A whitepaper from the KPMG/Ipsos Retail Think Tank
Retailers may feel that they have little choice but to slash their prices to hold onto customers as the cost of living crisis continues to hit household budgets. However, with their own inflationary pressures to contend with, this approach will only damage their margins and could even do long-term harm to their brand’s reputation.
The ongoing cost of living crisis sent consumer confidence plunging to a record low in September. While the Government’s freezing of the energy price cap at £2,500 is expected to curb inflation in the near term, household bills remain high and the early end to the utility price freeze means that from April 2023, inflation will once again be at the mercy of swings in wholesale gas prices. The rise in mortgage rates has left homeowners nearing the end of their fixed-rate mortgage deals facing sharp increases in their monthly repayments. This has increased the risk of mortgage arrears and repossessions and will cause a big reduction in households’ disposable income.
All of this will make for a challenging trading environment in the run-up to Christmas – where staying afloat, let alone achieving growth, will feel like an uphill struggle for some retailers. Profit growth in the current market might feel impossible for many retailers in Q4, especially those in the non-essential sector. Maureen Hinton, Group Retail Research Director, GlobalData, commented: “Demand is under huge pressure because of rising household expenses and falling consumer confidence and this is hitting discretionary spend the hardest. The priority is essentials, and the biggest priority is food as we all must eat. Non-food, on the other hand, is the most vulnerable to falling demand.”
At the latest quarterly meeting of the KPMG/Ipsos Retail Think Tank (RTT), members discussed why a data-driven approach to pricing and promotion was even more important in the current climate, and looked at the steps retailers could take.
But rather than engaging in a race to the bottom on pricing, members agreed that an intelligent pricing and promotion strategy could help retailers to both protect their margins and build longer-lasting relationships with their customers.
At the last quarterly meeting, they looked at the importance of using customer data to understand demand and deliver personalised experiences with relevant offers, deals and incentives.
A challenging economic outlook
RTT members highlighted the challenging trading conditions retailers are operating in currently due to high inflation and interest rate hikes.
Ruth Gregory, Senior UK Economist, Capital Economics, commented: “With inflation set to rise to a peak of 10.8% in April and to remain elevated in 2023, inflation will weigh heavily on households’ real incomes in 2023 by a huge 9 percentage points (ppts). Some of the pain for households from rising inflation will be dampened by the Government’s energy price support and by wages rising further. But households’ real incomes still look set to fall by a large 1.5% in 2022 and 2.5% in 2023. The latter would be the largest annual fall since records began in 1955.”
Despite the bleak economic outlook, the RTT believes that growth is possible as the world returns to normal after two-and-a-half years of Covid-related disruption. During this time, the retail winners and losers were primarily split between the essential and non-essential categories – now the victors within each category are starting to emerge once again.
In this climate, pricing and promotions management is now one of the most important, and historically overlooked, levers for growth. Indeed, KPMG analysis estimates there’s around $200billion left on the table globally from a lack of pricing and promotions management.
Pricing and promotion strategy – still in the dark ages?
The RTT noteed that pricing and promotion has undergone the ‘least transformation’ compared to other areas of the business, with decisions driven too much by supplier, not consumer, demand and without clear customer insights.
Paul Martin, UK Head of Retail – KPMG, said: “What’s astonishing is that many retailers often don’t have a senior person with cross-functional responsibility solely in charge of pricing and promotion strategy, it’s often done on gut feeling. They have targets with suppliers but they aren’t always retrospectively reviewed, nor are suppliers penalised or rewarded for delivering against a performance target. Compared to real estate, finance, HR and store operations, buying and merchandising feels like it’s operated the same way for a thousand years. Price and promotional management is an immature discipline – yet there are sophisticated solutions out there that would help retailers understand who they’re interacting with and become more scientific with pricing and promotions.”
His views were shared by Ruth Gregory, who added: “Involving pricing intelligence to tailor increases according to price sensitivities will also be crucial to building a more targeted approach to customers.”
Is growth possible?
Nick Bubb, Retailing Consultant, Bubb Retail Consultancy, noted: “An inflationary driven business environment need not be unhelpful to growth in retailing profits, if gross margins can be maintained by fully passing higher product supply costs on to the consumer and if sales grow at least in line with the rise in operating costs. The problem the UK sector faces is that it is hard to fully pass on higher prices when the consumer is under such pressure from the surge in energy costs and the cost of living, whilst sales volume declines are eating into the top-line benefit of higher inflation, as the hard-pressed consumer seeks to make cutbacks. This was evident even before the financial turmoil unleashed by the disastrous mini-Budget onSeptember 23rd as both retail sectors were already underperforming badly. They are both now running about 40% down in 2022 to date.”
However, members believe that growth is possible if retailers adapt their existing models in order to protect themselves from inflation and customers from price increases. They agreed that retailers should put a focus on growth in profitability, not revenue.
James Sawley, Head of Retail & Leisure, HSBC UK, agreed that the economic conditions are difficult – yet he believes the most agile retailers can still achieve growth: “High labour and fulfilment costs, and a drop in the value of sterling, have created strong headwinds for non-food retail, particularly online. In this climate, many retailers may have to shrink to survive by rationalising their product range and only buying products that are true to their brand, reducing the need to discount, and aligning cost base accordingly. If they take a longer-term view, and hedge their currency risk, they could gain an advantage by protecting customers from market volatility; become smarter about buying, design and pricing more scientifically.”
Despite this, lower business rates could provide a much-needed boost for retailers, offering greater flexibility in the future for pricing and promotion strategies. Jonathan De Mello, Founder & CEO, JDM Retail, said: “Business rates have spiralled out of control over the past five years since the last revaluation and, at this point, are completely out of kilter with rents. The forthcoming 2021 revaluation will correct this and will certainly be welcomed by retailers. Whereas costs such as staffing, utilities and service charge have all risen considerably this year – and will rise further in 2023 – rates are linked to rents, which have fallen by around 30% for retail premises across the UK between 2019 and 2021. Due to the government’s desire for ‘downward transition,’ retailers won’t see the benefit of these rates reductions immediately, but this reduction over the course of the next three years will go some way towards counteracting higher costs across the rest of the store P&L.”
Playing the long game
While pricing and promotion has traditionally focused on short-term tactics, such as ‘buy-one-get-one free’, in the current environment the RTT believes that a long-term vision is needed, and simply lowering pricing is damaging to both margins and brand reputation.
Martin Newman, The Consumer Champion, said: “The German discounters are value players, it’s part of their value proposition and they’re the natural place to go for people wanting low prices. However, if that hasn’t been your brand promise for the past five or 10 years, simply switching to a value-based proposition unlikely to have the desired impact and continued low pricing could be far more damaging in the long run. A relentless focus on building customer lifetime value (CLV) will help retailers to be more strategic in meeting customers’ needs – for example, offering a discount in exchange for bringing in old electricals and fashion to be recycled. This could help position the brand as a leader in conscious consumption, building a reputation that lasts beyond the immediate cost of living crisis.”
Members also agreed that the FMCG sector needs to move onto a more long-term approach towards pricing and promotions, driven by longer-term trends in consumer demand, not by supply-side availability.
Mike Watkins, Head of Retailer and Business Insight UK – NielsenIQ, said: “Delivering a demand-driven, long-term approach to pricing is dependent on a better understanding of the consumer. Brands and retailers that can find the balance between price increases and effective promotions to create the most efficient pricing strategy will benefit. A focus on everyday low prices and fewer short-term promotions will be how retailers generate growth where FMCG volumes are falling and shoppers are putting fewer items in their shopping baskets.”
Members also pointed out that the German discounters are leading the way in creating CLV, despite being known for their low-pricing. Martin Hayward, Founder – Hayward Strategy and Futures, added: “One new loyalty scheme is now outplaying some of the more established programmes. What they’ve done is come up with an ‘accelerometer’ where the rewards get bigger the longer people stay with them. This highlights the challenges for retailers to align price and promotion strategies with their brand values, helping them to develop long-term relationships when it can be easy to slip into short-term mindsets. This reward programme is a great example of how to lock in customer loyalty while protecting brand values, in contrast to many schemes which offer the same small rewards regardless of how much customers spend.”
A data-driven approach to pricing and promotion
Pricing and promotion will only be a vehicle for growth if retailers are able to use their data effectively to deliver personalised customer experiences – including deals and offers relevant to them. This will not only drive sales at this crucial time, but also help to build lasting loyalty.
Members point out that retailers need to understand how consumers’ needs and priorities are changing due to the cost of living crisis, and adapt their offer accordingly. Joe Marshall, Head of Customer Experience and Channel Performance, Ipsos, says: “Our data shows that an increasing proportion of customers view price as being more important than ESG issues due to the rising cost of living. The economic picture is changing so quickly at the moment, so retailers need as much insight into the latest data and consumer requirements in order to make intelligent and informed decisions on pricing.”
Retailers need to continue to invest in connected IT systems in order to capture and make sense of their data and break down silos between departments. This will allow them to drill down into the detail of what consumers really want, so they can determine the tipping point on pricing and identify customer segments where convenience, rather than cost, is the big motivator.
Paul Martin said: “If a family has a food budget of £30 per week, it’s all about value because any rise – even a jump of 4p in the price of pasta, for example – may mean they switch to a discounter. A more affluent customer, on the other hand, might be more concerned about convenience and getting the right products than price. If some of those products aren’t available when they place an online order, it’s an opportunity to direct them towards alternatives, such as their nearest store.”
Members agreed that the person responsible for pricing and promotion strategy should have analytics in their background so they can build a team and develop systems capable of delivering real insights.
Conclusion
As the sector heads towards Christmas, the challenges for retailers are clear. The Retail Health Index (RHI) forecasts a drop in performance – the biggest golden quarter decline since 2011 – as consumers feel the impact of higher energy bills more acutely and interest rates continue to rise. There are signs of hope though, with the World Cup expected to boost food sales.
What’s certain is that retailers need to move away from short-term thinking, where the only solution is to cut prices to impossible levels. Instead, they need to understand their customers and serve them in a way that’s relevant to their lives. To optimise their pricing and promotion strategies, and increase CLV, retailers should use readily-available technology to break down data silos and derive meaningful insights. What this strategy looks like will depend on what the data tells them, and it will be different for every retailer. Some might refine their loyalty programmes, rationalise their product range, roll out sustainability initiatives, or focus on keeping prices low.
The RTT believes that pricing and promotion has undergone ‘the least transformation’ compared to other areas of the business. But done right, it’s also a real opportunity for retailers to become leaders in the field and unlock their share of the potential $200bn available to them.
NAM Implications:
- In a scarce-money environment, every little helps.
- Bench-mark elsewhere, reallocate locally…
- …knowing that retailers need to move away from short-term thinking pre-Christmas…
- …and optimise pricing & promotion optimisation.
- This White Paper can provide insight on options for suppliers.
