As memories of Covid-19 lockdowns start to fade, retailers are now in the midst of a new challenge – the cost of living crisis.
Consumer confidence is falling and discretionary spending is down as growing numbers of households struggle to afford even the basics. Now retailers are faced with either taking a hit on their margins to retain customers by keeping prices low, or putting them up and potentially losing them. As with the pandemic, the public will remember how retailers respond during the cost of living crisis, and there will be clear winners and losers.
Members of the KPMG/Ipsos Retail Think Tank (RTT) are under no illusions about the challenges retailers are facing over the coming year. At the latest quarterly meeting, they discussed the impact of the crisis on the sector, and what retailers can do to increase customer lifetime value (CLV) and emerge stronger.
RTT members focused on how the cost of living crisis will impact retailers, their customers, and wider stakeholders, before discussing how the success of new initiatives should be measured and analysed moving forward.
A perfect storm
Rising food, fuel and energy price inflation – largely the result of Covi-related supply chain issues and the war in Ukraine – has caused inflation to soar to over 9%, and fears are mounting that it could rise to over 11% by the autumn as utility prices surge.
RTT members agree that applying a sticking plaster to existing retail models and strategies, hoping it’s enough to weather the storm, won’t work. The world has changed a lot since the ‘2007-09 Great Recession’, when online retail, and the fierce competition that came with it, had yet to explode.
Ruth Gregory, Senior UK Economist, Capital Economics, highlights the cost pressures bearing down on firms in Q3 – energy, manufacturing, transport, and wages – at a time when consumers are being squeezed. She commented: “This poses a big challenge for retailers to keep their costs in check, defend their competitive position and ensure prices for consumers remain competitive. With consumers becoming more price sensitive this provides a greater need for retailers to review their operating costs and focus in on increasing productivity to deliver value for money. Against this challenging backdrop, understanding and adapting to the changing preferences of consumers will be key.”
Her views are shared by James Sawley, Head of Retail & Leisure, HSBC UK, who said: “With the worst of the cost of living headwinds still in front of us, consumers will have to prioritise essentials, and discretionary product spending will come under increasing pressure.”
He goes on to say that those who survive or thrive in this environment will prioritise maintaining a healthy bottom line over growth and “do whatever it takes to shield customers from major price increases.”
What does the cost of living crisis mean for retailers?
There’s no doubt that retailers will have to fight for every penny over the coming months, not just competing with other retailers but other sectors too.
There may be a ‘softening demand’ in retail due to ‘revenge consumption’ following lockdown, where people are making up for lost time by spending more in the travel, entertainment and food and beverage sectors.
A race to the bottom on pricing will only damage margins further and isn’t sustainable over the long-term. Paul Martin, UK Head of Retail, KPMG, said: “Retailers can’t just reduce the size of goods, amount, weight or number of items in a pack to maintain margin. This mechanic has worked in the past, but they are ‘running out of runway’. It also raises questions about whether goods are too cheap anyway? The race to the bottom has resulted in a long period of historically low prices – and we have to ask whether 99p ready meals and t-shirts are sustainable?”
The RTT agreed that retailers should focus their efforts on better understanding their customers, especially as their circumstances change and vary their pricing and promotions accordingly.
Food retailers might be afforded some protection from the crisis, since people still need to eat, but the type of products people buy, and how much they spend, could change dramatically.
RTT members said that price, promotional activity and communications must be personalised for different customers or groups – but this only works if retailers know who their audience is in the first place. Many retailers have access to this type of data, but it requires investment (both human and financial) to organise and understand it, in addition to combining it with data from beyond their existing customer base to identify new opportunities.
In the non-food sector, retailers will have to work hard to increase their share of wallet, and it can be more difficult to achieve personalisation due to purchase frequencies, but the same principles apply – they have to get to know their customers better.
The RTT highlighted the success of independent retailers and e-commerce companies in creating highly-engaged customer communities. Premium watch sellers, for instance, have built long-lasting relationships with their customers by personally contacting them when a new model arrives, while online-only companies engage people with specialist products and targeted promotions.
Peter Luff, Managing Director, Ipsos Retail Performance, explained: “Specialist retailers are not chasing every customer; they’ve worked out who their customers are and have built a deep relationship. They pick up the phone and have conversations, so they know how they can best meet customers’ needs and when they’re ready to buy. This is more challenging for larger retailers and grocers, which is why segmentation and personalisation are so important.”
To overcome this, they’ll need to invest further in data analytics and other new technologies. James Sawley, Head of Retail & Leisure at HSBC UK, pointed out that many retailers are only at the start of their digital journey: “AI (artificial intelligence) and big data are still in their infancy. We all get marketing emails but they’re not bespoke, they are miles away from what we want, let alone being in a world where machine learning enables personal shopping in the cloud. Now is the time for retailers to invest in and become masters of them.”
Jonathan De Mello, Founder & CEO, JDM Retail Consulting LLP, agreed that preferential and personalised pricing is now key to building customer relationships: “We’ve seen retailers step up with offers on midweek dinners and kids’ meals, which can engender loyalty. Mining data generated from loyalty schemes will also enable them to offer preferential pricing. It’s a smaller pie but they all want a bigger piece of it.”
Whatever course of action retailers take, Nick Bubb, Retailing Consultant, Bubb Retail Consultancy Ltd, warned that they’ll need to maintain a healthy balance sheet above anything else: “It’s no good offering lifetime customer value if you go bust. Online pure-play retailers in particular will have to protect their cash position and ensure that any new initiative delivers value for both the customer and the business.”
What does this mean for consumers?
Covid-19 and the cost of living crisis might have brought unexpected challenges for retailers – but they also exposed weaknesses in the sector that have persisted for a long time.
Mike Watkins, Head of Retailer and Business Insight UK – NielsenIQ, commented: “Retailers have to find value for customers, and loyalty schemes now play an important role in driving frequency of visit. However, what we define as loyalty should change to reflect the fragmented retail landscape where people are more likely to shop around. The current loyalty schemes from Tesco, Sainsbury and Lidl for example, have been more successful in driving long term loyalty because they use digital communications to entice people into stores with relevant, targeted, and personalised offers.”
Maureen Hinton, Group Retail Research Director, GlobalData, also pointed to Tesco’s Clubcard scheme for setting a ‘benchmark’ for how retailers could get to know their customers better: “Tesco appeals to a huge amount of different customers, and they target them extremely well using the Clubcard. It creates compelling offers for its target customers because it understands their needs and behaviour. This is why it’s important to know your customer and invest in products that people actually want to buy.”
Service levels will also become a key differentiator as household incomes are squeezed – and RTT members believe the sector is in a strong position. Jonathan De Mello commented: “A number of retailers feature among the top 10 companies for customer satisfaction list including John Lewis, Waitrose and Apple. Compared to the airline industry, retail isn’t too bad. To promote customer loyalty, you need to build staff loyalty too through training and good pay. Sainsbury’s, for instance, has introduced more rewards and better pay for colleagues to help them feel valued.”
Members agreed that retailers don’t have to abandon their ESG agenda because customers have less money in their pockets; in fact, it’s an opportunity to cut waste in the supply chain, so prices can be kept low, and margins protected. Retailers should also be clear on their purpose and communicate it regularly because this is what customers buy into. Knowing which customers are value-driven, and which are focused on ESG policies, enables retailers to optimise their messaging towards them.
Ultimately though, the entire retail sector needs to be restructured to ensure businesses can continue to deliver on their ESG goals. De Mello added that retailers will also need to consider how ESG will impact their estates too: “Landlords have their own ESG targets, so they’re increasingly looking for environmentally-friendly brands.”
However, RTT members believe that changes in ESG within retailers’ operations will largely be driven by consumers and the government rather than capital markets. Retailers should therefore be proactive in order to stand out during the current cost of living crisis.
Wider implications
Of course, the cost of living crisis doesn’t only affect consumers and retailers but the wider supply chain and associated industries (including property and banking), as well as shareholders.
It’s likely that lenders and investors will exercise caution, opting for retailers with sensible long-term plans rather than chasing quick wins. Shareholders may also be willing to take a hit in the short-term if it means the businesses remain sustainable.
There was agreement that some brands have expanded too quickly in recent years, and that now the focus needs to be on quality products, customers and profitability not just ‘growth for growth’s sake’.
Bubb also said there’s a need for greater transparency from retailers: “There has always been too much smoke and mirrors about promotions, and consumers are cynical about low pricing claims by retailers. Isn’t it time retailers were more transparent about their gross margin trends?”
Getting it right – impact on demand, margin and cost
It’s clear from the RTT’s discussion that retailers need to strike the right balance between managing demand, margin and costs in a climate of economic uncertainty.
According to the RTT’s Retail Health Index (RHI), consumer demand will improve performance in the sector towards the end of the summer despite rising costs, including salary inflation. Yet it could be short-lived. It’s predicted that by September, discretionary spending will fall as consumers are hit by a further rise in utility bills and higher interest rates.
RTT members agreed that driving demand through personalised data-led communications and delivering value in their products and services is a necessity, if they’re to protect their margins as cost spiral throughout the remainder of 2022.
Measuring success, and moving from today to tomorrow
The current climate could also lead to a shake-up of how success is measured. Historically retailers’ reporting would centre around product and channel KPIs. The profitability of specific products, and the cost to serve and volume sold across physical and digital channels is how retailers would measure success – metrics concerning customers would very much be an afterthought or a footnote.
However, if retailers are going to place customers at the heart of their operations and restructure their businesses accordingly, KPIs and metrics directly linked to their customers will need to move to the very top of their reporting matrix. The retail sector can learn a lot from the technology sector, where platform-based retailers such as Amazon have long understood the lifetime value of a customer, how much they cost to acquire and how loyal they are to the retailer and specific brands.
KPMG’s Martin emphasised the opportunities this will bring the retail sector: “Understanding customers and being able to measure and segment individuals into groups will give retailers the opportunity to be more specific with their pricing and communications. Promotional activity and the amount of marketing time and budget spent can be increased or decreased depending on how desirable a customer is to a retailer – if someone only buys on offer or is prone to returning items a lot, it may be that they are not the type of customer that a retailer doesn’t want to invest in.”
Investment in data and a new focus on measuring the customer will allow retailers to better understand their customers’ motivations to purchase. In the midst of the cost of living crisis, wielding a broad brush to increase prices or implement promotional activity will result in retailers either creating unnecessary bad blood with customers, or ‘giving away’ more margin than they need to. Not every customer group will be motivated by price, and identifying these people allows for other drivers such as the latest product, upgrades, convenience, or value-added promotions to be utilised instead.
RTT members agreed that while traditional reporting metrics will remain important, ultimately, if retailers want to build loyalty with their customers, understanding the lifetime value of a customer will allow them to better serve customers and create more robust and profitable business models, especially during the cost of living crisis.
Conclusion
There are reasons for retailers to be optimistic: consumer demand remains high, at least for the moment, and leading brands are performing well in the customer satisfaction ratings. This is likely to change by September with rising household costs expected to reduce spend.
The current crisis underlines why bigger structural changes are needed to fix long-standing challenges in the retail sector. It’s not only an opportunity to stand apart from the competition but a necessity. RTT members agreed that retailers must focus on digitisation, innovation of products and personalisation as they navigate the cost of living crisis.
Whether they work in the food or non-food sector, this is an opportunity to understand and meet customers’ needs in new and different ways. Retailers could look to the niche and online-only businesses by getting to know their customers on a deep level, using data-led technologies to segment their audience and personalise communications and offers.
Getting the products right is key, as is pricing. But simply paying lip service through empathetic marketing won’t cut it – instead, they’ll need to shield customers from price rises with tangible money-saving offers and change.
Martin Newman, The Consumer Champion, concluded: “While this will impact short-term profitability, it will, if managed and communicated effectively, ensure that retailers come out of this period with a larger, more engaged customer base and will benefit from the lifetime value and increased market share this will deliver.”
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