Challenges mount for Australian retailers

“The weakness in the first quarter of the year appears to be more than just a pricing story, with retail volumes growth also coming in well below expectations,” JPMorgan economist Tom Kennedy says.

It “confirms our sense that the pace of household consumption recorded late last year was facilitated by a sharp drop in the saving rate and was unsustainable,” he continues.  

Vanishing consumers open another battlefront for Australian retailers already changing their business model as discount and global retailers such as Amazon line up to take a slice of the market. The question is, to what extent is this a story of the Australian economy, of retail disruption more globally or, rather, plain, old-fashioned management challenges?

Four retailers including fashion labels Marcs and David Lawrence went into voluntary administration in the first two months of the year. They added to other players in the sector under including Payless Shoes, Pumpkin Patch and Dick Smith stores which closed last year.

Across the ditch in New Zealand, it is a bit of the same story. Valleygirl and TMET went into administration and were shuttered by August last year. Globally, while store-based retailers such as Aeropostale, JC Penny and GAP have struggled, their online rivals such as Amazon have prospered as the economy recovered.

Yet there are success stories: Cotton On, based in Geelong in regional Victoria, is a global success story. So too the children’s chain Smiggles or brands like JB Hi-Fi which continues to thrive in the tough consumers electronics sector.

Particular factors

There are particular factors in Australia weighing on retail spend. Wages have shrunk in real terms since 2014 and consumer confidence has dropped to the lowest level since 2015, according ANZ’s Roy Morgan Consumer Confidence index.

With customers continuing to move away from store fronts more retail jobs were lost in the year to November 2016 than any other industry, government statistics show.

Myer, the venerable department chain, says May 11 third quarter sales dropped 3.3 per cent. Richard Umbers, the Chief Executive of the retail chain says retailing in Australia is in the worst shape he has seen for years.

“It is really tough out there,” he says.

But there is also the question of management. Ferrier Hodgson’s James Stewart has been the receiver of several major collapsed retailers in recent years, including Sportsgirl, Harris Scarfe, Colorado Group and Payless Shoes.

In a recent note for Ragtrader Stewart says “in the last two financial years, over 2,100 retail businesses closed their doors or went into administration – more than the mining and manufacturing industries combined”.

Yet his conclusion was sobering: “It is true that the retail industry is a tough place to be operating right now. Long-term annual retail sales growth has not returned to pre-GFC levels of six to eight per cent and many predict structural shifts mean that growth rates of 2-4 per cent are the new standard”.

“This, combined with rapid globalisation of major retail brands, digitisation and consumer empowerment, leads to a very volatile marketplace. But in my experience most retail failures are caused by internal rather than external factors.”

At the top of Stewart’s list of fatal failings was losing relevance to consumers.

“Brands that lack strong positioning, a clearly defined product offering and communication through relevant channels, risk losing touch with their customer,” he says.

“The key here is to understand who the customer is, what drives their purchasing decisions and how the brand can best communicate with them.”

Such failings are timeless.

Cotton On chief executive Peter Johnson agrees. He’s frequently spoken of the need to have a point of difference, a fresh offer and be fast on stock turnaround and distribution – particularly when taking on giants like Amazon.

Downdrafts

While most economists are predicting the Reserve Bank of Australia will hold interest rates steady for the rest of the year, mortgage lenders have started to move.

The major banks, which have an 80 per cent market share in mortgages to business loans, have started putting up interest rates as regulators impose lending curbs. Morgan Stanley analysts say regulatory moves to curb speculative housing activity by limiting the flow of interest-only lending could directly strip billions of dollars out of household consumption.

Macquarie analysts estimate the 30 per cent cap on interest-only mortgages could reduce household income by $6.5 billion or 1.5 per cent or consumer spending. Currently 40 per cent of new loans are interest only.

Complex

It does appear Australians can absorb higher interest rates but the ramifications are complex, raising further questions over consumption in an economy struggling to resuscitate wages and investment - or for the central bank, which has almost run out of interest rate ammunition.

It’s quite possible that all the regulatory warnings in recent weeks have provoked Australians to reassess their prospects and come to grips with the fact that the debt taken on in order to get into the property market will need to be repaid.

Households could slash their spending in response to any shock, meaning “an otherwise manageable downturn could be turned into something more serious,” Reserve Bank of Australia governor Philip Lowe said in May.

Wage growth has slipped to a record low and the unemployment rate remained anchored at a one-year high of 5.9 per cent in March.

None of this is a positive for consumer sentiment and hence retail spending.

The soft retail data “occurred despite some reasonable tailwinds for the consumer, including further increases in household wealth and a labour market that allegedly added 130,000 jobs over Q4 and Q1,” RBC Capital Markets Michael Turner says.

“For the rest of the year, those tailwinds are likely to moderate, which leaves it unlikely that household spending growth will recover much momentum.”

On top of this is disruption and competition - and not just from Amazon. Traditional retailers still struggle with online commerce, digital distribution and different supply chains. But as Ferrier Hodgson’s Stewart says, often it’s the old ways which are still (not) working.

“I often walk into retail businesses with little or no range planning. In fact, most of the time, their range plan is ‘do what we did last year’,” he says.

“Weak product planning is evident at the customer level through poor merchandising in stores, a fragmented range and a lack of clarity around what the brand stands for. Ultimately it will cost sales and margin dollars.”

For Stewart, it’s not the particular sector, or the sector within a sector. It’s not one model over another. Successful retailers run a tight ship, are alert to their customers’ needs and shift rapidly to keep them satisfied.

He says the new world may mean establishing a “change office” in the business, looking at how to manage the transition radically different ways of operating. But retail still demands retailing basics – particularly knowing your customer.

Narayanan Somasundaram is a freelance economics & finance reporter