The retail industry has never been so focused on price, and as interest rates rise it will force businesses to be more dynamic.

After the false dawn of the first half of 2014, 2015 has proved to be much tougher trading year for retail. No industry embraces permanent price deflation from choice, and I have never seen a market so dominated by price.

Discount retailers operate models with cost bases designed to deliver profits from low margins. Most of the market on promotion at present does not. Ignoring industry economics and company performance will be increasingly life threatening.

The market is hugely oversupplied. Since the Lehman Brothers collapse total capacity has increased by 12%, against the background of weak demand. Demand is weak because the consumer economy remains softer than many seem to think.

Household spending power remains below its pre-debt-crisis levels. It is the twin issues of weak demand and overcapacity that is producing this deflationary market.

Focus on value not volume

There is a problem here with expectations, the result of a rose-tinted narrative. Most commentators focus on volume sales. This is very misleading, especially in a market dominated by price. Deflation is allowing consumers to buy more items. So the volume numbers look better. Nevertheless, companies pay their bills in money, not units.

“The growth of online is pervasive in its influence over bricks and mortar”

Richard Hyman

A real world understanding needs to be based on sales by value and here, things are more challenging. In fact they are getting tougher. Annualised industry growth in the first half of 2015 is 3% (against 4.2% for calendar 2014) and the run rate is slowing, around 2.2% in the calendar year to date.

As well as oversupply, the growth of online is pervasive in its influence over bricks and mortar. On an annualised basis online now accounts for 12% of total industry sales but in non-foods, it is getting steadily closer to 20%.

Visit most retailers’ websites and the landing page will shout price-promotions and discounts of one sort or another. Driving traffic to retail websites relies on price offers to a significant degree.

And physical retail is following, partly because businesses cannot adopt two divergent pricing strategies and increasingly, because they have a growing need to use price to drive footfall to stores.

Interest rates increase

Deflation across the industry is running at an annualised -5%. The shakeout post-Lehmans was largely illusory – far from removing capacity from the market, floorspace in both foods and non-foods expanded steadily, on top of substantial capacity growth added online. The real shakeout will come – there are simply too many mouths to feed.

These conditions hit some far more than others, increasingly separating the winners from the also-rans. And the screw will tighten further.

Capacity is growing right now and Governor of the Bank of England Mark Carney tells us interest rates could be on the rise soon. Every 1% increase in rates is likely to shave around 1% off retail spend.

The upside is that it will raise the competitive bar. It is forcing leadership teams to be more dynamic and more innovative. And UK retail already leads the world. Being good is no longer good enough in this market.

  • Richard Hyman, founder, Richardtalksretail.co.uk