Special Report: UK’s Retail Revolution May Portent Future for Produce

TESCO

Deep discounter, the dining-out movement, convenience shopping and online retailers are just some of the factors affecting traditional retailers… and ultimately their suppliers.

Unquestionably, things are changing in the U.K. grocery market. Strongly held convictions about the power of the so-called Big Four (Tesco, Sainsbury’s, Asda and Morrisons) and concrete assumptions about the behaviour of British consumers have been ripped apart, never to return. The discounters (Aldi and Lidl) are no longer mere irritants in the eyes of the established retailers. Their combined market share — and the fact that they are often grouped as one, single force for low prices — now singles both out as major players.

The weekly shop — for so long the bedrock on which so many hung their analytical hats — has lost its status, as the convenient modern notion of ‘shopping more, buying less’ gains traction. Online shopping continues to rise, though not necessarily at the pace predicted by those same analysts.

Everything is changing, and it’s changing faster than ever before. Pronounced flux is the defining characteristic. Brand loyalty schemes are being toned down, and in-store promotions are being reduced. Arguably, the one thing we can rely on is that sensational talk of ‘price wars’ still dominates most media coverage of the grocery market. But is the U.K. market still an attractive proposition for suppliers? What about Brexit (or “British exit”), the possible exit of Britain from the European Union? Where’s the good news?

Preparing For The Perfect Storm

Well, first the good news. This is not a downward spiral. According to forecasts by the food and grocery research and training charity, IGD, the U.K. food and grocery market will grow to be worth £200.6bn (approximately $290 US billion) by 2020 (a 13 percent increase on its mid-2015 figures).

Indeed, IGD’s chief executive Joanne Denney-Finch believes that we’re living through a genuine revolution in food retailing. Speaking at the Asia Pacific Retailers Convention and Exhibition conference in Manila last October, she proclaimed change was sweeping through global food retailing.

“The revolution is so big and powerful, that no-one knows exactly what the future will look like,” she said. “While this is creating the most challenging conditions for food retailers I’ve ever seen, there are many opportunities too. Retailers around the world are responding creatively and starting to build a new future.”

asda storefrontShore Capital’s retail analyst Clive Black recognises that the industry is going through enormous, rapid and challenging structural change. He believes a number of factors have come together to create this shift — most notably the changing habits of the modern consumer. “People are eating more food outside the home,” he points out, “which is naturally a big challenge to supermarkets; people are wasting much less food; they’re cutting down their calorific intake and eating more food that is associated with health and well-being. And they’re also shopping in different ways … in convenience stores, in discount stores and online. All these changes have an impact on supermarkets.”

Fraser McKevitt, head of retail and consumer insight at Kantar Worldpanel, is another to acknowledge the shifting behaviour of consumers. Big trolley shopping in the expansive out-of-town superstores is slowing down, although it remains a big and important part of the market.

“That [customers making less big shopping trips] is the direction the sector is heading in,” he states. He says money is flowing out of those big supermarkets in three directions. “It’s going online, which the big supermarkets retain, but much less profitably because it costs a lot more money to deliver online. It’s also remaining in the supermarkets, but via basket, not trolley, shops and that brings into consideration the range you need in shops and how stores should be laid out. And then the third one is the flow of those trolleys towards discount retailers.”

This perfect storm has hit the Big Four hardest. “I think the big supermarkets know what the challenges are now,” says McKevitt, “but they haven’t yet found the device or the levers to stop that flow of money.”

Black picks up on this point. His analysis leads him to conclude that stronger management at the Big Four — which still controls 75 percent of the grocery retail sector — is finally paying dividends. “They realised some of their limitations,” he says. “In addition, some behaviour that wasn’t sustainable or in anyone’s interest — never mind the consumers — has changed; so rather than continuing to open new stores, they concentrated on making their existing stores more effective.”

Falling Values And Simplificationaldi storefront

One of the biggest challenges facing the U.K. grocery retail market in 2016 remains falling values. The value of food retail sales continues to fall; in short, that’s deflation. And while that may seem like good news for consumers — McKevitt notes that shoppers are enjoying a golden period of cheaper groceries with like-for-like prices falling every month since September 2014 — it’s still of great concern for retailers who consequently struggle to grow their revenues. David Gray, senior retail analyst at Planet Retail, sees some cause for optimism though. Whereas 18 months ago, the sector was hamstrung by both falling value and volume — consumers were buying less as well as prices going down — today, volume has risen. “Shoppers are putting more items in their basket,” he explains. “Which is a better situation than 12 months ago. It’s still a challenging situation, but it’s better.” So what is driving this rise in volume? Broadly speaking, Gray attributes it to a general improvement in consumers’ financial situation. “The economy isn’t doing too badly,” he suggests, “there’s a bit more confidence. There are, of course, some uncertainties around — the EU vote for instance — but generally there’s been an upturn in consumer confidence. Which should lead to increase in volume.” One area where the retailers, the Big Four in particular, have taken positive steps is in simplifying their price proposition. Granted, this happened in direct response to the discounters entering, then winning, the so-called price war, but it has led, in Black’s view, to a more honest relationship with the customer. “Absolutely,” he says, “because the large supermarket groups not only became detached from their customers, but they treated them as idiots. Those customers, particularly two or three years ago, really needed those supermarkets to have a stronger price proposition because their budgets were under so much pressure. And that’s why they went to Aldi and Lidl.” The superstore groups, Black believes, thought they were more intelligent; had more customer insight and therefore put forward very complex propositions and tried to fool their customers. Evidence of this was extensive coupons and vouchers, promotions between groceries and fuel, lots of promotions, lots of multi-buys and lots of price matching claims. In his estimation, it was behaviour that took some time to change.

“We are in a pattern now where there has been major progress in simplification to reduce the complexity of the proposition to customers,” he argues. “A far more stable, simple and straightforward, and ultimately lower-priced proposition, and also far more simple and cost-effective businesses to support that price proposition and strengthen the balance sheet. So there has been some quite fundamental structural change. I wouldn’t say that the industry is out of the tunnel, so to speak, but there is certainly light at the end of the tunnel where there wasn’t a couple of years ago.”

There seems to be a general shift in where retailers are putting their money. They’re taking it out of loyalty schemes and putting it into lower prices, which Gray believes is what customers ultimately want. To that end, Sainsbury’s halved the value of Nectar points, and it recently stopped brand matching with Asda (a move that inspired Tesco to announce it would honour any Sainsbury’s Brand Match coupons until June and, which prompted one media outlet to claim that Tesco had ‘parked its tanks’ on Sainsbury’s lawn). Morrisons retained its loyalty scheme, but not its price-matching discounts. And Tesco cancelled its Clubcard Boost programme, reportedly to the chagrin of a significant number of its legion of customers.

“There is a bit of a margin hit,” notes Gray, “but they are also taking with one hand and giving with another. A retailer’s main objective is to be profitable at the end of the day. I think there’s a lot of work gone into premium own labels, premium own brands. If you can get consumers to trade up, then you can make a lot more margin on a premium own brand. So it’s not just about a race to the bottom in terms of pricing. Tesco is investing in health and wellness ranges, it is investing in re-launching healthy lines, [it is] re-launching its Tesco Finest range and trying to get consumers to buy higher margin products.”

But price remains the dominant factor, for consumers and retailers alike, in the sector. Especially when it comes to those everyday staples that shoppers generally know the price of bread, milk, eggs and the like; where there has been extensive price matching and discounting of late. However, the price reduction on everyday items has broadened to include a far wider range of lines, dragging several fresh fruit and vegetable items into the fray.

Gray argues that casting the net wider — in the hope to get customers through the door and then make your margins on premium lines — only makes it more difficult for retailers to make money. “The discounters have come in and really disrupted the market,” he states. “If Aldi or Lidl had been a publicly listed company, I don’t think they’d still be in the U.K. They came into the U.K. in the early 90s and didn’t deliver their first profits for over 10 years. If that was a publicly listed company, shareholders wouldn’t stand for a market entry of 10 years without profits. So in effect, they’re reaping the rewards of their ability to take a long-term view. If you look at Tesco in the U.S., five years with no profit, the plug was pulled. Lidl and Aldi, they’re willing to stay 10 years and get that reward, and I think to a degree that’s what they’re getting now.”

Getting The Right Fix On Pricing

Professor Heiner Evanschitzky, chair of marketing at Aston Business School, believes that the Big Four’s obsession with price has been to their detriment. It is quite simply a battle they can never hope to win.

“Price seems an easy instrument to fix,” he says. “Simply make it cheaper and demand will increase. It’s classic economic theory. However, once competition is put into the equation, it doesn’t look that simple any more. It’s a myth that the Big Four can compete on price with discounters due to the very nature of the discounters’ business (smaller lines). It’s impossible for the Big Four to mimic that.”

morrisons storefrontOne of the secrets to the discounters’ success, Evanschitzky believes, has been their ability to re-focus the minds of UK consumers and make price the primary consideration when they go food shopping.

“[The discounters] managed to educate the customers in such a way that they now firmly believe that price is the most important factor in retailing. Therefore, the point of comparison will always be the discounter, and there is no way any of the Big Four can beat an Aldi or Lidl on price — no way!”

In its most recent set of grocery share figures (published on May 4 for the 12 weeks ending April 24) Kantar Worldpanel noted that the Aldi and Lidl axis maintained its record share high of 10.4 percent, with Aldi on 6 percent and Lidl on 4.4 percent. McKevitt predicts that they’ll have 14 percent of market share by 2020, and without the availability of a reliable crystal ball, most would agree right now with his assessment that there’s still room for them to grow.

“There are still some people who won’t enter their stores,” says Gray, “but to a substantial degree, they have changed the UK consumers’ perception of a discount store. Aldi has done a fantastic job with its advertising and marketing. It has done a great job in changing the perception of its products compared to brands, and that has had a positive effect for them. It has succeeded in that goal. However, this shift in perception hasn’t come cheap. Aldi has spent more in marketing comparatively than Sainsbury’s in recent years.”

Black adds: “I think it’s fair to say the rate of leakage from the Big Four to the discounters has slowed down. Aldi and Lidl are here to stay but their recent growth might start to decelerate. They’ll continue to open new stores but they’re going to have to fight a bit harder for their trade.”

He claims that once customers feel comfortable that the pricing in a superstore has sufficiently narrowed to discourage a trip to a discounter alternative, then other factors come in: choice, ease of parking and of ease of checkout services.

Prospects For Higher Retail

We are just over halfway through the second decade of the 21st Century and in the middle of the greatest shock to the system the Big Four has ever experienced since rising to prominence in the early 90s, so how healthy is Tesco, Sainsbury’s, Asda and Morrisons?

Tesco remains the largest single superstore group, with 28 percent of the retail market; followed by Sainsbury’s on 16.5 percent; Asda with 16 percent; and Morrisons on 10.6 percent.

Black regards Sainsbury’s as the most stable of these four operators. “It has a high specification customer base,” he says. “I think it will continue to plough its own furrow at the higher end of the market.”

Tesco, meanwhile, is engaged in a massive programme of reconnecting with its customers. Black notes that this involves material price investments and simplifications as already outlined, plus major changes to its supply chain and major changes to how its stores are configured. “We expect Tesco to stick to what it was 10 years ago, and that is a shop that anyone can shop in when it had broad appeal,” he explains.

And with Morrisons also ‘going back to the future’ in Black’s analysis, by focusing on the safety net of its idiosyncratic Yorkshire roots as a high service, high fresh food store, it is Asda that feels the most vulnerable.

lidl storefront“It feels exposed to Aldi and Lidl at the sharp end of the discount spectrum,” he states. “And the capabilities of Tesco and Morrisons in fresh food is stronger than Asda at the moment. It’s certainly going through a difficult time at the moment — it’s losing market share. One senses it needs to re-find the art of selling; it really doesn’t seem to know where it is at the minute.” As for the discounters, well, they’re becoming mainstream. They’re offering more premium products, which suggests opportunities to those in the food industry. As McKevitt puts it, they are no longer solely about being cheap; their message today is all about value.

It’s nothing new to predict that online shopping will continue to grow, but the analysts’ perspective has altered in recent times. Although Gray believes this growth is slowing somewhat; however, he notes it is still the fastest growing area of the grocery market. Of course, this has ramifications for superstore profits. It’s still proving more cost-effective at this point for superstores to fulfil most online orders, because it costs more to establish dedicated forms of consolidation and distribution.

And then there’s Amazon — the big, fat elephant in the room. Its Amazon Pantry service already delivers long shelf-life items, and it is only a matter of time before this evolves into perishable items such as fresh fruit and vegetables. But, as the behemoth discovered in trials across the pond, this brings with it a new set of challenges.

Gray notes: “I think Amazon doing Amazon Pantry makes sense, because it’s what Amazon is good at: putting stuff in a box, putting long shelf-life items that don’t need any attention into a box, and sticking it in a distribution system. Starting to deliver fresh perishable items is a whole new ball game. The costs are in distributing perishable items because it’s so difficult from a logistical point of view.”

Black shares the pessimism: “We expect Amazon to appear, but we don’t expect it to be in charge of the grocery market in 10 years time or 20 years time.”

Trends

As more people eat out of the home, the foodservice sector will continue to grow — both in size and importance. Black expects innovation within this arena to make great strides in the forthcoming years. Convenience is another key factor to take into consideration. McKevitt recognises that consumers will pay a premium for products that are expedient. He explains: “People will pay a lot of money to have a lot of effort taken out of their life in that way. People are also living in smaller households than they were decades ago, which impacts upon how they eat. People are eating on their own a lot more these days — so smaller portions, easier to cook portions.”

As the consumer demographic changes, the opportunities extend beyond formats and products. Evanschitzky points to our aging population as a key sector that is being failed by the current retailers. “Someone needs to capture that huge segment, and I’m puzzled why no one does it,” he sighs. “We’ve done research on the elderly that confirms their purchasing power, brand affinity and the like. The market is ripe for a new entrant.”

There are still plenty of opportunities out there, says McKevitt. “Classic marketing done right will still bring great results to people.”

Gray argues it’s about the Big Four acclimatising to the new normal. Previously, they could count on overall profit margins as high as 5 percent — much higher than on the continent. Since the arrival of the discounters there has been a reset of what can be achieved, he says.

So as long as retailers adapt to changing consumer behaviour, adjust to lower profit margins, find ways of making online shopping profitable, reconfigure stores to allow for smaller, more convenient shops, resist the temptation to fixate on price and simplify their offer, all will be fine.

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