A little inflation is good for large supermarkets

Tom Traill - 25 January 2017

Will the return of inflation be good for supermarkets? Around the world, consumer inflation rates are undergoing a rapid normalisation: in the UK CPI is back to 1.6%, in Germany inflation is 1.7% and the US 2.1%. In the UK, the rise in inflation will have transformative effects all over the economy, including the large supermarkets, which, as we explored in the January edition of UK Economic Perspective, have been under the cosh over the past couple of years.

The progressive migration to online food shopping, the popularity of Click and Collect, and the arrival of online-only stores, such as AmazonFresh, have disrupted the supermarket business model, while at the same time, limited assortment discounters such as Aldi and Lidl have taken large bites out of their market shares in the past three years. A long-running food price war has played into the hands of the selective discounters. Does the return of food price inflation offer the supermarkets a convenient smoke screen, behind which to rebuild their profit margins?

Supermarkets’ ability to raise profits is a balance between the rise in retail price inflation and blended cost inflation. A Sterling-related jump in prices, dislocates the reference points that consumers have built in their minds, allowing the large supermarkets the chance to rebase their selling prices. Falling product weights adds further confusion. Supermarkets’ cost structures infer that they benefit more from rising wage inflation, and any associated rise in disposable income, than they suffer from an associated increase to their employment costs.

Not only does inflation likely give the major supermarkets a chance to rebase, but it puts the discounters under pressure. The ‘big 4’ supermarkets previously had a comfortable oligopoly, but it is likely that these firms can adapt better to the rising prices. Their larger, more established positions, mean that they can exert more pressure on suppliers and afford longer term currency hedging contracts and are more agile in their response to uncertainty. The traditional supermarkets also have better-suited supply chains for inflationary times. Furthermore the discounters have seen their sales growth fade in recent quarters as their selections grow and they become more like traditional supermarkets.

Not only is inflation likely to aid the larger supermarkets, but Aldi and Lidl have both adopted the voluntary living wage (the level suggested that is needed by the living wage foundation, not the official National Living Wage for over-25s). From March, Lidl will pay hourly rates between £8.45 and £9.75 in London. Aldi has gone one step further offering £8.53 for those outside London. These extra costs are going to weigh down the discounters’ profits. They have, nevertheless, acquired good will in the process:  they were recently voted numbers one and two in the popular British brands ranking.

The over-expansion in the supermarket sector over the past 10 years has left many of them with excess floor space. This has meant that many supermarkets have sought to diversify, with the larger supermarkets almost becoming department stores: notable progress has been made in clothes sales, Asda’s George range in particular, and Tesco was previously involved with the coffee chain Harris and Hoole (now sold to Café Nero). This diversification has raised profit per square foot and the additional sources of revenue are beginning to help the bottom line of the bigger stores.

While rising inflation challenges all businesses, it is an ill wind that does nobody any good: the larger supermarkets have an opportunity to fight back.

Data source: Kantarworldpanel

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