Christmas and the cost of living crisis: how will retailers cope?

The past two year’s holiday seasons were tough for the UK’s retail sector, with lockdowns and resulting changes in consumer behaviour. The hope for Christmas 2022 was that things would be back to normal – but inflation, rising interest rates and the threat of recession have put paid to that.

The UK’s retail sector has seen a wave of problems emerging throughout the year. Optimism in early 2022 that the worst effects of the pandemic might have subsided has given way to pessimism about trading in the wake of deteriorating economic circumstances.

Russia’s war against Ukraine has sparked a cost of living crisis. While not the only contributor, the conflict has been a major factor in driving supply difficulties, as well as causing a rapid rise and greater volatility in energy prices.

Retailers were already having to cope with difficulties in supply caused by Brexit, Covid-19 and global shipping disruptions. This combination of challenges has meant that the smooth movement of products around the world has been replaced by uncertainty, volatility and cost increases. Brexit, for example, has significantly driven up the price of food in the UK.

The UK government has had to respond to the large and rapid rise in energy prices. Surging prices have affected retailers’ costs, with heating, lighting and refrigeration being hit especially hard. The same energy spike has affected producers and households.

Consumers have seen inflation rise rapidly, notably in food (see Figure 1). This, in turn, has reduced their capacity to spend on food and other items in shops.

Figure 1: Consumer prices index including owner occupiers' housing costs (CPIH) versus food and non-alcoholic drinks inflation (2012-2022)

Source: Office for National Statistics (ONS)

Rising interest rates are also a concern for retailers (see Figure 2). Hikes in the Bank of England base rate have increased the cost of borrowing for both retailers and consumers. Mortgage rates have also risen, and the Bank has indicated potential further increases, with inflation set to remain high for several months.

The Office for Budget Responsibility (OBR) has said that the UK is already in recession – defined as a fall in GDP over two successive quarters – and will remain so until 2024. What’s more, we are seeing the worst drop in living standards since records began.

Figure 2: Bank of England base interest rate (2000-22)

Source: Bank of England

There are also environmental factors to consider. The very mild autumn has altered shopping patterns, leading to a stock overhang as products mount up in warehouses and across supply chains. At the same time, avian flu has hit the production of some items, notably eggs and turkeys.

Some retail sectors have been affected by the men’s football World Cup and a disruption to spending patterns at this time of year. There is a benefit to some retailers and the sales of products such as beer, crisps and snacks have increased, particularly as England has progressed in the tournament. But at a time of straitened consumer spending, sales are hard won and growth in the hospitality sector may come at a cost for retailers.

How are retailers managing the crises?

These are very unusual times for retailers and there is virtually no managerial expertise of similar circumstances on which to draw. Inflation is at a 40-year high, while consumer sentiment is around a 40-year low. At the same time, supply certainties have been broken and interest rates are at their highest level in 15 years. High street retailer Marks and Spencer has described the situation as ‘the gathering storm’ for shops. This confluence of issues has not been experienced by retail managers and operators in a generation.

The managerial task has become about handling cost, supply and demand crises. Cost control has become a central focus for operations managers, but it is tempered by the need to have enticing shops and sufficient quality staff in a tight labour market.

Supply is being managed with more caution in placing orders and a focus on the most likely products for sale (though for Christmas, much of this was completed months ago). Demand is being stimulated by cost reductions, discounts and other focused promotional and price activity. In all cases, the aim is to ensure sufficient cash flow for the business.

How will consumers react this Christmas?

The good news for retailers is that at Christmas, there are sales to be had. If they can supply their product ranges at good prices, then consumers with money will spend.

Nevertheless, there is more nervousness and care about spending this year despite it being the first non-Covid-19 holiday season for three years. As ever therefore, some retailers will hit the festive sweet spot and do well, while others may struggle. It is always highly competitive at Christmas, but the pressure on retailers will be greater this year due to the economic context and outlook.

The problems that retailers and consumers have faced over the past year have already resulted in notable changes to purchasing. There has been a long-run slowdown in the volume of products purchased in retail as consumers have seen their budgets shrink. While there has been an increase in value, this is driven primarily by inflation (Figure 3 shows this for food stores, which have experienced the highest inflation).

Figure 3: Volume and value of sales in food stores, seasonally adjusted (October 2019 - October 2022)

Source: ONS

Consumers are less likely to buy and are searching for value. The price of Christmas basics such as mince pies, Christmas puddings and Christmas chocolates are increasing above the average rate of inflation. This is also the case with elements of Christmas dinner, such as turkeys and Brussels sprouts (see a longer-run view here).

Tesco have noted a switch from fresh to frozen products for Christmas this year, something that other retailers may also experience and benefit from. There has been a considerable rise in sales of retailer own-label products and a continuing increase in sales and market shares of the leading food and non-food discounters.

Aldi and Lidl have gained market share rapidly recently (on the back of relentless store expansion and sales growth). Indeed, Aldi has overtaken Morrisons as the fourth largest food retail chain in the UK (see Figure 4). It will not be long before Lidl too overtakes Morrisons in the rankings. Together, the two German brands are now larger in market share than either Asda or Sainsbury’s.

Figure 4: UK grocery market share, by company

Source: Kantar, 2022

With the cost of living crisis and other economic problems, consumers are being more cautious this Christmas. Seeking value is one dimension of this, but seeking difference may be another.

There has been a relative rise in smaller independent retailer performance and openings as consumers have sought out local, authentic and different products. These producers and retailers are often less affected by some of the pressures that larger retailers face and can be nimbler.

This effect could expand at Christmas, building on the localism seen during the pandemic. Some of this could be associated with gift-giving for Christmas, but may also arise as consumers ‘treat’ themselves at home rather than venture out to hospitality and other venues.

Indeed, restaurants and pubs have been badly affected by the same issues as retailers – a pattern seen last Christmas. Smaller retailers too can be badly affected by cost increases and the consumer slowdown, as seen by the stallholders in Cardiff Christmas market, whose profit margins have been hit.

How are different consumer groups affected?

Given the widespread nature of the economic issues affecting the country, it is tempting to think that everyone is struggling and suffering in the same way. But this is not the case.

It is hard to see how the most well-off in society are affected. There is money around and people are willing to spend. During the pandemic, sales and spending patterns were disrupted and those with money saved more.

The savings ratio rose (see Figure 5) and there remains a volume of money that has been saved and not (yet) spent. This is now slowly being unwound, as people are travelling and spending on leisure and home improvements. The recent shifts in the housing market – notably price reductions and a slowdown in mortgage availability – may add to this. Some of this money may well get spent at Christmas.

Figure 5: Households savings ratio (1963 Q1 to 2022 Q2)

Source: ONS

At the other end of the financial spectrum, people are really struggling. The use of food banks has soared. The development of ‘warm banks' points to other problems with affording basic needs.

Food inflation is outstripping broader measures, and this affects lower-income families more as a greater proportion of their income is spent on necessities. As inflation rises, interest rates increase, putting pressure on mortgage payments, all while real pay is held down.

This means that more people are drawn into difficulty and struggling to get by. There is also evidence that the cost of living crisis is exacerbating health inequalities, driven mainly by income and poverty.

These disparities play out at the individual and family level, but there are also differences across the country. Some towns and regions are more impoverished, and so the retailers in these areas are struggling badly.

In other neighbourhoods, relative affluence leads to a sustainable and strong retail heart to a place. The disparities are considerable and appear to be growing. The Centre for Cities cost of living tracker suggests that the October 2022 inflation rate for Cambridge was 10.2% compared with 13% in Burnley. These averages will hide wider disparities.

So will it be a good christmas?

As with every Christmas season, there will be retail winners and losers. There is money around (for some) and people want to have a good festive time. But the wider economic pressures mean that this will not be the case for all.

In simple terms, retailers are in search of consumers with money, and consumers will be looking for retailers with the right products at the right price. This is the essence of retailing and not every business will be able to get it right all the time.

Over the festive period and beyond, we should be concerned about the increasing disparities among people and places, and their experiences. These gaps are widening, and the consequence of this turbulent year has been to accelerate the differences. But retailers and their shops will be trying their very best to ensure that all consumers can get products that they want for Christmas, whatever their circumstances.

Where can I find out more?

The Office for National Statistics (ONS) publishes regular updates on their data series and a range of analyses of the trends and directions. They are adding to their standard data series with a range of experimental data sets.
The House of Commons Library contains a range of reports and briefing papers on topics mentioned in this article.
Consumer confidence is reported monthly by GfK.
In addition to setting the current bank rate, the Bank of England produces a range of data on consumer and business activity.
The British Retail Consortium provides a range of data on the sector, often in association with partners.