Jessica Walker surveys the retail landscape, identifies the major question marks looming over the sector and addresses what can be done to adapt to a volatile, challenging and unpredictable market
The retail sector has been through some difficult times over the past few years. The fall of a few big names – most recently BHS and Austin Reed – with big flagship stores and large property portfolios seems to exemplify the struggle, but is the pessimism justified?
There is no doubt that the sector continues to face challenges as a result of changes to shopping practices and an ever-more-demanding, technically-savvy customer base. The ability of retailers to address and deal with them will depend to a large extent on their capacity to adopt new practices and embrace new technology. However, in addition to these sector-specific issues, there are also several external influences to take into account which are likely to impact on profitability and, therefore, the ability to weather a testing market.
Business rates
One very real concern that will affect any retailer with a bricks-and-mortar base is the increase of business rates to take effect in April 2017.
The current way in which business rates are valued may give an advantage to retailers that place more emphasis on their online shopping provision, so the delay to the increase from 2015 has been welcome.
The announcement of the new draft rateable values for the 2017 business rates revaluation has provided store occupiers with much-needed visibility as to the potentially increased overheads over the next year.
While the government has extended the relief for certain businesses from April 2017 (it has estimated that 600,000 small businesses will pay no business rates at all), the impact of this relief will be of scant comfort to many retailers as a result of the revaluation.
Commentators are predicting an average increase nationwide of 4.7%, but that figure hides huge disparities across the country: some areas will see an average reduction in rateable values, while some retailers in central London will face a hike of around 100%. Where a retailer is already stretched, it is easy to see how these increased rates may push it over the edge.
Brexit
But business rates are only one piece of the puzzle and these increases are unlikely to lead to a swathe of restructurings on their own. Other, potentially more pressing, issues for retailers are being presented, unsurprisingly, by the prospect of Brexit.
Since the EU referendum vote, the value of sterling has taken a substantial hit. While most retailers will have hedges in place to protect them from the impact of the devaluation of sterling, operational costs are likely to increase as those hedges unwind. We have already seen reports in the media of issues arising as a result of increased costs in the supply chain resulting from the pound’s decline and this is likely to become a more common theme.
Certainty as to Brexit’s impact in the future is still a long way off, as we will not have full visibility until after the negotiations have completed and the UK has actually left the EU – which, on the current government timetable, is likely to be March 2019. That is a long time for any business to be unable to predict its future costs, which may itself create additional problems for a struggling business, perhaps with a short-term refinancing requirement.
If a hard Brexit is the end result, with the UK leaving the free market, retailers may also have to face pronounced increases to their cost bases as a result of tariffs and higher import duties. These issues may then be compounded if Scotland uses a hard Brexit as an opportunity to break from the UK, though a further Scottish referendum is by no means a certainty.
Consumer confidence
It is not all doom and gloom, however. Consumer confidence appears to be rebounding after the immediate aftermath of the Brexit vote, footfall numbers over the summer looked positive (despite conflicting reports) and retail like-for-like sales were up in September, according to the British Retail Consortium and KPMG.
This trend is likely to continue while interest rates remain low, wages rise faster than inflation and credit is cheap.
Even so, we can certainly see retailers taking steps to protect their position. By way of example, luxury retailer Wolf & Badger had planned to open an additional four stores across the UK but has put those plans on hold following the EU referendum in favour of opening a new store in New York in February 2017. In this way, it aims to continue to broaden its business without taking on the risks of the uncertainty of the pre- and post-Brexit UK until the effects are evident and can be addressed.
Also turning its back on pre-Brexit expansion plans is Waitrose. The supermarket was planning to open an additional 14 new stores in 2016 but that number has been reduced to seven after its parent, the John Lewis Partnership, suffered a 15% drop in profits to the end of July 2016, largely as a result of a £25m property write-down.
Waitrose’s decision is said not to be linked to the referendum result (and indeed Sir Charlie Mayfield, the partnership’s chairman, has said that Brexit has not had a discernible effect on John Lewis) but it demonstrates that no retailer is immune to the challenges in the market, not least the continued growth of online shopping and the entry to the market of e-commerce specialists such as Amazon. This is evidenced to a greater and more disconcerting effect by Marks & Spencer’s recent announcement of the closure of 60 of its stores and a change in the focus of its business away from clothing and on to food.
Aldi
But not everyone has been put off their expansion plans: Aldi UK announced in September that it will invest £300m in its stores over the next three years, part of which will involve opening 70 new stores and refurbishing more than 100 of its existing stores in 2017.
Aldi’s positivity is rare, however, with most retailers being considerably more cautious. Brexit aside, the higher minimum wage and the national living wage have had a considerable impact on many retailers, as they try to balance customer care against an increasing wage bill. The introduction of the workplace pension has also increased employee costs.
In addition, many tenants are facing increasing rents as a result of upwards-only rent reviews on leases which are already over-rented, particularly in prime areas, and vacancy rates were increasing even before the EU referendum.
According to figures released by the Local Data Company, 2015 brought a net increase in vacancy rates, with 17,975 closures as against 16,513 new openings and this trend continued into the first half of 2016, with closures outweighing openings by 1,997.
It is clear, therefore, that Brexit cannot be blamed for all of the difficulties being faced by the retail sector.
Saving the high street
In an attempt to halt the decline, a new initiative was launched in August 2016 called Save The High Street, which is a coalition supported by Google’s Digital Garage, the Interactive Media in Retail Group, PocketHighStreet, Tech City (the scheme set up by the government to accelerate the growth of the UK’s digital economy) and the Future High Street Forum (a government body working to support and champion local high streets).
The movement aims to establish a “10-pillar framework for successful modern retailing” and help retailers on the high street to adapt to the changing circumstances of trading, including the increase in technology. This will undoubtedly be a valuable tool for retailers, particularly small businesses, but it is not likely to be enough in and of itself to protect businesses from the additional costs and challenges presented by Brexit, increased business rates and rents or competition from new e-commerce specialists.
E-commerce
More commentators are calling for real change to the way business rates are calculated so that they accurately reflect the way that income is generated and do not penalise those businesses that are less technologically advanced.
Such a change would not be the whole solution, however, and many retailers need to invest heavily in their e-commerce platforms simply to be able to compete in today’s on-demand world.
Those retailers that are able to develop their IT and e-commerce offerings while saving costs elsewhere are likely to be those most able to ride out the uncertainty of Brexit.
It is clear that retailers are facing a protracted period of vulnerability which is likely to leave at least a few casualties in its wake.
Jessica Walker is a senior associate in the restructuring, bankruptcy and insolvency group at Mayer Brown
