Rising inflation usually correlates to rising costs for the end consumer as industries, including retailers, increase prices to protect margins.
Surprisingly, though, some of the UK’s leading supermarkets have done the opposite and reduced the prices on some, if not most, of their products.
Tesco’s profit warning today reflected a stance that it will continue to keep prices low despite inflation, a line rival grocer Morrisons’ made last week when it too warned about trading due to increasing inflationary pressure impacting spending.
Marks and Spencer Group PLC announced yesterday it would be reducing the prices of ‘everyday essentials’ as well as Remarksable, its budget range.
In essence, costs rising and prices flat mean margins are being squeezed.
For some of the ‘higher end’ retailers like Waitrose, it’s likely a large chunk of their customers can absorb the costs, meaning they can probably afford to pass them on.
Mid-range and discount retailers, on the other hand, usually don’t have the luxury of customers who can afford the price rises, so will have to cut costs to keep people shopping, especially the big four, Tesco, J Sainsbury PLC, Asda and Morrisons.
Fierce competition from discount supermarkets Aldi and Lidl adds to the problem.
Deciding to pass on costs and changing the pricing model is “always a tricky decision” according to Matt Britzman, an equity analyst at Hargreaves Lansdown.
A lot of the factors that influence the final decision are based on the business and model proposition.
Sector leaders, such as Tesco, are clearly “willing to forego some performance in the coming year in order to maintain their value leading proposition”
As a result, choosing to take a hit on profits makes sense to establish themselves as a ‘discounter’ and maintain market control, especially as ‘traditional’ discount retailers are ready to snap up any customers willing to make the move.
Losing some of that precious market share, according to Dan Lane, senior analyst at FreeTrade, is the most worrying prospect for the big four.
“What the sector faces at the moment is the scary prospect of a fickle consumer who will switch to a German discounter [Aldi, Lidl] if it’s worth it and feeling like they have to pass at least some costs onto them,” Lane adds.
Supermarkets face a serious balancing act between keeping costs low in the hope it keeps customers, or matching prices to inflation and hope they can retain their most loyal consumers.
Both decisions are likely to hit profits and it will really come down to which one will impact margins less.
Tesco’s shareholders didn’t seem too keen on the decision of keeping prices low, with the shares falling nearly 5% to 258.3p.
And there comes the second balancing act for supermarkets, which is keeping investors on board.
Lane argues that the current price war “might not be the biggest thing on investors’ minds,” with battles over cost, races to the bottom, and attempting to please picky customers nothing new for the sector.
Instead, investors will be looking at what else can be offered.
Using Tesco as an example, its high-speed delivery service Whoosh adds an extra weapon to its artillery.
A strong Tesco express portfolio is “another nod to the big proposition at Tesco now-convenience.”
Inner-city customers might be tempted by the convenience offered by a local Tesco Express on the way to an Aldi or Lidl.
Consensus based on recent updates would suggest that the price drops are a market-wide movement in an attempt to keep customers.
But balancing pricing with the needs of customers and investors will be tough, and should inflation keep soaring, there may come a time when one takes priority.