How are UK retailers navigating the cost-of-living crisis?

Inflation and the cost-of-living crisis are top of mind in the UK.

While we expected discretionary spending to fall in response, recent results from non-food retailers and leisure companies show UK consumers are still willing to buy clothes and to travel.

However, while consumer spending is proving more resilient than anticipated, grocery shopping behaviour is evolving.

What are the data telling us?

The latest Kantar data showed UK grocery sales rose 11.7% year-on-year in June 2023, with grocery price inflation of +14.9%[1]. This does represent a slowdown, but it is still very high, and it is impacting shopping behaviour with continued consumer trade-down.

Looking at individual supermarkets’ performance, hard discounters Aldi* and Lidl* are continuing to outperform the market and grab market share from their upmarket peers. This is impacting the competitive environment, with food retailers trying to protect consumers’ purchasing power and their own market positions.

Supermarkets must also reckon with suppliers requesting higher pricing, with food and beverage companies needing to compensate for higher input costs that might be trending toward normalisation, but remain at high levels.

Overall, this is a complicated game where different stakeholders’ interests must be carefully balanced.

Food suppliers balance higher costs and investment

Suppliers have been facing a significant surge in input cost inflation – the prices of milk, sugar, packaging, etc. have been rising significantly since mid-2022, and have been negatively impacting their profitability ever since. Large investments in innovation (new products, range extensions) and premiumisation have also been weighing on margins, but they are necessary today: strong brand images are key to maintaining consumer loyalty and justifying higher prices.

As a result, food and beverage companies have been reporting strong organic growth, driven by high pricing (high single-digit at latest 2Q earnings). So far, volumes have also been quite resilient: broadly flat, or only slightly declining.

This shows that strategies to invest in brands are delivering positive results: consumers are still willing to pay more for their favourite products. On the other hand, the profitability of food and beverage suppliers has been weakening. We have seen a reset in margins in recent months, despite the cost-saving initiatives in place as strong pricing and flat volumes are not yet sufficient to offset higher input cost inflation and large investments. However, recent earnings do show an inflection point in margins, but it will take time before profitability is back to historical levels.

The sharp price increases also have to be frequently negotiated with food retailers and have an impact on the relationship between suppliers and grocers.

Food retailers focus on value, quality and customer experience to protect market share

If we look specifically at what British food retailers have recently been telling the market, they all put a strong emphasis on value and quality.

Consumers are now more price-conscious than ever, and this is impacting the average basket: consumers are buying simpler meals, and are shifting from fresh to frozen food, from branded products to private labels, and so on. Consumers are also looking for promotions, using loyalty cards and personalised discounts.

As a result, food retailers have focused on their value proposition, with a lot of price investments announced. While this should have helped them fight against hard discounters, recent trends have shown that this is not sufficient, and Aldi and Lidl have constantly increased their market share in the past few months.

This also despite the fact that hard discounters have been inflating prices faster than the market, and the price gap has decreased between them and the traditional UK supermarkets. Hence, in today’s environment, investing in prices is not enough, and food retailers must work on their private label offering, on enhancing shopping experience (in-store and online) and on their brand image.

While many supermarkets have reported that inflation is starting to ease, we also understand that it will take time before this is reflected in the average basket. Current behaviour, with consumers price-conscious and downtrading, seems likely to last a little longer. Ultimately, this implies that while most grocers are focused on actual profit generation, strong toplines will naturally result in pressured margins.

Wrapping up

What is key to succeed in this pressured environment? For suppliers, maintaining a strong brand image while continuing to invest behind product offerings (premiumisation).

For retailers, keeping a tight focus on value and sustaining investments behind own brands and customers experience.

Overall, a strong relationship between suppliers and retailers will allow all players to navigate this environment. An efficient cost-saving programme and a robust balance sheet are also key, as this will allow them to minimise pressure on margins and ultimately on leverage.

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.

[1] https://www.kantar.com/uki/inspiration/fmcg/2023-wp-biggest-drop-in-the-uk-grocery-price-inflation-since-the-peak