COMMENT We have seen record inflation in 2022, with concurrent wage increases – all of which have impacted retailer margins. But the year has been one of two halves, with reasonably strong demand in Q1 and Q2, prior to cost-of-living headwinds impacting both demand and costs in Q3 and Q4.
We are expecting a similar picture for 2023 – with the first half potentially even worse than the second half of 2022 from the perspective of both inflation and consumer demand, with signs of recovery starting to appear as inflation starts to abate in the latter half of the year. This, however, very much depends on the wider global macro-economic environment, and assumes no further escalation of hostilities in Ukraine into Nato territories such as Poland and beyond.
What this means for physical retailers is increased store trading costs and net margin decline. The energy crisis will deepen in 2023, after which related costs – such as the cost of goods – will fall, stabilising by 2025. Our growth predictions assume that labour cost growth will track the growth in energy costs, stabilising around the same time to average pre-crisis levels.
In light of the war in Ukraine, energy price inflation has been the overarching concern for many businesses, in part due to the impact on consumers, the cost of production and logistics. However, in terms of store trading costs, utilities typically comprise only a small proportion of costs, and so energy price inflation has only a small impact on profitability – which for many will be offset by the forthcoming reduction in business rates. Food stores are the exception as energy costs associated with refrigeration are higher, although supermarkets benefit from more inelastic demand than non-food retail.
Rates and taxes
From April onwards retailers will benefit from lower business rates. The impact of the rates revaluation varies by asset class and location, as it is based on 2021 rents, versus 2017 previously. The rates revaluation will have a beneficial impact on large centres in particular – such as out of town malls, city centres and large towns – with small rateable value increases in local shopping locations.
The government has announced that the UBR is once again not subject to a CPI-linked increase this year, and that any reduction in rateable value is also not subject to downward transition, although upward caps are applicable. The result for many is that rates payable will be lower in 2023, which will help alleviate some of the cost increases retailers will experience next year – but 2023 will be extremely tough regardless, with retailers forced to take a significant hit on store net margins.
This will mean that some retailers will likely close stores next year that do not deliver sufficient contribution to the business, assuming lease ‘events’ coincide with these closures. Other retailers looking to open stores in the wake of these closures would do well to negotiate a couple of years rent-free over the course of a standard 10-year lease – to ride out the storm in 2023 and to an extent 2024, prior to what will hopefully be better trading conditions in 2025.
The government decided not to introduce an online sales tax in its recent Autumn Statement, partly because although some retailers are in favour of a tax, many that invested heavily in their online transactional capability during Covid are against. The online pure-play business model is proving challenged anyway, as shown by the failure of Made.com and consistently poor results from the likes of Boohoo and ASOS. Pure plays will ultimately pay higher property taxes anyway, given that the rateable value of distribution centres and warehousing increased significantly since the last revaluation. Amazon, for example, will pay about £29m additional business rates from 2023 onwards.
The government estimates that total business rates paid by the retail sector will fall by 20% but will rise 27% for distribution centres and warehouses. This will of course impact brick and mortar retailers too, but to a lesser degree.
Positions of strength
Make no mistake – 2023 will be tough for retailers, with many struggling or even falling into administration. One or more online pure plays may indeed go the way of Made.com before the year is out. In terms of physical retailers, with a couple of exceptions there are very few big names that are likely to fail, with the majority of the weaker performers such as Debenhams and Arcadia Group failing during Covid. This, if anything, has strengthened the position of the stronger retailers such as Primark, Frasers Group and Next – the latter two snapping up struggling retailers for a cut price on a regular basis, to further bolster their own trading positions.
Retailers that are not Primark, Frasers Group or Next, however, will need to do everything possible – across the value chain – to mitigate the impact of high inflation. One point we should remember in all of this – retailers survived the worst possible trading environment since the Second World War in Covid. This current cost-of-living crisis pales in comparison to that.
Jonathan De Mello is founder of JDM Retail
