What is the state of UK retail in early 2011? That’s what Retail Week sought to find out with Retail 2011, the authoritative analysis of UK retail today. In this extract from the report, we look at the key themes that emerge.

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When consumers sneeze, retailers catch a cold. So it’s no wonder that the retailers surveyed for Retail Week’s Retail 2011 report in late 2010 were approaching this year with caution.

Higher VAT, higher unemployment on the cards, the return of inflation and the prospect of interest rate rises are all reasons for retailers to worry. But they have heard enough bad news over the past few years to know that even when the media and politicians are preparing for the worst, it usually doesn’t turn out as bad as feared.

In our interviews, we found most retailers - with the exception of those whose businesses are on the precipice - are investing for future growth.

Multichannel is by far the most important priority for retailers surveyed

Multichannel is by far the most important priority for retailers surveyed

To benchmark retailers’ priorities for 2011, we asked them for their top three for their business over the year ahead. They were ranked from 1 to 3, and to show their relative importance in graph A, a scoring system was created with the most important given 3 points, second most important 2 and the third most important given 1. The results are quite striking.

“Customers are using combinations of channels to shop in whatever way suits them best”

With more than double the score of any other investment area, multichannel is by far the top priority for retailers. Building a multichannel infrastructure has become a must - even for those retailers that are taking a cautious approach to investment.

Retailers are back in growth mode after having made most of the obvious cuts

Retailers are back in growth mode after having made most of the obvious cuts

What is also interesting to see is that there are no longer any ‘no-go’ categories when it comes to selling online. The only groups of retailers that did not place any importance on multichannel were those with a bias to low price-point items, or those in difficulty and more focused on survival, although it was a higher priority to non-food retailers than supermarkets.

Unemployment is the most significant concern raised

Unemployment is the most significant concern raised

International got the next highest score, with many retailers giving the category 2 points after ranking multichannel growth as their main priority. Many of them are exploring international growth as part of their online plans. International is still considered more important than UK store expansion, which was mentioned by the fewest retailers.

However, UK store expansion’s total score was boosted by most of the food retailers we spoke to ranking it their top priority, while only one of the non-food retailers ranked it as highest.

The retail take-aways

  • Building a multichannel infrastructure is a must for the majority of retailers. Retailers should focus on building a flexible and extendable platform for multichannel trading that maximises their options for new initiatives in 2012 and beyond
  • Town centre retailers face a twin challenge to drive footfall, competing with out-of-town centres and online retail, and tend to be focused on specialist categories, which will suffer when incomes are squeezed. Such retailers must use the internet to drive traffic to their stores, and conversely encourage online loyalty for those customers who use stores as a showroom
  • Internet sales comprise a bigger proportion of the retail total than many realise: 7.8% of total retail sales excluding petrol in 2010, according to the ONS. So retailers must reassess their estimates for how much of their business could migrate online this year
  • The VAT rise appears to be having a disproportionate effect on consumer confidence surrounding big-ticket items. Even retailers appealing to middle-class consumers are advised to explore offering in-store finance options as other sources of credit dry up
  • Despite a small backlash against promotions, most retailers believe that significant promotional activity will be inevitable throughoutthe year. Fashion retailers in particular are anticipating price reductions on current season products
  • Reduced footfall is considered by many retailers to be a sign of more considered purchasing by consumers. Retailers must be aiming for improved conversion rates on the footfall that is achieved
  • The cost of fuel will impact consumer spend this year, reducing shopping trips and likely pushing spend towards supermarkets, especially those with petrol promotions. The 6p-per-litre fuel discount Morrisons has offered to customers that spend £40 in stores is the type of offer likely to be repeated throughout the year
  • For fashion shoppers there is a move towards quality items that can be worn with a variety of outfits. Product remains central to clothing retailers’ success, and there is some evidence that consumers’ love affair with value fashion is waning
  • With three of the big four supermarkets having new leaders, more experimental initiatives - such as Morrisons’ push into ecommerce - should be expected
  • Retailers are concerned about the potential for rising interest rates - but the fall in the latest inflation figures should give hope that the Monetary Policy Committee of the Bank of England will hold off raising rates back towards the long-term average for a little longer

Cost versus growth

The cost base was a particular focus for non-food retailers, while range and category expansion received the second highest number of mentions by retailers and was on the agenda for most of them, although no retailer made it their top priority.

We asked what sort of balance the retailers would be seeking between cost savings and driving growth. Most of those surveyed (see graph B) said their attention would be going on driving growth, both to take advantage of opportunities as the economy emerges from recession, and because a lot of cost had already been taken out of the business over the past two years, meaning there remains little left to cut.

“We did a lot of cost reduction throughout 2009,” said the chief executive of one food retailer. “We restructured the whole business and 10% of our staff were made redundant. I don’t see the opportunity to reduce costs any further.”

We also asked retailers about whether they would be focusing their investment in new or existing channels. The majority said existing channels would be the focus, but the picture is complicated as some retailers consider online as a new channel, while for others it is well-established.

With the tough economic conditions in mind, retailers were given a list of five external factors that might have the most impact on the industry this year, but also given the option to name their own. Again, the most important factor named by each retailer was given 3 points in the scoring system, the second most important 2, and the third most important 1. Graph C shows the results were clear.

Many of the retailers surveyed saw the ‘negative’ factors - especially unemployment - to be more significant in 2011 than the potential for a recovery in consumer confidence. With thousands of public sector jobs set to be axed this year, it was perhaps unsurprising that unemployment was mentioned more times than any other factor on the list.

It was also mentioned as the most important factor by a high number of the retailers surveyed, and while higher taxes (including VAT) was mentioned almost as many times, no retailer said it would be the most significant factor seeing it more as a contribution to a gloomy consumer mood. A north/south divide in spending habits was mentioned by relatively few retailers but was very significant to those who mentioned it.

Two retailers named factors not on the list. One retailer that operates only at the upper end of the London market mentioned overseas spending in the UK, while another ranked the potential for interest rates to go up as the most important potential factor.

The numbers

At least the first half of 2011 is already proving to be even more difficult for retailers. The impact of the VAT increase to 20%, the prospect of further increases in inflation, disposable incomes failing to keep pace with higher prices (especially if interest rates rise), plus higher unemployment and media reporting of poor economic news and company results, will all contribute to the further undermining of already weak consumer confidence.

This, in turn, will restrain consumer spending, especially on higher ticket, household and other less essential goods and services. On more essential items there is also likely to be a continuation of the shorter-term propensity to trade down.

And so far, retailers’ predictions for the year have been borne out by the figures that have been reported, with the British Retail Consortium’s latest figures showing total retail sales for March falling 1.9% year on year, and like-for-like sales dropping 3.5%.

But the future of UK retail is now inherently bound up with the digital age. According to the ONS, the internet accounted for 10.6% of total retail sales, or £770m a week, and the proportion has been on a sharp upward curve, accelerating since the middle of last year.

And even this figure underestimates the impact the web is having, as several retailers responding to the survey highlighted that web-influenced sales are much higher. Increasingly, customers are using combinations of channels to shop in whatever way suits them best, researching products via one channel but buying from a different one.

However, the multichannel age reduces the number of stores retailers require to have national coverage, and the likelihood is that more store portfolio reviews will take place and CVAs may be the tool that retailers turn to in order to get rid of underperforming stores.

New retailers, such as Theo Paphitis’ Boux Avenue, see a smaller number of stores plus a strong web presence as key to national coverage . That isn’t a problem to the major city centres and regional malls, which are continuing to consolidate their position not just as retail centres but leisure hubs too and in which retailers will always need representation.

The problem is that the next tier of centres will require reinvention and the introduction of new types of uses to fill the empty shops. The value discounters have plugged the gap but that market is now close to saturated and it may be that town centres become focused on a smaller core with vacant units being converted to other uses such as residential.

Multichannel may hold part of the answer, with the potential for local shops to also serve as collection points for online orders. This has the benefit of being close to where people live, and drives footfall into local stores. Boots is already trialling such a strategy, but it’s early days and certainly won’t save the high street alone.

Continued polarisation

It will be the undifferentiated middle market that suffers most as successful retailers generate funds to reinvest while weaker players struggle to keep up.

The UK remains over-shopped, and non-food retailers are going to have to be more ruthless when it comes to pruning their store portfolios, manage their cost base obsessively, yet still become more focused on carving a clear position in the market and knowing their customers better.

The supermarkets will continue to grow, with their landbanks and expansion into new formats continuing, and the web, and in some cases non-food only stores, helping them to grow share in general merchandise and fashion. This is bound to put pressure on the mass general merchandisers, many of which increasingly lack a point of difference in the face of growing supermarket non-food offers.

Some retailers will face structural challenges. For example, as the year progresses it is becoming clear entertainment retailers such as HMVwill need radical reinvention to give the business a sustainable future. If any category is likely to disappear from the high street it will be entertainment, but a raft of specialist retailers in many sub-sectors of non-food retail continue to struggle and will need to do more to develop a distinct purpose if they are to survive.

“The future of UK retail is now inherently bound up with the digital age”

The most successful specialist retailers will be those operating in niches that the supermarkets find it hard to gain authority in, such as Pets at Home and HobbyCraft, and these will continue to find favour with investors.

But it’s not all doom and gloom. Not only is the UK leading the field when it comes to online retail, with innovative pioneers such as Asos and Ocado, but also bricks-and-mortar businesses. This has shown that UK consumers still have a real appetite for new and exciting brands and, even better for the retailers concerned, are happy to pay premium prices for them even in a recession.

Jack Wills and Superdry are two outstanding examples, but there are many more niche retailers operating particularly at the aspirational end of the market which by knowing their customers and understanding their interests have carved out successful niches in upper middle-class locations.

Their success proves that whatever changes in the economy, retailers offering the right product in the right environment - either physical or virtual - with the right service will attract customers. That doesn’t change and should provide reassurance that whatever the rest of the decade throws at them, retailers that manage to do that will emerge in good shape.