The UK hasn’t experienced deflation for nearly 55 years but it’s set to hit us this year. Alan Osborn finds out what wholesalers can do to cope with this old problem.
With Britain facing deflation for the first time since 1960 and the prospect likely to affect the economy to a greater or lesser extent for the remainder of the year at least, wholesalers are entering uncharted territory.
It may be true, as business information and research company Nielsen claims, that the long decline in sales in the UK retail food sector is over. But with deflation, it may be foolish to conclude that wholesalers and retailers can look forward to healthier profit margins as a result.
The word from business consultants, economists and academics is pretty bleak for operators in the food chain at the moment.
The latest Nielsen report shows that the volume of items purchased from leading supermarkets increased year-on-year for the third consecutive month in the four weeks to February 28, after 17 consecutive monthly year-on-year declines (barring one seasonal anomaly). But while the volume of sales was up 1% in that month, their value was down 0.7% and food inflation stood at -0.4%.
The explanation of this is familiar. “Lower commodity prices, more retailer price cuts and ongoing promotions continue to make grocery shopping cheaper than it was last year,” says Mike Watkins, Nielsen’s UK head of retailer and business insight. “This is now leading to sustained volume growth, suggesting the consistent decline in supermarket sales may finally be over.”
Watkins says that deflation is having the biggest impact on packaged grocery and fresh and chilled foods “so we expect volume growth to follow in these categories, too.”
The good news is likely to be amplified with spring on the horizon, as Easter is often a turning point in sales momentum and he says it is realistic to expect to see “a sustained period of shoppers buying in higher volume.”
Sales are one thing, but profits are another. “I think generally there are pressures across the whole sector at the moment,” says Julie Palmer, a partner in the UK’s largest professional services consultancy, Begbies Traynor. “It’s become a declining sector, over the last two or three years, for the first time in many years, and food generally is facing a changing landscape at the moment.”
She adds that the German discounters are getting stronger and the big four in the middle are getting squeezed. In turn, they continue to put the pressure on further down the supply chain.
“I think there is increased pressure that is starting to affect everybody. It’s quite difficult to preserve profit margins when that’s being played out across what’s happening in the sector generally,” she says.
“If you’re talking about the supply chain, the problem there is that you’ve got this commercial tension: on the one hand, the supermarkets typically play very hard ball; on the other, some of the suppliers wonder if they’re better off not having that contract on supermarkets’ terms at all,” she says.
Palmer adds that while the suppliers are probably better off having the contract, it is quite difficult to see what more they could do. “What might be helping at the moment is that there’s more general awareness of some of the mistreatment that’s been handed out to them.”
It’s difficult to see what suppliers are going to be able to do to maintain their own margins “apart from just fighting the good fight and trying to keep the contract alive,” she says.
Given the tighter trade and financial restrictions affecting companies right down the chain, wholesale suppliers will have to be very careful about the ability of their own customers to pay, says Duncan Swift, head of the food advisory group at business consultancy Moore Stephens.
“Cash is king,” he says. “Payment terms need to be observed. If they’re not observed, they need to be enforced and certainly there’s a need to assess the credit-worthiness of customers because the war in the groceries supply market is causing a lot of financial distress.”
Swift says his initial prediction, made two years ago, was that the supermarket price war would be a ‘perfect storm’.
“I said it would last about five years so it has about three years to go, and I haven’t heard anything from the supermarkets themselves that tells me otherwise,” he says.
Professor Wyn Morgan, of the School of Economics at the University of Nottingham, says there are two aspects to falling food prices: one related to the costs of food production and particularly the plunge in oil prices over the last few months; and another centred on increased competition among the retailers.
Generally, rising prices act as an incentive for firms to invest and innovate. “Falling prices reduce this scope and potentially squeeze margins, meaning there is often a keener focus on costs. If coupled with increasing price competition in the retail sector, this can have a particularly powerful effect on wholesalers, processors and indeed producers of raw food, such as farmers.”
Andy Goodwin, senior economic adviser to forecasting group the EY (Ernst & Young) ITEM Club, says: “We see some negative inflation readings for the UK as being a good thing because of the impact it’s going to have on household spending power.”
It should be “relatively short-lived, something that’s going to be over in two or three months and after that we’ll probably return to something more approaching normality, with inflation in to the 1-2% range,” he says. “We think we’ll see probably two or three months this year having negative inflation readings. It’s probably going to bump around the zero mark for most of this year and there’ll be a couple of months when it just dips below.
“People are much more likely to spend on more discretionary items. Negative inflation may affect the hospitality sector and the way we consume food but I’d be very surprised if it makes much difference to grocery sales,” he says.
How long can we expect deflation to go on? “Food is volatile,” says Steven Barnes, economics and commercial services director of the UK’s Food and Drink Federation. “A bad harvest in the western hemisphere this summer could change things completely. The reality is we’ve been through a series of relatively poor harvests and we’ve got some good news for once.”
Barnes says reports of record amounts of grain in silos throughout the world are a classic pointer to lower commodity prices.
Sainsbury’s, Morrisons and Tesco are now going in for self-imposed food deflation and range rationalisation. “If the supermarkets are taking smaller ranges and therefore asking suppliers to produce fewer products – maybe concentrating on sales of products that remain in store – they’ll sell more of the products that remain on the shelf that have longer production runs and therefore there’ll be more economies of scale.
“So it introduces a bit of deflation as well, just through the economies of scale, and you would expect that to be of benefit to wholesalers as well.”