Alarm bells must have been ringing across the retail sector following Primark’s profit warning, and even more so after it laid down the gauntlet to its competitors with its pricing.
Associated British Foods PLC (LSE:ABF) (ABF), which owns the discount clothing store, said it expects profit margins to be lower next year as it battles with the cost-of-living crisis, sending its shares tumbling 9% to 1,322p.
Next PLC (LSE:NXT) and Marks and Spencer Group PLC also both slipped, 3% and 4% respectively, a sign Primark’s update is bad news for the industry.
Interestingly, Primark became one of the first to say it will not hike its prices any further, seemingly willing to take the hit on its margins to prioritise sales, customer loyalty and its reputation as a discount retailer.
Whether it’s a move that pays off, and one that forces competitors to follow, remains to be seen.
How does pricing work?
Retailers, like many businesses, operate on a cost-plus basis when deciding what to charge customers for products.
In its simplest form, a company will factor the money it wants to make in a profit on an item and add that to the cost of manufacturing or buying the product from its supplier.
Usually, this process is quite flexible, with price ranges decided to help mitigate any external factors, such as inflation and soaring energy bills that currently have a boa-like grip on the market.
What Primark said it will do, however, is keep its prices at their current level, willing to absorb the hit on its margins and in essence forcing itself into issuing the profit warning.
Why has AB Foods done this?
John Stevenson, a retail analyst at Peel Hunt believes Primark is the “first ones to come out and talk about next year’s pricing.”
By doing so, Primark is putting sales, customer loyalty, and its reputation above its margins in the short term, with the expectation it will benefit from it in the long term.
“People’s perception is that Primark offers exceptional value,” Stevenson added, “so when they pick up that newspaper tomorrow and see it won’t be raising prices, that is almost reputation enhancing.”
It also signals a more long-term approach as opposed to a short-term fix.
Raising prices further than they already have could leave it open to alienating its loyal customer base which is vital to its “long-term record of growth and profitability,” said Russ Mould, an investment director at AJ Bell.
While alienating customers is never a good thing for any business, the implications for Primark and its model could be disastrous.
Rapid stock turnover is the key to keeping prices low, and even losing a small number of customers due to pricing could leave it with more stock than it wants, forcing its hand into price cutting and sales regularly. Not helpful for margins in the long-term.
What does it mean for the rest of retail?
As Stevenson said, Primark is one of the first in the sector to come out and let people know it won’t be putting its prices up further.
For the rest of retail, it has laid down the gauntlet.
While the entire sector faces the same challenges existing in the macro-environment, cost-of-living crisis, inflation, energy bills etc - as warned by retail analysts at both Jefferies and JPMorgan this week, how they choose to tackle that comes down to the needs of the business.
Usually, the options are to increase prices to protect margins or keep prices the same to protect sales.
However, margin protection “is not likely to work, no matter what cost efficiencies you can find,” according to Mould.
The market may therefore be looking at Primark as the leader in that respect as to what should be done during these tough times.
Boohoo Group is the next retailer to provide an update, with interim results set to be announced on 28 September.
Any information on whether it will keep prices the same or pass on costs to consumers will provide a clearer picture of what the retail sector is thinking.
Primark has acted. Now it's time to see whether others will follow or stick to their guns.