David vs Goliath: the supermarkets’ battle for the consumer

Tim Pike, Juliette Healey and Carleton Webb

Price inflation for food and drink rose sharply between July 2016 and July 2017, going from minus 2.6% to +2.6%. But could those increases have been even steeper?  In this post we examine the evolution of the UK supermarkets sector. Monitoring their pricing behaviour can be important for understanding short-run inflationary developments given the supermarkets’ high share of imported goods, the general volatility of food prices, and the fact that the largest four supermarkets account for over  a quarter of UK retail sales.  We find that intense competition in the sector has slowed pass-through of higher import prices following sterling’s recent depreciation.  We think that competitive pressures will bear down on food price inflation for the foreseeable future, despite pressure on supermarkets’ margins.

Recent trends in the supermarkets sector

(i) Decade up to 2012

There are two distinct periods in the recent history of the supermarkets. The first —broadly the decade to 2012 — was one of rapid domestic expansion. The big four supermarkets — Tesco, Sainsbury, Asda and WM Morrison — grew their share of the groceries market from around two-thirds in 2000 to three-quarters in 2007-2012. In addition to expanding their catchment areas, supermarkets grew through broadening their product ranges — mostly in non-food goods retailing (for example, in clothing and electrical goods) but also some consumer services such as restaurants. That in turn necessitated larger stores, often located at out-of-town retail parks.  Finally, the supermarkets improved non-price competitiveness through the adoption of multi-channel retailing, especially e-commerce, through ‘click and collect’, home delivery and online banking.

This period was associated with very substantial investment in new stores, regional distribution centres and IT systems covering logistics and e-commerce. There was also a large increase in staffing, commensurate with the rapid rate of new-store openings. Including acquisitions, total store numbers of Tesco, Sainsbury and WM Morrison increased by nearly 60%, while total employment (measured in full-time equivalents) grew by almost one-sixth, from 2004-2012.

These trends were partly in response to the supermarkets’ perceptions of changes in consumer behaviour. Those included increasingly affluent shoppers’ preferences for a greater choice of goods within a single store and improved convenience — including shorter travel distances to the store, larger car parking facilities and home delivery of goods ordered online.

Competition between the major grocers for new sites was intense, and the urban density of supermarkets increased significantly. The associated increase in capacity measured by total retail floor space exceeded the growth of the big four supermarkets’ sales volumes. So there was a steady decline in sales intensity, i.e. sales volumes per square foot of retail space, from 2006-2012 (Chart 1). Labour productivity slowed (Chart 2).

Chart 1: Sales volumes per square foot of retail space (Tesco, Sainsbury, WM Morrison)

Chart 2: Sales volumes per full-time equivalent employee (Tesco, Sainsbury, WM Morrison)

Note: Years shown relate to the financial years of the various retailers.

Sources: Annual Reports of the various retailers, ONS and Bank of England estimates.

(ii) 2013 to 2017

Recent developments have seen the abatement, or reversal, of most of these trends.  Households have suffered a marked slowdown in the growth of their disposable incomes since the financial crisis (Chart 3). So it’s not surprising that consumers began looking for cheaper alternatives at a time when technological improvements meant they could compare prices much more easily, at home and on the move using smartphones.

Chart 3: Households’ real post-tax disposable income growth

Source: ONS

Consumers’ shopping habits have changed. Nowadays, shoppers:

• make more frequent, smaller-value shops, often at convenience stores. That has reduced consumers’ need to stock large amounts of food and has shifted demand away from larger stores — particularly the out of town stores which incurred extra travel costs;
• purchase more groceries as single items, and fewer multi-buy offers, so reducing household waste;
• prioritise value-for-money rather than the degree of choice available within a store, resulting in much less loyalty to any single retailer or brand; and
• order online. In 2016 Q4, 25% of non-food retail sales were made online. By contrast, the share of grocery sales made online has increased more slowly and was just over 5% in 2016 Q4 (Chart 4).

These changes have led some consumers to switch away from the large supermarkets offering wider product ranges towards lower-price, “no frills” competitors: in particular, to Aldi and Lidl (Chart 5).

Chart 4: Shares of food & non-food retail sales values purchased online

Source: ONS and Bank of England estimates

Chart 5: Total grocery market shares of the big four supermarkets and Aldi and Lidl

Source: Kantar Worldpanel

Sunset for the majors?

In the decade to 2012, the four major supermarkets continued to gain market share (Chart 5). But in recent years many of those gains have been surrendered, partly due to the following factors:

• Their estates of out-of-town hypermarkets have suffered a loss of non-price competitiveness to more conveniently located urban, metro-type grocery retailers.
• More consumers now purchase their staple groceries at discount retailers such as Aldi and Lidl, while completing their weekly shopping at one of the major supermarkets. According to Kantar Worldpanel, the groceries market share of the big four has declined from a peak of just over 77% in 2011 to 69% currently. By contrast, the groceries market share of Aldi and Lidl more than doubled over the same period to 12%. Figures published by The Grocer magazine suggest that Aldi and Lidl are consistently cheaper than the big four supermarkets on the narrower range of items they stock.
• Pure internet retailers have benefited from substantially lower overheads, predominantly arising from much smaller estates of commercial property. That has contributed to some of the supermarkets losing market share in non-food. Online food retailers have struggled to have the same impact. That reflects a number of downsides: the fees charged for the service, the risk of unwanted substitutes and the trend to smaller numbers of purchases per shop (see above).

Can Goliath fend off David?  How are the majors responding?

The effects of persistent changes in consumer behaviour; the emergence of new bricks and mortar and e-commerce competitors; and greater price transparency on account of the internet, have led the major supermarkets to abandon further growth of floor space, and instead focus on improving price competitiveness and productivity (Charts 1 and 2).

The majors have gone ‘back to basics’ and closed unprofitable stores; reduced staffing in ‘back office’ functions while adding shop-floor staff; simplified product ranges (including greater focus on value-for-money and own-label products); and accelerated the adoption of simpler pricing by moving from irregular promotions and multi-buy offers to everyday low prices. They continue to look for ways to automate, innovate, cut costs and use existing space more effectively.

Looking to the future, evidence from other European nations such as Ireland suggests the discounters could increase their UK market share to perhaps 15-20%. Indeed, their announced plans are consistent with continued expansion.  This leads us to believe that the price wars — which have been a marked feature of the UK grocery sector in recent years — will continue.

The challenge of rising costs

Of course, these price wars are taking place in an increasingly challenging cost environment for retailers.  Alongside issues such as rising average labour costs (for example, due to increases in the National Living Wage), there has been a sharp rise in import costs.

Sterling has fallen almost 20% since its peak in November 2015, while food import prices have risen by 8%. About 40% of UK food and non-alcoholic beverages (FNAB) is imported, and dollar prices of many UK produced commodities such as wheat are set globally.

In past episodes when sterling has declined sharply, pass-through of higher import prices to retail food and drink prices has been relatively fast.  But FNAB prices in UK shops actually fell throughout much of 2016 (see Chart A, p26, February 2017 Inflation Report). And, despite rising by 3% since late-2016, they are currently no higher than they were two years ago. Contacts of the Bank’s Agents in the retail sector and their supply chains report this restraint is at least partly due to the intensely competitive environment of food retailing described above. Acutely aware  of the price sensitivity of consumers – and the increased choice available to them  – retailers have been forced to sacrifice margin and seek cost reductions in their own businesses and from suppliers in order to keep prices as low as possible.

Conclusion  

Competition for market share between the major supermarkets has left the sector with excess capacity, while the recent expansion of the discounters has opened up significant price differentials. These two factors are likely to bear down on retailers’ margins and FNAB price inflation for some time.

Tim Pike and Juliette Healey are Agents who work in the Bank’s Monetary Analysis Division. Carleton Webb is an Economist in the Bank’s Monetary Analysis Division.

If you want to get in touch, please email us at bankunderground@bankofengland.co.uk or leave a comment below.

Comments will only appear once approved by a moderator, and are only published where a full name is supplied.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.