Sector Foresight - Consumer Spending

The UK economy and its deeper impact on consumer spending

Chain reaction

As you might expect, the UK’s economic situation continues to dampen consumer confidence and cap overall spending activity. But beneath the surface the picture is more complex with varying fortunes among consumer goods and services segments and  knock-on effects within the supply chain. Consumer durable segments such as automotive and white goods have struggled for sales, as have high-end leisure activities including overseas holidays and fine dining. Elsewhere, some segments have held up well, particularly lifestyle technology (eg smartphones, tablet computers). However, as a general comment, and despite extensive discounting in the high street to prop up volumes, on the whole  consumer facing businesses continue to suffer from depressed sales activity and weak margins.

Introduction – the macroeconomic position

The protracted recovery from the 2008 recession, elevated inflation, destabilisation of the Eurozone and ongoing austerity measures  have reduced consumer spending power both in real terms and also by lowering consumer confidence. Although interest rates remain low, economic uncertainty  is stifling a consumer-led boost to the economy. Average family spending power was down 6.3% year on year in February (source: Asda Income Tracker). The effect has been felt across the country, but has further exacerbated the north-south divide between those in London and the South East and the rest of the UK. At current rates, average income growth across the UK stands 1.2% behind headline inflation, and with rising and record levels of unemployment expected, the UK’s road to economic recovery remains bumpy.

The effect on consumers spending power is illustrated in the extract from the ASDA income tracker below:

(Source:  Asda income tracker –  Feb 2012, released  March 2012)

This  6.3% reduction in disposable income is compounded by a rise in unemployment due to public and private sector layoffs and private sector conservatism, and these factors are having a significant impact on consumer spending patterns. To counterbalance this situation to a degree, the rise in the cost of living in the UK is decelerating, but remains high following two years of sustained increases (particularly in utility costs). During 2012, the expectation is that the Bank of England’s target inflation rate of 2.0% will be reached, but with February RPI still at  3.7% – albeit down from  January’s  3.9% – there is some way to go. The inflationary rise has varied by sector, meaning that consumers need to be increasingly wary of their lifestyle and spending patterns, and the behavioural changes they may need to make to keep within the household budget.

The recent Budget announcement will both help and hinder distressed businesses in the UK. As the budget confirmed, the government expects the recovery to remain sluggish. Growth of less than 1% is forecast for this year and, although accelerating thereafter, output will not fully recover until sometime in 2014. But the decision to raise the personal tax allowance next April to £9,205 and move towards £10,000 in the future is generally welcome and will provide consumers with a little more disposable income to spend on goods and services. However, whilst this is helpful in the long term, it is too little too late for those retailers already in distress, some of which may see challenges in meeting the quarter day rent payments due in March.

Impact on consumer spending

The impact on retail sectors is perhaps surprisingly mixed, as a challenging environment affects consumer spending in different ways. Both the luxury and value ends of retail markets are holding up well in terms of throughput, but middle-value spending has been hugely affected by spending choices. It would seem that the overall tendency is for consumers to budget more wisely and opt for cheaper purchases in essential goods and services but make some provision, albeit more modestly, for luxury items. Overall retail footfall remains low despite extensive discounting. Rising inflation has held prices for those sectors that can maintain sales volumes without significant discounting.

This is what the average family spends money on:

This picture is likely to change as consumers review their options. This is what we are beginning to see in specific consumer segments:

• Fuel & power. Fuel and energy costs have risen substantially, but consumers continue to purchase similar volumes presumably due to inelastic requirements. The net effect is a fall in spending power after fuel and energy purchases.
• Food. Food prices have risen dramatically. Again due to inelastic demand, the opportunity to drastically alter food costs is limited, but increased pricing polarises the purchasing decision. For example, premium lines  doing well as consumers swap a meal out for a night in; and budget brands taking the spend away from the middle-range products.
• Automotive. Auto retail activity and pricing fell significantly during the recession, and then rose by 45% thanks to the scrappage scheme. Since then, levels have dipped again, with a slight uptick in last quarter. This suggests consumers remain cautious about major non-essential purchases, but are happy to spend where they see value for money.
• Clothing. There has been a marginal increase in volume in the last quarter, but not in value. Consumers are looking for bargains and value for money in their purchasing.
• Leisure. Prices have started to affect demand. Pubs and restaurants have experienced a downturn in consumer activity, with fewer meals out. More people are turning to the ‘meal deal’ offers for dining in rather than eating out. Even cinema audiences are falling as online entertainment and multi-channel TV usage increases, both of which are substitutes for cinema and DVD consumption.

Other particularly hard-hit sectors include household goods and other consumer durables.

Impact on companies

Changing consumer behaviour of course has a direct effect on consumer-facing businesses. Some of the phenomena we see today we suspect will stay with us for some time to come.

Not only are companies experiencing reduced demand, be that because of reduced disposable income or low consumer confidence, suppliers are also struggling to pass their increasing costs on to customers, so for some there is pressure from every angle.

Meanwhile, companies are also having to adapt to ‘channel shift’. Like-for-like internet sales were up a staggering 38% this January, fuelled by consumers using the channel in favour of retail visits. As discussed in our recent Retail Sector Foresight, the multi-channel offering is currently providing retailers with most comfort. High street presence alone is no longer viable, but it’s interesting to note that consumers are starting to favour the high street again ahead of trips to out-of-town retail parks, understandably deterred from travelling by the rising cost of fuel.

Some of this changing behaviour will be permanent – for example the ongoing shift from physical retail to online purchasing – but some more temporary, such as the move away from mid-range branded goods to value lines and occasional luxury purchases.

Supply chain

We can expect the change in consumer spending to have a knock-on effect right through the supply chain, via wholesalers and distributors to manufacturers and in turn to the lenders supporting each of those areas of the economy. The current situation is both volatile and complex: as well as rising commodity prices in the UK, alongside increasing inflation and unemployment levels, many UK suppliers are working with an international supply chain. Those that are can add increased freight rates, import commodity charges and Far East wage inflation to their woes. So much so, that only those with flexibility in their supplier choices will fare well; those bound into long-term contracts at decreasingly favourable margins and with increased exposure to other risks (eg ethical, political, geographic) will struggle. On the plus side, this volatility has led some to UK importers sourcing goods closer to home, for example in Europe or the Middle East, which in turn is reducing the impact slightly on UK manufacturing.

Indeed, UK manufacturing seems to be weathering the storm pretty well, as KPMG corporate finance director Robert Baxter explains: “Because the manufacturing presence in the UK tends to focus on goods that are less susceptible to short-term margin pressures, ie because the nature of the products or markets is niche, we haven’t seen the dramatic knock-on effect that could have been envisaged as a result of a consumer spending downturn.”

However, all companies with significant exposure to the Eurozone, through customers, operations or critical suppliers, are still susceptible. The potential default and possible Eurozone exit of one or more countries remains a real risk.

Market structure

In terms of market structures, and as noted, we continue to see a rise in online purchases of goods and services, eroding the market share of physical sales outlets. In addition, there is also a growing impetus to restructure businesses at holding level in order to reflect economic and taxation changes across Europe in the light of austerity measures imposed by governments.

KPMG restructuring partner, Roger Bayly, comments: “As a result of all the structural changes, lenders and landlords may experience short-term discomfort as some businesses fail or where restructuring results in write-offs or renegotiations. But in the longer term, the majority of sectors most dependent on discretionary consumer spending will come out of the protracted recovery in a healthier state than they were at the start.”

Available remedies

So what can businesses do to protect themselves against the volatility in consumer spending and the current economic environment? The obvious step is to remain close to customer demand in terms of product ranges and service levels. By responding quickly to customer demand – through product innovation and evolution and aggressive margin management to allow competitive pricing – businesses stand a better chance of keeping up with or leading market changes. This shorter-term outlook also means reducing planning horizons and increasing responsiveness of the supply chain to fluctuations in demand. However, being responsive can put huge pressure on working capital demands and the balance sheet overall, so management need to find ways to make the balance sheet as resilient as possible,  with a hard focus on cash flow management and a deep review of financing and the underlying asset base.

Given the increased volatility in some sectors compared to others, it will help to have some scenario planning in place to anticipate what the business response should be in the case of say a 5%, 10% or 20% reduction in trading volumes and values.

Because of the increased pressure down the supply chain, it will pay for businesses to have contingency supply plans in place to cope with supplier failure in addition to maintaining an awareness of how key suppliers are faring in the current climate.

Against this backdrop of protection and risk management, there will be opportunities for some businesses to do very well in these times. There are good deals to be struck for those with purchasing power both for traded goods and services and on the capital side where assets are likely to be available at substantially lower cost than in buoyant times. Furthermore, those with international growth aspirations and sufficient capital resources will be well placed to invest in developing economies now whilst others are hamstrung to do so.

Looking ahead

The continued pressure on consumer income has changed spending patterns and forced retailers and other suppliers to react by discounting goods and taking other measures to survive and protect their market share.

In the immediate term, there may not be much by way of good news for retailers and their suppliers, but this period will no doubt bring with it a time of improved predictability and continued low interest rates while the economy slowly picks up.

In the medium term, structural changes and some restructuring will be required in most sectors that are dependent on consumer spend. Businesses that act early to build flexibility over channels to market (including online) and source of supply (eg reducing reliance on China) will probably fare best.

The position for lenders

Lenders need to be looking at customer cash flow forecasts carefully. Businesses that appear to be cash-positive today can easily slip into the red during the downward phase of the working capital cycle.

Furthermore, in a broader context, customers should be encouraged to act early in order to build flexibility over channels to market and source of supply, before cash flows become a problem.

Companies with significant exposure to the Eurozone should be acting now to prepare for the range of potential outcomes as the situation evolves over the coming months.

Feedback & comments

To provide feedback on this Sector Foresight, or to suggest other sectors you would like us to cover, please email hayley.payne@kpmg.co.uk.

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