Good news or bad news first?
The good news is that the EY ITEM Club Special Report forecasts that UK consumer spending will continue to grow over the next few years. However, the bad news is that growth is likely to fall below the 2.5% expected in 2014, being closer to 2% in the following years. This is a much lower level of growth than we have become accustomed to: growth in the decade to 2008 averaged 3.7% a year, almost double the current forecast rate.
Slow as it may be, this rate of growth is higher than the expected outlook for the Eurozone as set out in EY’s Eurozone forecast published on September 25th. High unemployment, the threat of deflation, limited bank lending and high levels of debt are all acting to limit consumer confidence and hence spending in the Eurozone. With emerging markets also slowing there are no easy options for consumer products companies looking to grow revenues and earnings. For businesses, understanding the macro market drivers is a critical first step to maximising the available opportunities.
I thought the economy was improving?
The UK economic recovery continues but this is a recovery unlike any other. Consumer spending has been the key driver of the recovery, both on the high street and in the housing market. However this spending is being driven by an increase in the total numbers employed rather than by real wages. In 2014, the impact of increased employment on income growth is likely to be four times greater than the impact of higher real wages.
There will be no rapid increase in consumer spending until real wage growth accelerates. While EY ITEM Club expect real wage growth to strengthen in the coming years, the hangover from the shock of the downturn, continuing increases in the labour supply, higher employer pension costs and the relative weakness of trades unions compared to the past will all act to keep wage rises in check. Hence we are in for a period of little growth in consumer spending.
Well it is definitely changing.
The economy is recovering but it is not returning to its pre-crisis shape. The EY ITEM Club report sets out how the highest and lowest earners are likely to fare relatively better over the coming years, due to the war for talent on one side and the changes to taxes and minimum wage levels on the other. By contrast the middle of the income distribution will continue to be squeezed. In real terms, the median income will fall from £18,852 in 2008 to £17,827 in 2017 according to the EY ITEM Club forecast. Similarly, older people are likely to do better than the young, the latter group facing proportionately greater unemployment and being much more exposed to housing costs. Since 2008, the number of over 50s in work has increased by around 1.1 million while the number of 18 to 24 year olds employed has fallen by 200,000.
Creating winners and losers
Consumer behaviour changes due to a number of factors, one of which is the economic environment. As the recovery becomes entrenched but consumers recognise that growth in incomes will be low so their spending is adjusted. The first development is likely to be a slowing in the recent rate of growth in sales of high ticket items such as cars, furniture and large domestic appliances. This reflects some satisfying of pent up demand, the decline of the PPI effect, a slowing in the growth of housing transactions and the fact that consumers recognising that incomes will be relatively flat for some time, hence purchasing on credit needs to be carefully managed.
By contrast, EY ITEM Club expect the demand for more immediate satisfaction to increase. In this environment consumers will allocate their resources towards buying the latest technology and games and buying clothes and shoes. Gardening is also expected to do well as is spending on health. There will be a slowdown in alcohol and tobacco sales, reflecting taxation, regulatory and lifestyle factors as well as income changes, and education as people struggle to afford private options. There is no good news for the food industry with spending set to lag average growth in consumer spending as competition and price conscious consumers limit revenue growth.
A call to action
Consumer oriented businesses need no reminding of how challenging market conditions are. The last EY Profit Warnings identified increased competitive and pricing pressure as a major driver of profit warnings in 2014. Nevertheless there are some key steps to maximise the chances of success.
1. Ensure the business has the most detailed possible analysis of trends by segment and that all budgets and forecasts are up to date and accurately reflect the implications of the outlook for prices, competition, distribution and promotion strategies.
2. Assess the appropriateness of the business model for a low growth, low inflation environment in the light of economic outlook but other technological and social changes.
3. Be very clear on the future plans for the size and shape of the workforce. A low wage environment creates the temptation to hire labour rather than invest in technology and facilities however innovation remains critical to long-term success and investment should not be neglected. On the other hand, the labour market is fragmenting and highly skilled individuals will command a premium, talent development strategies need to reflect this.