A VAT increase is looking like an inevitability. George MacDonald asks what promotional feats retailers will need to pull off to counter the blow to consumer confidence in the January Sales season

After a year of paying less VAT, consumers will wake up on January 1 to find the pound in their pocket does not stretch quite so far.

That day, VAT will go up again – from 15% to 17.5%. While the rise looks small on paper, it is likely to register in consumers’ minds. Still spooked by the reality of recession, the threat of job losses and the debts they have run up, jittery shoppers are likely to be watching their spending.

For retailers, nervy customers are bad news. And cautious expenditure in January, when the Sales traditionally prompt another wave of spending after the Christmas beanfeast, would be a most unwelcome start to the new year. Some even fear a sales wipeout in the post-Christmas period as the mood of frugality decimates takings.

In some ways, the level of gloom is surprising. After all, many retailers complained at the time of last year’s VAT cut that the reduction would be insignificant in driving spend.

And research published last week by PricewaterhouseCoopers indicated that the measure had failed to make much of an impact. The survey of 2,000 consumers found that 88% said the cut had had no effect on their spending. Just 8% said they had spent more as a result of the reduction, and 5% had no idea that the level of VAT had changed at all.

Given that the systems and operational changes retailers had to make to adjust to last year’s unexpected VAT reduction cost an estimated £90m – and a similar amount will be needed to move it up again – the impact might seem piffling.

But some of retail’s biggest guns have made headline-grabbing pleas for the lower VAT rate to be retained – or at the very least, for any increase to be delayed until the end of the crucial December and January trading period.

As early as June this year, Arcadia tycoon Sir Philip Green was sounding the alarm bell. In a TV interview, he said: “The single most important thing is what happens to VAT.” The entrepreneur warned that he “could see a lot of concern going down the track”.

At the same time, Marks & Spencer chief executive Sir Stuart Rose expressed similar views. He warned: “Increasing VAT on New Year’s Eve is an insane time. If the Government had any sense, they would delay it for a month.”

He added: “The key question is what it’ll do for sales, because the cost to customers will rise at a really important trading time. And there’s all the admin.”

And Hamleys boss Gudjon Reynisson entered the fray last week. He argued: “The reason for the cut in the first place was to boost consumer confidence. It should not be raised until consumer confidence returns.”

Facing the inevitable

But all the signs from the Government, official and informal, are that there is no chance of a shift in position.

So retailers are assessing what tactics could most effectively be deployed to sustain trading when the increase hits. Eye-catching promotions and legerdemain are likely to feature in equal measure.

First of all, retailers will have to confront a basic fact of consumer psychology. The tax – and therefore price – rise may well register more prominently in shoppers’ minds than the original reduction. Sir Geoff Mulcahy, one-time Kingfisher chief executive and former BRC chairman, notes: “Putting VAT up at the end of the calendar year is a double psychological whammy.
It’s the time when people are thinking about the Sales and it’s the time when people are thinking about their credit card bills.”

Therefore, he says, retailers will need to use smart tactics in order to bring forward sales that might be lost in January if shoppers decide to rein in spending, and to ensure January promotions take account of shoppers’ potentially more impoverished mindset.

Some retailers, especially big-ticket specialists, may decide to stage the sort of promotions in December that would more traditionally have been held in January. Clearly, VAT on a high-price purchase such as a new kitchen will be more obvious to consumers than a few pence on a low-ticket product. There has been speculation that Home Retail Group, owner of home improvement chain Homebase, is mulling the option of a December spectacular.

One retailer says: “Some big-ticket retailers almost used to shut up shop before Christmas – it wasn’t their important time. This year they will want to mop up all the available sales.”

Some retailers are sceptical, however, that such action will be necessary. Kingfisher chief executive Ian Cheshire, for example, maintains: “It’s hard to see people bringing forward kitchen purchases – people have other priorities at Christmas. And if you’re spending £4,000 then the VAT is not going to make a difference.”

Christmas 2008 revisited

It is true, however, that retailers have increasingly been staging big price promotions ahead of Christmas and the VAT rise planned for January is likely to mean similar practice this year by many retailers.

The trend has been especially evident in fashion and department stores. Last year’s Christmas period was marked by the spectaculars staged by Debenhams and mirrored by M&S.
In many such instances – although not all – the goods sold are bought in especially and are not straight markdowns of the season’s hot lines.

The VAT rise means a repeat is almost inevitable. One fashion retail chairman says: “There’s been a consistent pattern of people moving forward the big seasonal Sale. We used to talk about the January Sales, but now they often start on Boxing Day. It’s been creeping into the retail repertoire and the VAT rise will exacerbate that.”

And when January arrives, expect the ante to be upped again as retailers unveil a raft of promotions ranging from the imaginative to the opportunistic. Cheshire forecasts: “We will see all sorts of price stunts.” Options might include holding VAT at 15% during January, price cuts on non-VATable items, thereby emphasising wide-ranging value, and even the removal of VAT entirely during the month – the cost more than covered by skilful price architecture across the offer and effective price management during the golden month of December.

“My sense is the broader promotional messages will outweigh the 2.5% rise,” Cheshire says. The fashion chairman concurs. “The VAT change will be a marketing hook. You can just see the Asda’s of this world offering to swallow the VAT rise,” he says.

Another retailer says: “There will be a flurry of ‘we’ll pay the VAT’ deals.” He suspects stores will price-establish product for the requisite 28 days in order to be able to reduce tickets as the VAT rise hits – perhaps by category, such as fridges, or by SKU.

The media will be a vital player in the VAT war. The timing of the increase, during the year’s biggest holiday, coincides with what is often a quiet news period. That, combined with the consumer-interest nature of the story, makes it a near certainty that the change will make headlines, simultaneously threatening to put the frighteners on shoppers and providing retailers with a powerful marketing opportunity.

“How the media play it and consumer confidence will be the issue,” observes Cheshire.

“Newspapers will be writing about it and retailers will play the game,” agrees one senior industry figure.

If consumer sentiment is undermined by the VAT rise, some retailers may be able to sustain momentum, and even benefit, because they sell goods to which the tax does not apply.

Children’s clothes, many foodstuffs and books are among the products that do not attract VAT. More than half of WHSmith’s assortment, for instance, is zero-rated or exempt. That, combined with the low-ticket nature of the retailer’s range, should provide some protection, even if shoppers keep a closer eye on spending next year.

Silver lining

Ironically, however, a VAT rise may bring some opportunity for those retailers that do sell items subject to the tax – particularly for those that did not pass on the original VAT cut to customers – offering the opportunity to raise prices. UBS analyst Andy Hughes observes: “Conversely, WHSmith may benefit less than the sector from any gross margin gain in calendar 2009 if the full VAT cut is not passed through.”

Recalling the VAT reduction, he says: “Although larger retailers are more likely to have been sensitive to the pass-through, at least initially, a recent ONS report suggested that more than one-third of retailers did not pass on the reduction.”

Last month, the ONS reported that the VAT cut took 0.5 points off CPI inflation in December as the reduction was passed on to shoppers. The ONS found that 14% of stores changed the prices marked on the shelf and 43% implemented reductions at the till. The biggest evidence of the rate reduction’s contribution to lower CPI inflation was in categories such as TVs and DVDs.

But the study also revealed that 34% of stores did not pass on the cut at all. How those retailers respond to the January increase remains to be seen, but it is certain that some – if not all – will put up prices.

Another unwelcome aspect of the VAT change is that January’s rise may not be the last. Next year will bring a general election. The Conservatives have conspicuously refused to rule out a rise in VAT to as much as 20% if they win, and other tax rises may be implemented whoever comes to power, as a new government struggles to address the dire state of the nation’s finances. “Any new government will be looking at a radical budget, including public sector job cuts,” says Cheshire.

However he, and other retailers, remains sanguine. Store chiefs are confident that although times may remain tough, the sector’s mettle will show through in the face of issues such as the VAT rise.

The fashion chief executive says: “In the same way that most of us didn’t see a dramatic reaction when VAT was cut, I think that consumers will get over a rise within a few weeks and so will retailers.”

Another senior retail source says: “There’s no situation in which the entrepreneurial and creative skills of retailers will be exhausted. They will always find a way to catch the imagination of consumers.”

VAT is simply being returned to its previous level, but a rise is still a rise, and past experience elsewhere shows the change is not likely to be plain sailing for the consumer economy.

In Germany, for instance, the government of Angela Merkel ramped up VAT by 3 percentage points to 19% in 2006. Some retailers complained they ended up paying the price through sluggish consumer spending. UK retailers will be doing all they can to minimise the danger of the same thing happening here.


The BRC has been lobbying hard for the reintroduction of the 17.5% VAT rate to be delayed by at least a month.

Coming at the busiest time of the year for retailers, the changeover is likely to be both costly and labour intensive. As part of price realignment, retailers will need to make complex IT adjustments during a period in which systems are usually put into lockdown in order to minimise the chances of IT changes disrupting the crucial Christmas selling period. However, all the official and unofficial indications are that the Government will not back down on timing.

Retailers are therefore seeking to ensure a pragmatic approach by trading standards officials during the changeover. The scale of the task is likely to mean that in some cases shelf-edge labels will not match those charged at the till.

VAT returns are also a potential problem. The calculation of VAT on items returned to suppliers as damaged or taken on a sale or return basis, for instance, will be more complicated
than usual.

The BRC is also campaigning for the removal of VAT on energy-efficient appliances – a measure, it says, that would assist in combating climate change as well as stimulating sales.

Adoption of the policy would remove £507m a year from the VAT take, the organisation calculates. That is about the same as the cost, over a fortnight, of the across-the-board cut introduced last year.