Customers are redefining value and ‘returning to quality’. So what does the future hold for discount retailers?
Two years ago, as the banking system went into meltdown, discount retailers were the hottest topic in retail. In food retail in particular, there was a sense that chains such as Aldi and Lidl were set to make it to the premier league of UK retail and achieve the same success they’ve managed on the continent.
How things change. Last week Retail Week revealed that Aldi had slumped to a £54m loss in the UK last year. Rival Lidl, like Aldi, has had to make changes at the top, while Netto has called it quits altogether and sold its UK business to Asda.
So does discount retail have a future in the UK, or are - as Marks & Spencer chief executive Marc Bolland said last week as he delivered strong second-quarter results - customers “returning to quality”?
Bolland’s view is that when customers feel cautious about the future, their natural reaction is to choose items that will last, rather than disposable product. “Customers buy once, and buy well,” Bolland maintains.
The thirst for quality has helped lift M&S’s clothing sales but there is evidence that the trend extends to other sectors, including food and general merchandise. Retailers such as Sainsbury’s and Waitrose are powering ahead, while Aldi struggles. And although discount general merchandisers are delivering growth, there is some evidence of like-for-likes slowing.
Tom Savigar, partner at trend forecasting consultancy Future Laboratory, says the quality shift represents “value redefined”. He says: “At the height of the banking crisis, then into the recession, value meant cheap so shoppers were buying cheap. Value has now been redefined and it’s not just about price. It’s about quality.”
Does that change mean that only ‘quality retailers’ will prevail as next week’s public sector spending cuts are revealed and consumers brace themselves for another year of uncertainty? Or will the discount retail sector make a comeback as shoppers become more anxious about their financial outlook?
Tim Manasseh, partner at Roland Berger Strategy Consultants, says the move to quality is a general trend but will “vary by category”. He explains: “Customers will be selective in their purchases and look for quality in what they buy but there will still be room for cheaper brands or products in areas of less importance.”
The trend for quality can be seen in food, fashion, health and beauty and some general merchandise, says Manasseh. “There’s a distinction between cost and value and shoppers will pay for something if they see the value in it,” he says.
The trend can be seen in the performance of Waitrose - which has prospered in part because of its Essential Waitrose range - Sainsbury’s and Tesco. Sainsbury’s relaunched its top-tier Taste the Difference range last month, which chief executive Justin King said last week was a success, while Tesco chief executive Sir Terry Leahy said at its first-half presentation last week that like-for-likes in its top-tier range Finest were “recovering sharply”.
The growth in the big supermarkets’ top-end ranges seems to have come at the expense of the discount food grocers. Aldi’s £54m loss in the year to December 31, 2009 followed a profit of £93m the previous year. The loss partly reflected investment but was also evidence that the so-called ‘Aldi effect’ - the flight of middle-class shoppers to its stores following the banking crisis - was not sustained and customers soon switched back to traditional supermarkets.
Rival discounters Lidl and Netto have also suffered. Lidl has been through three UK heads in the past 18 months and its market share is static at 2.4% while Netto gave up the ghost and sold its UK operation to Asda this year.
Verdict Research senior retail analyst Matt Piner says the move to quality is part of the reason Aldi is losing out but he points out that the discount food grocers were only going to grow so far.
“The growth in the food discounters came from them mopping up the share left by the collapse of Kwik Save. Once they reached that point, they then started to get squeezed by the mainstream players,” he says.
Manasseh agrees. “The discounters will continue to suffer as shoppers don’t understand their tertiary brands and the reason they are big on the continent is because there isn’t as well organised competition as there is in the UK,” he says.
He says the trend for quality in food is evident more in the fact that Asda is suffering. Asda has admitted it has not been trading as well as it should this year, and in the latest Kantar figures it showed the lowest growth of the big four.
Asda chief executive Andy Clarke said last month that the grocer wanted to be recognised for quality as well as price. Its mid-tier range has been relaunched as Chosen By You, with an emphasis on quality.
“Asda is almost a big discounter in that it is the cheapest of the big grocers but all it is known for is price,” says Manasseh. “While price is important it isn’t everything. It’s about quality and service as well and those grocers offering all three are faring better.”
Piner believes the discount general merchandisers such as Poundland, 99p Stores and Home Bargains could also suffer slowing growth now that most of the sales from the collapse of Woolworths have been soaked up.
“The growth from Woolworths has now annualised and while much was made of the middle classes trading down in the recession, the huge gains were made in the months after Woolies disappeared and we won’t see those levels of growth again,” he says.
Home Bargains operations director Joe Morris said last month as it reported figures for the year to June that “the sector’s getting tougher”. Home Bargains’ pre-tax profits edged up from £43.5m last year to £46.6m this year, which, while is still an improvement, has dramatically slowed from the 25% growth delivered last year.
Morris said increasing costs of transport and raw materials, reduced margins and fierce competition on the high street are likely to hit profits. “The value sector is attractive [for retailers] to go after,” said Morris. “It’s getting more crowded. If you’re a weaker competitor you will find it tough.”
The increasing costs of raw materials such as cotton, plus rising freight costs, could be one reason shoppers are turning their backs on discount fashion players and buying quality pieces to last. Manasseh says: “Shoppers are going for quality fashion pieces as some discount fashion players are having to put their prices up because of rising costs. Therefore they don’t seem to be getting the same bargains as they once did. Throwaway garments are only valuable if they genuinely are cheap.”
Bolland said M&S will try to absorb rising costs where it can and was adamant that the retailer will retain its opening price points. He gave schoolwear as an example. He says: “We had a smashing year on schoolwear. We had strong promotions, which are important, but customers also chose quality.” He says M&S sold about 8.5 million items on its three-for-two offer.
Premium fashion retailer Ted Baker also said last week that quality is winning out over disposable fashion. It reported pre-tax profits up 24.6% to £7.5m in the 28 weeks to August 14. Boss Ray Kelvin said: “People are dressing smarter, people want product quality. It’s been doom and gloom and people want to dress up.”
Savigar notes: “We saw a lot of sobriety in the catwalks this season, where you might see a camel jacket for example, but that’s the sort of jacket that shoppers will keep for 10 years or so.”
There is one notable exception to the rule - Primark, which continues to power ahead, and benefits from its scale and volumes compared with its value fashion rivals. “Primark has an extremely efficient operating model and is fashionable and cheap enough to have a good market share,” Manasseh says. “The others might suffer but Primark will no doubt sustain good growth.”
Piner agrees. He says retailers such as Ethel Austin and Store Twenty One “never really took off in the same way as Primark” and such retailers “will suffer as commodity prices go up and they’re forced to put up prices meaning they don’t look so cheap compared with the likes of M&S, where you can get better quality too”.
Good service, says Savigar, is a key part of the quality offer. He gives the example of music download site Spotify, which allows customers to download free music as long as they listen to some adverts, or pay a £9.99 monthly fee to stream out any ads. “They’ve seen huge take-up for the annual fee in recent months because, while you can get a lot for free, what comes with value is the premium experience and that is about service,” he argues.
Manasseh maintains that service, quality and price make up the “whole package”. He points to health and beauty products as an example. “Retailers such as Boots are putting products of £20 to £30 on the shelves, which it never used to have, but they’re selling well because shoppers are using them as alternatives to treatments,” he says.
“Plus at Boots you get the knowledge that it is a quality product, at a cheaper price to a treatment, and a great service. Shoppers are not splashing out all the time, so when they do they want the whole package.”
It is this package that is also helping retailers such as John Lewis perform better than some of its department store competitors, he adds.
Manasseh says the trend for quality will continue into next year in the tough climate, and increasingly the definition of quality will also include the values behind the brand.
“A lot of importance will be placed in the values behind the retailers’ brands, what they are associated with, and those that have the ethics, provenance and quality message will win out,” he thinks.
So is the era of discount retail over? It all depends on the strength of the retail brand, but less is more seems to be the consumer’s mantra for now.