Comment: The mid market takes on the value players
Most retail chief executives believe the recession is not over for retailers. Tax increases, public sector spending cuts and likely unemployment will continue to depress consumer spending. So the value formats are sustaining their momentum and are taking market share from the mid-market players. Some of the weaker formats have failed to survive, resulting in a re-distribution of expenditure to the remaining value players.
A move to value by consumers in recessionary times is not new. For instance, the early 1990s saw the birth of some of today’s strongest formats. In the past, support for value slowed or even reversed when economic recovery occurred. This time, things are different. Structural change has taken place, and value retailing is here to stay.
What is ‘value’?
Value equals price multiplied by quality. It is this second ingredient which has become critical to the continued success of the value retailers. In past recessions, a return to the mid market was led by people seeking to enhance their lifestyles through better quality. However, the quality offered by value retailers has vastly improved and is appropriate for the price. Loyalty to these retailers is surviving beyond consumers’ belt-tightening phase, and the stigma associated with value shopping has disappeared. Regardless of income level, it is acceptable and even desirable to brag to friends about your latest bargain.
Young shoppers are growing up with value formats, trust them and like the variety and volume of goods they can get for their money. As clothing trends emerge and die within a season, the value players have the design and supply chain capability in place to ensure a swift turnover of goods. In fact, consumers get relatively good-quality products but at such affordable prices that they do not feel guilty about tossing them aside in short order.
How can mid-market players respond?
So, with no compulsion towards higher quality, an eclectic customer base which perceives spending less to be canny, and a loyal generation which will be the new parents in ten years, the mid-market players are challenged to maintain their profitability in the medium and long term. How should the traditional brands amend their business models to capitalise upon the changing attitudes of the consumer?
The mid market has already fired the first warning shot across the bows. The Christmas trading performance of the larger mid-market players was enhanced by a much more hardened attitude towards management of ranges and stock levels. This resulted in the shortest period of sale for many years and vastly reduced markdowns, which will reflect well in full-year results. In fact, it is quite likely that the January Sale will decline in importance as the process of aligning stock levels with customer demand becomes more refined.
This improved margin will buy some time. But declining volumes and inevitable margin pressure from increased costs (which cannot be passed on to the consumer) mean that fat needs to be trimmed from somewhere. Retailers are examining their property, supply chain and people costs to establish where to wield the knife.
The major mid-market players have an ace card - their property covenants. Through their immense leverage, they should be able to obtain improved terms on existing property sites and secure good deals in new situations where landlords are in urgent need of tenants to fill empty space. In many cases, landlords will agree to zero rent as long as the retailer covers business rates. The long-term consequence is that the strong players will take a greater proportion of the available retailing space, squeezing out the weaker formats and preventing the birth of new formats.
Logistics costs are less than people and property for most retail businesses. But the entire end-to-end cost - from collection at supplier, consolidation in country of origin, shipping via air or sea (or both), warehousing, and distribution to point of sale - are immense and increasing. Rising freight costs, with some even doubling, are affecting supplier selection. Lengthened supply chains were accepted in the past because of the low initial cost of the product. Now, the cost of moving goods eats into margin. This will force some rebalancing between nearer (and more responsive) countries and the low-cost producers. More will be shipped via sea and less by air, forcing the design-buy critical path management process to be refined. This will be a key competitive advantage in the future.
While efforts will be made to offset freight cost increases by reducing the returns to the domestic third-party logistics providers, these are already at a level which makes serious reductions difficult without a complete overhaul of the frequency of picking and delivery service levels. The consequence may well be a move toward a US-style replenishment model of cases rather than items.
There is likely to be a polarisation of service levels. Increased customer service will be the focus of some mid-market retailers, while others will seek to drive cost out by forcing more customer self-service. Some retailers are already refreshing their customer database to understand customer purchasing behaviour and to allow them to communicate more effectively. For example, creating a sense of community among pregnant women and providing ‘new mother’ support groups is a service which goes beyond the associated maternity and baby products and will encourage the development of a longer-term bond.
So, should value players be worried? They have got where they are through great prices and relevant quality, and those that have a good supply chain are well placed to meet demands for even better prices and quality. But if a value retailer’s business model relies on offering discounted brands without the support of a well-engineered supply chain, they could be at risk as those individual brands recover some power. Meanwhile, the mid market must rise to the challenge by improving costs and controls and differentiating through additional quality and service levels. The jury’s out on which format will be the winner in 2010.
Mark McMenemy is a Senior Director and co-head of the UK Retail & Consumer team in the performance improvement practice of Alvarez & Marsal
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