Retailer Adaptations / New Retail Models
Another national lockdown has muted the jingle bells of this year’s festive shopping season, and it’s clear the upheaval to retail and leisure industries will continue through what is normally the ‘Golden Quarter’. For many businesses, the next few months will be very tough. Operators who managed to successfully – or at least, sufficiently – pivot to a relevant and accessible offer during COVID-19 will cope, and e-commerce giants will inevitably emerge as winners in this environment. Amazon in particular finds itself in a fortunate and exclusive collection of retailers for whom the pandemic has been a 2020 revenue boon. So, as we trudge through a disrupted Christmas and look to 2021, we ask ourselves: how will we be Christmas shopping in 2021, and where?
Much of this depends on the course of the pandemic over those next 12 months, the resulting policies and their impact on the both the economy and consumer spending. Given that the UK economy is driven by the services sector and subsequent consumer spending, I hope that next year we will move to a more mature management of the COVID-19 risks, where retail, leisure and supply-chain businesses are free to transition to a sustainable business model and there is equal responsibility on the consumer as to the level of risk they are prepared to take.
It’s clear to me and my colleagues in the logistics sector that 2021 will continue to see growth in e-commerce and logistics demand. During the lockdowns of 2020, the uptake of shopping on digital channels more than doubled in many categories, and thousands of brands hurriedly cobbled together new plans to distribute stock to their home-bound customers, from using stores for ad-hoc fulfilment and click-and-collect, to setting up traditional warehouses. Into 2021, these reactive innovations will mature into proper fulfilment channel strategies with investment and infrastructure (both digital and physical), becoming an acknowledged part of all retailers’ core operations. Some growth will come from rebasing and rebalancing logistics networks to adapt to the accelerated channel shift from physical stores to e-commerce. Meanwhile, those already dominating that sphere, will continue scaling their portfolios. Alongside this, we expect to see further growth in F&B fulfilment operations, such as Deliveroo and Just Eat, which are expanding their delivery capacity to release the constrained supply (and demand) of F&B operators.
For physical retail and leisure, the picture is harder to discern. Blanket national lockdowns, will become less politically acceptable. While fewer lockdowns mean fewer forced closures, I expect unemployment and individuals’ anxiety over their personal finances will suppress consumer spending. Furthermore, spend on big-ticket items like holidays, will be significantly down in 2021 so some positive substitution, particularly into the domestic leisure sector, would be most welcome. These consumer behaviours will lead to a variable patchwork of winners and losers in the retail sector. ‘Close-to-home’ categories will thrive, including essentials such as grocery, home and DIY, electronics, jewellery and sports/leisure equipment, but it should be noted there can still be profitable retailers even in categories that have suffered! Next has done an outstanding job in the last year. Building upon its already-strong channel offering, the brand has updated its product mix to be relevant to lockdown living, and has performed well in a category which has suffered overall. Similarly, Watches of Switzerland, a purveyor of high-end products synonymous with ‘trying-on before purchasing’, has had a relatively strong recent set of results, combined with a strong e-commerce offer.
Many retailers will use 2021 to re-evaluate the long-term role of their stores. The focus will shift to fulfilling all transactions, be they in person, or digitally, and the implications that has on inventory management, labour patterns and the required physical and digital infrastructure to optimise profitability. Progressive multi-channel retailers, such as John Lewis, have already declared that they expect online share in many categories to stay at, or exceed, current levels and are targeting c.70% online penetration. Traditionally, this transition suggests moving most of the stock (and costs) to a central fulfilment centre and reduced number of stores, however, the speed and quantum of the shift catalysed by the pandemic has also shown that in-store fulfilment can work. Leading retailers such as Target teach us that overcoming challenges in inventory management can make store-based fulfilment the most economic and flexible solution, particularly in catchments where a dedicated online fulfilment centre is not cost-effective. Kingfisher has recently announced it will support its online growth via in-store fulfilment, for all the reasons above and because in-store can provide very quick fulfilment times (i.e., same day or less) - almost impossible for a warehouse-fulfilled approach, unless an operator has the scale and coverage of Amazon. This is a significant advantage, even at higher fulfilment costs, because if customers are willing to pay more to receive product more quickly this can shift the economics and relative competitive advantage of the channels.
The Central London market will remain strained until tourism and City occupiers return in full, at which time we still expect London to be a global leader for retail. In the meantime, trade will remain depressed. Whilst this might slow the market for Central London retail property, the requirement and role of Central London stores has a strong future. Whether showrooming, providing exclusive experiences, or simply holding the most premium stock profile from the brand inventory, a flagship store (or stores!) in Central London will continue to be a mainstay of the retailer portfolio. In the shorter term, this highlights the argument for continued support to the London retail sector by delaying or abandoning the government’s decision to restrict tax-free shopping for international tourists. Clearly the retail, leisure and tourist sectors all need as much support as possible and the idea of potentially redirecting demand to other global capitals seems counterintuitive when so much of the economy depends on it.
Investor Response / New Lease Models
One added benefit of the shocks of 2020 is that retailers and landlords are being forced to understand each other’s businesses in much greater detail than ever before. This means not just inserting ‘pandemic clauses’ to mitigate for forced closure, but more fundamentally, to understand how to split both the risk and reward of successful physical retail assets. Turnover-only leases have been around for some time, albeit intermittent. By the end of next year, I expect a significant proportion, if not majority, of newly agreed leases or lease renewals will have performance criteria within them. Effectively negotiating these terms will require explicit agreements about the role of the store in the online channel, and how the performance of the online channel is accounted for. To be successful, this demands a much greater level of transparency and analysis of performance data. Shrinking lease lengths and early breaks will shift the retailer-landlord relationship to a new model resembling the joint-business-planning process between a retailer and its product suppliers: sharing the value created in-store through collective business goals and contractual scorecards with graduated incentives for both parties. This is a massive undertaking, but one that needs to happen for the long-term health of the sector. Larger institutions with the scale and incentive to make this transition such as Hammerson, British Land and L&G have already declared their intent to do this in 2021, but smaller landlords with less corporate scale and resource will probably make the transition on a longer timeline when both occupiers and the landlords have a better understanding of how to make it successful.
While many landlords had a long-term plan to rebalance retail-dominant assets into varied mixed use, the pandemic has created urgency and we will see the outcomes of this in 2021. Adapting retail to alternative sectors such as housing or offices takes a long time, but I believe that the environment and economics are now supportive of introducing sectors such as healthcare, logistics and education into these assets with little change to configuration. The planning system’s new “Class E” classification should also boost landlords’ ability to quickly pivot the use of space so it is most relevant to customer needs within the catchment, without undertaking significant bureaucracy that would then create a permanent constraint if that use fails. Increasing the diversity of consumer missions and overall footfall into retail centres will be a welcome benefit and the industry will learn a lot about the shape of future development priorities by taking some smaller but more agile steps in the coming months. This would be even better supported if business rates were abolished. Whilst we all recognise the importance of collecting government income to support our economy, business rates were already criticised for being out of date and throttling innovation on our high streets. Securing appropriate planning, policy and taxation structures to reflect the new role of urban or local centres will need support and engagement from the public sector.
Ownership of retail assets remains a hot topic and will likely continue into 2021 and beyond. We’ve seen intu Properties dismantled, Hammerson continuing to dispose of assets, and British Land and Landsec have both announced some rationalisation of their retail portfolio. Investment in out-of-town retail parks and outlets has remained reasonably resilient during the pandemic and we expect this to continue, particularly where there is a clear alternative use case. Shopping centres, however, presents little activity beyond distressed sales unless new buyers can be found and acceptable pricing identified. Given the shifts already discussed above, I believe that new capital and ownership entering the UK will be a real positive. New ownership, likely international in nature, will bring new thinking and perspectives to the market, and will likely support and catalyse the changes already underway.
As for Brexit, the other ‘should have been’ talking point of 2020, I think much of the previous analysis on the topic still stands, but is dwarfed by the potential impact of COVID-19, a blessing in disguise for the government as we move to an ever ‘harder’ arrangement. Brexit outcomes will likely see some disruption to retail supply chains in 2021, and this will provide further support to logistics and industrial demand but, depending on what the final trade arrangements are, we won’t understand the full impact on retail and leisure for some time.
So, where will you be shopping in Christmas 2021? I think probably the same as you are now: staring at a screen or making focused trips to retailers and leisure operators who stand out to you. The bigger difference will be behind the scenes, as 2021 proves to be the year not of just reacting, but capitalising on the structural shifts accelerated by the pandemic. Retail, leisure and other supply-chain assets will need to be fit (and flexible) for the future.