MHP Retail Report July 2011

Mandate, Hogarth & Penrose combined

MHP, 60 Great Portland Street, London W1W 7RT T +44 (0)20 3128 8100 F +44 (0)20 3128 8171

Retail - an investment appraisal focused on politics and public policy

What is this report about? It is now over a year since the formation of the Coalition Government. With the wheels in

motion on some of the most radical reforms to public services and fiscal policy in a generation,

we analyse the investment prospects for the retail sector over the next three to five years, from

a political and public policy perspective.

Our findings The Government’s Localism Bill and a community ‘right to appeal’ gives communities a

greater say on the retail mix in their vicinity – and could cause a headache for retail

developers

An overall majority for the Scottish National Party in Holrood has increased the potential for

SNP policies such as minimum pricing for alcohol and a so-called ‘Tesco Tax’ on large

developments to be introduced in Scotland; if successful Westminster may follow suit

Retail has already been considered as part of the Government’s ‘Red Tape Challenge’, but

issues such as Sunday trading laws remain contentious, with the Treasury pushing for

liberalisation

Likewise employment law, health and safety and other cross-market issues are being re-

evaluated every 4 months – the Government’s rhetoric on health and safety has been firmly

in favour of a shift away from an apparent ‘compensation culture’

Work is underway in the European Commission on water ‘footprint’ labelling for products –

pressure on retailers to keep ahead of public policy on sustainability and maximise the

reputational and commercial benefits of sustainability initiatives will increase

Commercial and reputational risks will likely increase for companies failing the Government’s

Carbon Reduction Commitments, but opportunities will increase for retailers to be Green

Deal providers

The Government has now concluded its Waste Review with ambitious targets to make the

UK a ‘zero waste’ economy. It is clear that pressure on retailers to reduce waste –in

particular food waste – will only increase

Single issue campaigns and pressure groups are increasingly focused on high profile brands

and retailers – digital mobilisation means that pressure groups can reach wider audiences



and build momentum much more quickly and effectively; the impact on retailers is often

immediate, particularly if direct action affects sales

Introduction

This paper analyses the future for retail in the short to medium term (three to five years). More

specifically, the paper examines the implications for retailers and investors of the broader

political and policy environment. It identifies key policy trends and analyses the potential

impact on the sector.

Political context: Uncertainty in Westminster, Holyrood and beyond

The Coalition Government plans are radical. Its first priority is to cut the UK’s

deficit. The success of the programme to cut the deficit will hinge on

whether the UK economy can shoulder austerity or falters as the spending

cuts bite.

Although there are clearly tensions within the Coalition, we still expect

Westminster’s centre-right coalition to last the course. It is certainly not in

the Lib Dem’s interest and in particular those of Nick Clegg’s to leave the

Coalition. Terrible local election results on 5 May, as well as near wipeout for

the Lib Dems in Scotland, removed any doubt that a general election is not in

the interests of Mr Clegg’s party.Therefore we expect the next general

election is likely to be May 2015.

Cuts to the

deficit

UK General

Election due by

2015

Scotland went to the polls on 5th May, and voted in a majority SNP

administration in a landslide victory for the Nationalists – the first of its kind.

The clear result should provides some clarity for retailers in Scotland in the

coming months as policy becomes clear – for example on key issues such as

alcohol pricing.

The Scottish National Party had mooted a ‘Tesco tax’ on the square footage

of retail stores but this never made it into the Budget at the end of the last

parliament. It was perceived to be a blunderbuss approach to deter out of

town retail developments. However a working majority in Holyrood may

mean that the issue re-arises.

The Scotland Bill, which enacts the recommendations of the Calman

Scotland –

Election May

2011

‘Tesco’ tax

dismissed

New tax powers



Commission on devolution, is likely to have a significant impact on the future

tax system in Scotland. Key provisions in the Bill include increased tax-raising

powers (including the ability to set a new variable rate of income tax) for the

Scottish Parliament and the devolution of stamp duty, giving the Scottish

Parliament power to set its own tax rate on land transactions. If the Bill is

passed, which we expect it will be, the new powers for the Scottish

Parliament should be in place by 2015. First Minister Alex Salmond has made

clear to the Prime Minister that he will fight for as much autonomy as

possible, and Mr Cameron will likely not want to be seen to be ignoring the

will of the Scottish people.

for Scottish

Parliament

likely

The European Parliament elections will be held in 2014, at which point new

Commissioners will be appointed. Observers do not expect the direction of

policy on key issues such the Working Time Directive and the single market

to alter dramatically.

EU – European

Parliament

elections in

2014

Fiscal policy

Ministers in London hope that the effect on retailers of the recession and

public spending cuts will be offset to some extent by tax cuts. Having

previously announced that it planned to cut the corporation tax rate to 24%

by the end of the Parliament, the Chancellor recently announced a doubling

of the proposed tax cut this year of 2%. Accordingly, corporation tax by the

end of this Parliament will be 23% - a full 5% lower than in 2010.

VAT has already gone up and we do not expect to see another rise in the

next two to three years. However with an election in 2015 the Government

may well think it would be expedient to announce a small reduction in the

run up to the Election and therefore we expect that a small reduction will be

announced by the Chancellor in the 2014 Budget.

Corporation tax

lower than

expected.

VAT expected

to remain

broadly the

same

The Coalition hopes that these measures will help businesses grow even in

the tough economic climate. However, the Government has little room for

manoeuvre. Indeed George Osborne has said that “a significant reduction in

overall business taxation is simply and sadly unaffordable in the short term”.

We expect tax to remain a challenge for the retail sector and the proportion

of tax paid is unlikely to decrease significantly. General taxation on

consumers will remain at high levels and, coupled with relatively low wage

No reduction in

business

taxation



increases and the squeeze on take home pay due to inflation, will impact

negatively on consumers’ purchasing power.

The big issues for retailers Next 1-2 years Planning

The Government’s localism agenda is altering the retail planning

environment, shifting limited planning powers to local government and

communities.

The Government has made a specific commitment that a new ‘National

Planning Policy Framework’ will give local communities greater freedom to

set their own policies and abolish regional strategies in favour of local and

neighbourhood plans.

Furthermore, as part of the provisions set out for communities in the

Localism Bill, communities will be given a new right to draw up a

‘neighbourhood development plan’. As such, communities that take the

opportunity to organise forums are likely to have the power to designate the

desired retail mix for their neighbourhood. This will include the location and

look of new developments and the use of existing premises; for example,

these plans may prioritise independent stores over larger brands.

Communities are also likely to be given a ‘community right to appeal’, where

an approved development contradicts the parameters of an existing

neighbourhood plan.

However, it is important to note that ‘neighbourhood development plans’ will

only exist where communities initiate the process. More specifically, they will

be at the bottom of a pyramid of local and national plans, and will be obliged

to be broadly in line with the over-arching plans. Note also that the Localism

Bill is still to be passed in Parliament and therefore subject to further change

and amendment.

As such, we expect the changes to have a limited positive impact upon small

retailers, some of whom may benefit from neighbourhood plans which

prioritise independent stores. Conversely, larger retail chains may find that

the planning process becomes more challenging, as communities use their

new powers.

Impact of

localism agenda

uncertain

Power to

designate the

desired retail

mix

Community

right to appeal

Localism Bill yet

to be passes

Local councils

to take health

into account

when making

planning

decisions



Finally, and in line with the shift of power to local government, we expect to

see an increase in the number of local authorities banning fast food

businesses from opening near schools. Waltham Forest became the first

council to introduce such a ban and others are following suit, buoyed by a

High Court decision which ruled that councils ought to take into account the

health and wellbeing of pupils when making planning decisions.

The Government’s commitment to local and civic empowerment, as evident

in the Localism Bill, means that retailers must take more account of local

government and communities when making investment decisions about new

developments.

Alcohol

Prior to the May 2011 election, attempts by the Scottish National Party to

bring in minimum alcohol pricing in the Alcohol Bill 2010 failed. However, we

expect this issue to be raised during the course of the next Scottish

Parliament, particularly since the SNP now commands a majority. It is likely

to gain traction south of the border if supporters of minimum pricing see an

opportunity to gain momentum.

Earlier this year the UK Government launched the Public Health

Responsibility Deal in order to tap into the potential for businesses and other

organisations to improve public health and tackle health inequalities through

their influence over food, alcohol, physical activity and health in the

workplace.

Established by Andrew Lansley, the Health Secretary, it is likely to consider a

proposal to require a proportion of alcohol advertising to be spent on the

promotion of responsible drinking. However, to date, there have been no

strong commitments or policy announcements.

Minimum

alcohol pricing

Red Tape

The Government recently chose the retail sector for the first in a series of

“Red Tape Challenges” aimed at cutting unnecessary regulations. The public

are being asked for their views on consumer information, restricted goods,

weights and measures, trading requirements and Sunday trading.

Sunday trading

under scrutiny



There have been tensions within the Coalition and across government with

regard to Sunday trading. The Treasury were arguing for further liberalisation

on the basis that it would lead to growth. However we understand that there

was a strong body of support for not making any changes and therefore we

would expect that there will be no liberalisation in the current Sunday

trading laws.

Of more interest is the long term plan to force Departments to comment

every four months on the six cross-cutting themes across the campaign,

covering: employment law; pensions; company law; equalities; health and

safety; and environment legislation. If the Government achieves its aim, in

theory retailers should enjoy a reduction in regulation, however in reality the

impact is unlikely to be of any real commercial significance.

Government

aims to reduce

‘burden of

regulation’

Next 3-5 years Utilities

Utilities policy is the area with perhaps the clearest commercial risks and

opportunities for retailers, starting with energy. Most large retailers are

currently required to display energy performance certificates and the

Government is seriously considering making private commercial buildings

display similar certificates. We expect this to offer smaller retailers an

opportunity to negotiate over leasing arrangements and associated costs.

However for the big retailers there will be an opportunity to become both

users and providers of energy, a move that will be warmly welcomed by

Government. Large retailers will increasingly take advantage of the

commercial opportunity to sell energy back to the grid.

As Paul Polman, CEO of Unilever, said last year, “those companies that wait

to be forced into action or who see it solely in terms of reputation

management or CSR, will do too little too late and may not even survive.”

Those who are ahead of public policy and maximise the reputational benefits

of such achievements are likely to offer a good return on investment.

To take just one example, the data regarding the Government’s Carbon

Reduction Commitment, aimed at non-energy intensive industries such as

Energy

performance

certificates

Users and

providers of

energy

Carbon

Reduction

Commitment

data

Partnership

working



retail, will soon be available as a league table. Those retailers that are taking

action now will avoid being ‘named and shamed’. Crucially, they can also

reap the bottom line benefits as evidence shows that sustainability matters

to consumers, especially those at the higher end of the retail market1.

And finally, we expect innovative business practices to deliver results. For

instance, we are increasingly seeing large brands with a substantial presence

on the shelves in the UK working together to solve business issues. Heinz has

just announced that it has been working in partnership with Coca Cola and

will soon adopt their ‘PlantBottles’. The PET plastic ‘PlantBottles’ are partially

made from plant materials and have a lower reliance on non-renewable

resources compared with traditional PET plastic bottles. Switching to

PlantBottle is a step in Heinz's global sustainability initiative to reduce

greenhouse gas emissions, solid waste, water consumption and energy usage

at least 20 percent by 2015. We expect this to have a positive impact on

their bottom line. The big retail brands are likely to adopt similar practices to

solve their business issues faster.

Supply chain security and sourcing

Sustainability matters are central to retail because they are at the heart of

long-term competitiveness. There are real potential benefits for retailers that

are prepared to take the lead and who will clearly get prime mover

advantage. Water is a good example. A third of the world’s population live in

countries that are experiencing water stress. Retailers that source flowers

from Kenya, for example, will already be aware of the pressure on the water

table in Kenya and the impact that it has on the cost and quality of the

product.

The scale of potential geo-political threats arising from water shortages,

amongst other environmental issues, is enormous. This means that retailers

and investors need to anticipate the future direction of policy both at a

national and international level. Building on schemes such as the EU

Emissions Trading Scheme, work is underway in Brussels to explore a similar

market for water. From pasta to cotton, the ‘water’ footprints of many

products commonly found in UK retail stores are increasingly seen as

problematic by policy makers. Companies with high water usage, including

Sustainability

at heart of

competitiveness

Water

‘footprint’

labelling on the

horizon

1 The Future Laboratory, The Futures Report – Retail 2010, p. 170 (‘Sustainability hierarchy’)



P&G and Coca Cola, have been focusing on this challenge for some time, with

positive results for their respective bottom lines. Those who choose to ignore

the warning signs from Whitehall and the European Commission are likely to

find themselves on the receiving end of regulations and tax changes over the

next few years.

Last year retail market monitoring report, ‘Towards more efficient and fairer

retail services in the internal market for 2010’, was adopted by the European

Commission (DG Internal Market). The Commission analysed the entire retail

chain from suppliers to consumers by accounting for all the relevant EU

policy objectives, be they competitiveness, social, environmental or

consumers. The subsequent report identified a series of problems for the

sector and, should the European Parliament show an interest, this report may

well lead to EU action or indeed legislation.

Should the Commission seek to address unfair contractual relations through

legislation then there may well be cost implications for UK retailers, as they

may be forced to review existing contractual arrangements with suppliers.

However, the consensus is that outcomes will be broadly positive,

particularly for larger retailers. The latter are likely to welcome better

enforcement of the Services Directive as this would open up difficult markets

within the EU.

EC Retail

Market Services

report – follow

up legislation

possible

Scrutiny of

unfair

contractual

relations.

Pressure to

open up

difficult EU

markets

RISKS Localism The Government is actively considering whether to allow councils to retain

locally-raised business rates and give local authorities the power to grant

business rate discounts if they wish; the Local Government Resource Review is

due to report in July 2011.

In line with competition between countries over corporation tax, competition

between neighbouring councils to have lower business rates and thereby

attract businesses is likely to benefit retailers. Councils are also expected to

compete by offering attractive deals, for example refunding business rates to

New locally-

raised

business rate

possible

Competition

likely to lower

business rates



a proportion of build cost over a number of years with a view to securing

additional rates in future.

Employee costs Following recommendations from the Low Wage Commission, the

Government recently increased the National Minimum Wage (NMW). It refuses

to be drawn on whether the NMW will be increased in years to come but it

would clearly be politically expedient to do so especially as the next election

approaches. This is also an area where the Lib Dem partners in the coalition

will be keen to be seen to be delivering something of benefit to low paid

workers.

National

Minimum

Wage may

rise before

next general

election

Waste

The Government recently published its Waste Policy Review, setting out its

plans for a ‘zero waste’ economy. However, much UK waste policy is, and will

continue to be, driven from Brussels. Resource efficiency is an EU priority, one

of only seven flagship initiatives of the EU’s 2020 Strategy. Retailers will be

familiar with the main Waste Framework Directive, which sets the basic

definitions relating to waste management and lays down waste management

principles such as the ‘polluter pays principle’. More specifically, retailers are

increasingly concerned about how the WEEE (Waste Electrical and Electronic

Equipment) Directive will be implemented in practice. The European

Parliament is currently arguing that consumers should have the right to

‘unlimited take-back of small volume waste’ and stores should be obliged to

sort ‘reusable’ from ‘unusable’ waste.

In 2012 the European Commission plans to undertake a full review of EU

recycling directives, aligning product-specific waste legislation (including the

Directives on end-of-life vehicles, batteries and packaging) to the Waste

Framework Directive. More changes are in the pipeline but the implications for

UK retailers are not yet clear.

What is clear is that this policy area is hugely significant. Get it wrong and it

will directly impact on the profitability of retailers. Get it right and innovative

developments such as anaerobic digestion could benefit local communities

and retail revenues.

Alongside the Waste Review, the UK Government also published an anaerobic

European

Commission

to review

recycling

directives

Anaerobic

digestion and

similar

innovations

likely to

benefit

retailers



digestion strategy aimed at increasing energy derived from waste through the

anaerobic digestion process; they are under pressure from retailers and others

to provide a level playing field so as to promote investment in this area.

Countries such as Germany are leading the way in such innovative waste

programmes and businesses are benefitting.

More specifically, retailers could benefit because there are financial incentives

for them to use anaerobic digestion; it is among the technologies that receive

additional support in the form of multiple Renewables Obligation Certificates

(ROCs). The latter is a green certificate with a cash value issued to an

accredited generator for eligible renewable electricity generated within the

UK. Retailers using anaerobic digestion to generate heat will also benefit

financially from the 2011 introduction of the Renewable Heat Incentive.

Therefore early indications are that, subject to sensible regulation, UK retailers

may also have an opportunity to gain from such innovations.

Tobacco Campaigns, led by health charities, to ban tobacco displays are gaining

momentum. However, the Health Secretary, Andrew Lansley, is known to be in

two minds regarding the ban due to come into force for large shops in 2011

and 2013 for smaller shops.

If the ban on tobacco displays comes into force, there are cost implications for

smaller retailers regarding changing their displays, in addition to a potential

loss of revenue arising from tobacco.

Tobacco

display ban

uncertain

Cost

implications

for smaller

retailers

Employee costs

The EU Council of Ministers rejected a recent proposal from the European

Parliament to legislate for 20 weeks of maternity leave at full pay. They

expressed concerns regarding the cost implications of extending paid

maternity leave. They also rejected plans to include paternity leave in a draft

Directive on maternity leave.

The Council concluded that the European Commission's original proposal to

extend the minimum length of maternity leave from 14 to 18 weeks could be a

European

Parliament’s

proposal

about

maternity

leave rejected

by member

states



more acceptable basis for a compromise than the European Parliament's

proposed amendments.

Without the EU Council’s approval, the proposal cannot now become EU law.

The EU Presidency will therefore now consider how best to continue with the

draft Directive. The very earliest that these rules could have been endorsed by

each member state is not for at least another five years.

Note that the UK Government lobbied heavily against the European

Parliament’s proposal, and HM Treasury in particular is concerned about the

cost to UK Plc of any changes.

However, Nick Clegg is personally committed to shared parental leave. He

recently set out his vision for a "properly flexible" system of shared parental

leave in Britain by 2015, condemned Britain's "Edwardian" system that places

the burden of childcare on mothers and discourages fathers from taking a

central role. We expect the Department for Business, Innovation and Skills to

open a consultation on shared parental leave shortly.

We expect minor changes to the existing legislation prior to the next general

election, primarily because the Liberal Democrats will negotiate changes in

order to deliver on one of their key priorities.

Clegg’s vision

for shared

parental leave

in UK by 2015

Consumer credit Labour MP Stella Creasy recently introduced a private member’s bill, ‘The

Consumer Credit (Regulation and Advice) Bill’. It aims to impose certain limits

on consumer credit interest rates and charges; to establish a levy on credit

and debit card providers to fund the provision of debt advice services; and, to

make other measures relating to the regulation of, and availability of advice

on, consumer credit.

In common with most private members bills it was derailed, however it

succeeded in putting the issue of loan sharks and consumer credit high on the

political agenda. Therefore retailers who have successful store cards which are

significant sources of profit will need to be prepared to see their profit margin

reduced as they come under pressure to reduce their APR on store cards.

We expect this issue to be re-visited by the Government and legislative

changes to be made. As such, retailers should consider reviewing customer

Regulation of

consumer

credit likely



store card programmes.

Pressure groups There has been a significant rise in pressure groups targeting high profile

retailers and other companies in the UK. Only recently, UK Uncut, a group

opposed to the Government’s cuts to public services and tax avoidance, shut

down high street retailers through direct action protests.

UK Uncut is unlikely to achieve major concessions from companies or the

Government but this is part of a growing trend. We have seen effective single-

issue campaigns, often led by high profile celebrities, gain increasing traction

amongst consumers and decision-makers. Only this year major retailers,

including ASDA and TESCO, changed their supply chain policies on tuna,

following pressure from Hugh Fearnley Whittingstall’s successful ‘Fish Fight’

campaign, consumers and Greenpeace.

Single issue campaigns are increasingly focused on high profile brands as its

an effective way to communicate their message. A recent example is

Greenpeace’s advertisement highlighting the use of palm oil in Nestlé’s Kit

Kats which was part of wider campaign about the deforestation of rainforests.

Digital mobilisation also means that pressure groups can reach wider

audiences and build momentum much more quickly and effectively.

The impact on retailers is immediate, particularly if direct action affects sales.

More interesting is the impact on a company’s corporate reputation in the

medium to long term and the cost implications of any changes to the business

model or supply chain management.

The impact of

single-issue

campaigns

If you have any questions or require further information, please send an email to

Fiona Holroyde at Fiona. [email protected] or Lucinda Kemeny at

[email protected] or call +44 (0)20 3128 8100

News & Politics

MHP Retail Report July 2011