hefty tax bill if proposed changes come to pass. In many ways, Amazon is, directly or indirectly the common denominator between all three vignettes of this Retail Note.
Stephen Springham
Partner – Head of Retail Research
+44 20 7861 1236
stephen.springham@knightfrank.com