Future of UK retail with KPMG – Part one: Evolving business models

The world of retail is being turned upside down as covid forces stores to close and customers increasingly rely on e-commerce to fulfil their needs.

There is little doubt that the landscape has changed for good, but what does the future hold?

We had the privilege to chat to Paul Martin, head of retail at global business advisers KPMG, about the future of UK retail and how companies will need to accelerate change in order to survive the shift in consumer habits.

In part 1 of our discussion, we look at how businesses will need to adapt their models to make themselves leaner and more profitable.

Paul told us: 

“We’ve classified the covid outbreak into four key phases: you had the react phase, which generally started once lockdown measures were imposed, not just in the UK but also in other markets around the world.

“We then moved into the resilience phase, so how could you trade in a lockdown environment? And then you moved – and this is where the UK is today – into recovery but in that context you then move into a new reality and the recovery and new reality are happening in parallel.

“Many retail leaders are saying to me ‘We thought we had two to five years to transform our businesses’. Covid has accelerated many of the trends that we have seen and we’ve probably got 12 to 24 months.”

The changes retailers must embrace

Within the area of business transformation, Paul provided the detail on what the retail sector will need to change. He said:

“I would highlight four key themes here. The first theme is all around business models. The traditional retail business model is increasingly outdated.

“For hundreds, if not thousands, of years the retail business was: you source great product, you ship product and you sell it and if you’re good at it you open more stores.

“It’s not as easy as that anymore and, going forward, organisations in the retail space are going to have to re-engineer that business model.

“The second key point is the cost of doing business. Retail has, for many years, been a low-margin business in markets like the UK. Increasingly we are moving towards a no-margin business so therefore re-engineering your cost base is becoming more and more important.

“In essential retail, even with the spike in demand, I still believe 10 to 20 percent of costs need to be taken off the cost base and in non-essential retail it is even more extreme: 20 to 50 percent of costs will need to be eradicated over the next 12 to 18 months.

“We then move into the purpose agenda. If you think back to the 08/09 financial crisis, the sustainability agenda had gathered pace but it fell off a cliff and broadly took five years to reappear. That’s not going to happen this time.

“Purpose, sustainability, the broader ESG (Environmental, Social, and Corporate Governance) agenda is going to remain a top-three board item.

“And the fourth key point is the customer. For many years, alongside the ‘you source, you ship and you sell great product’ you also had the defined thinking that if you have great product, you have a great location, you open the doors and they will come but the reality today is if you do not know who she or he is specifically, competing against online and other growing channels you have a significant disadvantage.”

How to reduce retailer costs

For established retail brands, particularly, reducing the cost base by such a large amount is no easy task and Paul points to four key areas that retailers are going to need to focus on:

“Taking 20 to 50 percent of cost out is not tinkering around the edges. I am a retailer by background and the cost agenda has always been key for the retail sector over many years and some retailers will tell you we’ve always been lean.

“I would argue it’s going to be four key areas that retailers are going to have to address when they’re looking at costs.

“The first area is cost of goods. If we think of how significantly ranges have grown over recent years and you go back to pre-covid and you look at which types of retail businesses were successful, you had on the one extreme those offering unlimited ranges – mainly the platform ecosystems – and then those offering very curated limited ranges. That’s where we saw the biggest success.

“Everybody in the middle that was trying to cater for unlimited on the one side, and match prices on the limited ranges on the other side felt it very difficult to compete so going forward I believe we will see range reductions of around 30 percent with most retailers and that will improve working capital positions, it will improve supply chain efficiencies and it will enhance store operations, if you think of replenishment.

“But if you also think of many organisations having a very large workforce, dealing with a long tail of suppliers, that can be optimized.

“The second key area, and of course we’ve read an awful lot in the media about this, is real estate. I believe that we have 25 percent too much retail real estate in the UK and I have highlighted we need to reduce that by 2025. I think this will now happen by 2023 so that’s going to be a key point but the second point is also the rental business model.

“It’s broadly governed by an act from 1954, so somewhat outdated, which guarantees broadly upward rental reviews every year. That is not in line with where the market is today anymore.

“Demand and the structure of retail has changed so therefore the rental business model has to change. The rent to sales equation is completely out of kilter and in some cases 30 percent.

“We often hear from a residential perspective in cities like London the percentage of your salary you have to pay for rent just doesn’t work anymore if you think of all of the other overhead costs you have got, so we will move away from quarterly rents paid in advance to monthly rents paid in arrears based on turnover and five to 10 percent of turnover is the sort of general number I’m hearing from retail leaders from around the world.

“The big problem here though is there is a lack of trust between landlords and retailers today and the regulators are going to have to think how they intervene and bring those two cohorts together as there’s not just a danger for high streets, in general, losing their importance.

“If you think of where large proportions of our pension funds are invested they’re invested in real estate funds so there is a ticking time bomb here.

“The third key cost driver is around the workforce, a very emotional topic I do appreciate, but we are going to have to understand where does automation make sense versus the real human value-adds.

“I think the word ‘selling’ has become a bit of a dirty word generally in society but that’s where the human adds real competitive advantage, specifically against the online channel. 

“If you think of supply chain distribution centres and health and safety aspects around carrying heavy boxes etc this is where automation might make sense.

“And the fourth key area is around technology and supply chain. This is where we have to really understand the cost equation going forward. If you think of CapEx spending in retail, over decades now it has always been around store openings and store refurbishment. That will have to pivot towards technology.

“If I take a very large global retailer, they spend 1.4 percent of their annual revenue on technology, their single biggest competitor is a large platform business based out of Seattle who spends a significantly higher number – how do you compete?”

E-commerce needs to change

Paul also suggests that the online model in the UK might have to change in order for businesses to focus more on profitability. He said:

“In the UK we have, after China and South Korea, the highest penetration of online but I would argue the UK has built the most customer-friendly online business model but the least profitable of anywhere in the world because we basically give the customer broadly the largest possible choice at the cheapest possible price.

“We do not charge for deliveries we do not charge for returns and this is where, in the UK, we’re going to have to re-examine the business model.

“The problem is how do you re-educate the consumer and this is where technology increasingly is going to be important. You cannot pull the wool over the consumer’s eye but you’re going to have to be smarter and investing in consumer customer knowledge is going to be really key.

“Who are your most profitable customers? What do they really want from you? Who are your most notorious returners? Who are the people that are not at home when the grocery home delivery arrives?

“Those are all things that you’re going to have to answer without negatively impacting the perception of customer experience.

“Take France for example – they’re very big on click and drive. If I look at China, I look at the US, they have been much further in their thinking from a profitability perspective and the UK is going to have to address that.”

Watch the full interview with Paul – and delve into our entire Engage with E-commerce series – here.

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