Tough Conditions for Retailers
The RBA has warned in its latest bulletin that the retail sector of the economy was suffering poor business conditions. The inability to cope with tough competition and declining margins has put the health of many retail businesses at risk.
Retail Competition in Australia
Intense competition has always been observed among firms in the retail sector. The root cause can be traced back to the turn of the century, which brought with it new technologies and accelerated globalisation. These factors have fundamentally altered the retail competition landscape, with the entrance of foreign firms and the popularisation of online shopping. eBay’s entrance into the Australia in 1999 radically altered the way consumers shop. Evolving from an online auction house, eBay today connects millions of people around the world, offering a platform where more than 40,000 businesses can sell to over 11 million unique Australian visitors every month. It is today joined by the likes of Amazon, Etsy and Redbubble who compete within the online domain. Traditional retailers have also recognised the benefit of increased customer traffic, and many have moved away from a bricks and mortar approach to an integrated “online and in-store” experience.
Technological developments have also been further advancing the online shopping space. More purchases are being made with mobile phones, and consumers today are embracing the flexibility offered by new digital services like the Buy Now, Pay Later (BNPL) payment facilities. These developments have fuelled the growth of online shopping in Australia.
Online shopping has eroded market share held by traditional retailers. According to Australia Post, online spending growth outstripped traditional retail growth by more than 16% in 2017. While these are worrying figures for traditional retailers, their situation has been made worse by foreign retailers entering the market. The most prominent of these has been the German retailer Aldi, which set up its first store in Sydney in 2001. Aldi’s strategy to provide a limited product range, minimal customer service and focus on home brands has made it possible for Aldi to undercut competition. The store chain remains popular with shoppers, and it currently holds more than 10% market share in the grocery market. This phenomenon has also been observed in the fashion, electronics and home decor space within retail, given the arrival of Uniqlo, Zara and Costco.
No respite for retailers
The $320 billion retail industry is currently the weakest link in the Australian economy. Business conditions in the retail space has been much worse off comparatively to other industries, stemming from increased competition, price wars and declining margins. Consumers are becoming increasingly price sensitive, forcing retailers to increase the size and frequency of their discounts. Retail items such as food, clothing and footwear make up about one third of the Consumer Price Index. Excessive discounting has contributed poorly to the economy, contributing in-part to historically low inflation.
Price competition has also affected margins as retailers seek to become a “loss leader”. The reduced cost of information has allowed easy comparison of prices offered across different products and firms, forcing retailers to be more proactive in pricing their products. Due to competitive pressure, over 60% of retailers today are forced to review their prices on at least a weekly basis, compared to 30% ten years ago. This downward spiralling effect has had far reaching consequences, with retailers culling staff, foregoing investment opportunities, and sustaining losses as they strive to maintain their market share.
Net margins in the retail industry have seen a consistent decline since 2006. Net margins decreased from 7% to 5% in the food retail sector, and decreased from 7% to less than 4% in the non-food sector. The decline in net margins have been driven by a decline in gross margins, reflecting a general reduction in pricing power as retailers descend into a never ending price war.
Coles recently announced a turnaround plan that is envisioned to cut $1 billion in costs, while its rival Woolworths is pushing through a new operating structure that is hoped to generate store level efficiencies.
However, there will be no respite for retailers; tough conditions have already caused the closures of major retailers such as Toys R Us, Laura Ashley and Gap.
In the short to medium term, retailers are trying to rebuild their gross margins by adjusting their business strategy. More attention in particular has been paid to home brands. As these products are manufactured by retailers directly, incorporating more home brand products affords retailers a degree of pricing power. Some retailers have reduced their inventory to avoid costly sales, and narrowed their product range. Non-food retailers have also moved to embrace an “everyday low price (EDLP)” strategy and moving away from discounts. Retailers hope to increase the flow of traffic through physical stores, thereby increasing consistency and boost sales volume. Finally, retailers have stepped in to reduce costs by vertically integrating supply chains and removing third party intermediaries.
By Oliver Ju
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