How retailers will navigate a 4th consecutive year of pressure

Since the second half of 2021, retailers have responded in various ways to heightened global inflation. While inflation levels are projected to moderate in 2023, retailers will continue to face entrenched levels of high pricing and constrained shoppers. In addition, they must contend with a concoction of factors which, in addition to inflation, are contributing to the new profit reality:

1. Supply chain hangover: While post-pandemic global supply chain chaos has subsided and shipping costs have eased, shipping reliability and average delay times for vessels have not yet fully rebased to 2019 levels.
2. Higher borrowing costs: Central banks have been raising interest rates which is driving up the cost of debt. This is causing business investments to be put on hold or restructured.
3. FX challenges: In 2022, global investors flooded into the US dollar. Some Asian currencies, the Euro and the British pound saw their values fall sharply against the dollar. For retailers operating across various currency jurisdictions, the fallout of these headwinds will continue to have an influence throughout the year.

In this current context, retailers will be evaluating and drawing the lines between those factors they can and cannot control.

The uncertainties: Timelines for high Inflation and interest rates plus normalization of global commodities pricing

Levels of inflation will remain above target in most economies, forcing shoppers into ongoing reassessment of discretionary spend. The outcome is a state of continual flux around basket dynamics, cross-elasticities, shopping trips and channel switching. For European retailers, economic growth projections are lower versus developed economies elsewhere.

The breadth and depth of energy support packages given to households across Europe to manage energy costs also has a key role in determining pressure on shopper wallets. The German Federal Government has agreed a €200 billion gas price relief fund which will benefit private households with a cap of 80% of their usual consumption. This will be effective from March 2023. This huge package was only possible via the government suspending its debt brake on borrowing.

Like all businesses, retailers are at the mercy of how central banks calibrate monetary policy to determine interest rates throughout the year. Where interest rates will land, and hold, is a significant unknown that will play a key factor in retailer strategic planning.

And finally, the duration and impact of the Ukraine war is still of huge importance. This particularly applies for retailers in markets most exposed in terms of raw material supplies and, subsequently, finished goods prices. Global food prices spiked dramatically at the outbreak of the war, followed by some cooling off, partly due to the on-and-off grain agreement between Russia and Ukraine. In response to high food inflation and supply risk, some countries restricted exports to prioritise local supply. These policies restricted the movement of about 7% of the global food production.

In 2020, retailer risk profiles were dependent on the extent of demand shocks due to lockdowns and the pace of vaccines roll-outs. In 2023, stabilisation of inflation and interest rates and full restoration of global supply chains will be key areas retailers will be watching closely.

Retailers move to control what is within their reach

Throughout 2022 retailers typically defaulted to three core inflation responses. The first was a pronounced effort to fight for their shoppers. They shifted away from traditional promotional calendars to “always-on promos” and protracted price freezes.

There were strong “value” plays across a broad range of levers to improve the appeal to a higher base of constrained and value-seeking shoppers. We saw louder messaging around core baskets, private label amplification, fine-tuning of loyalty schemes and using technology to make it easier to shop for value. Some retailers were more willing to sacrifice short-term margin than others. This was reflected in the depth of pricing investment and, subsequently, the positive top line Q3 2022 results against bottom line softness for some of the largest grocery retailers. Walmart, for example, implemented higher than normal markdowns in 2022 to reduce inventory levels while Tesco invested heavily in pricing. Both reported positive top line growth in Q3 last year versus pressure on net income.

The second and most marked way retailers responded to inflation was by pursuing a tougher negotiation environment with suppliers. There were numerous high-profile supplier-retailer pricing conflicts between leading European retailers and large FMCG players, often resulting in dramatic product delistings. While these incidents are not unique to high inflation environments, the frequency and extent of the conflicts was amplified, especially in Germany. The year also saw heightened levels of activity for European buying groups beyond their cyclical evolution of formation and dismantling. Alliances were recalibrated more frequently as retailers reviewed their buying structures with greater zeal.

The third pillar was a re-evaluation of retailer financial equations. One of the most striking outcomes from the pandemic was how retailers held on to high levels of cash. For some, this has become a standard way of operating. Cash provides a degree of insurance in times of uncertainty. Carrefour, for example, had a pre-pandemic net free cash flow position of around €300 million and had increased it to €1 billion by 2020. In its latest financial report, the French giant said it intends to sit tight on over €1 billion in cash as its baseline. As is typical in tough trading environments, retailers will be examining a range of ways to right size their business and some are already letting go of distressed or low-yield assets to free up resources.

In 2023, retailers will continue to shape initiatives around these pillars. However, financial outcomes will vary based on the mix of headwinds they face due to the geographies in which they operate, the full impact of FX based on their currency exposure, their operational efficiency and how much headroom exists to reduce their COGs.

Tackling the Big Profit Challenge will be the no.1 priority for retailers in 2023. However mid-to-long-term growth ambitions remain on the table and retailers largely remain invested in growth programs, opening up new revenue streams and transformative partnerships. They will be looking to their suppliers and partners for support on tackling immediate challenges as well as demanding they embrace blue-sky thinking around new ways to disrupt and compete in the future.

I’m Paida Mugudubi, Director of Insights at Kantar, the unit behind the syndicated Retail IQ platform. We deliver expert retail thought leadership, as well as advisory services on where to play and how to win across markets and channels.

https://kriq.kantarretailiq.com/