The purpose of this report is to explore the wider economic environment and its relation to the London Department Store Industry. This involves exploring social, political and economic factors and how they impact the profitability and alter the competitive environment surrounding the stores investigated.
The UK economy is changing steadily due to social habits, terrorism and other external factors. This has a huge effect on every industry, including the retail industry. Specifically, for the purposes of this report, economic shifts also have an effect on the success and profitability of London Department Stores
Demand & Elasticity
The law of demand states that if a product’s price is reduced while all other surrounding factors (such as price of the competition, disposable income, etc) remain constant, demand for the product will increase. This is especially true for the retail sector where products are not deemed ‘necessary’ but ‘luxury’. However, since department stores sell a variety of different products including necessary and luxury products all for relatively the same prices as one another, other factors may influence consumer decisions more than price, such as location and income.
In other words, the market for department stores is fairly inelastic unless prices are reduced to such an extent that they are in competition with discount stores, by which point the business would not cover the cost of overheads. The reason for this inelasticity is that London department stores are in perfect competition with one another and if there is any discrepancy in prices, it would be either within the stores’ own brands or different products entirely. For instance, Harrods has a reputation of being more expensive than other stores because of the products it sells versus other stores. Harrods sells the highest quality products whereas John Lewis sells less expensive brands. Thus, a shop which sells a combination would have lower prices on average than Harrods even though the high-end prices are the same in both stores.
The economy and the retail industry are directly related in that when inflation decreases and consumers have more money to spend, demand increases. Likewise, when personal income is low or the economy is experiencing a slump, the retail industry will suffer. Non-specialist stores showed the lowest quarterly growth since July 2005 of 0.3%, according to the Office of National Statistics. This could be due to the rate of inflation of late being at 3%, or the fact that December 2006 showed enormous growth and consumers were recovering after Christmas, or even reflect the increasing popularity of internet shopping.
Technology & Market Trends
Technology also has an effect on the supply and demand of products in department stores. Historically, when department stores first came into being, shopping was quite an exercise. For instance, women used to go through viewing, fitting and ordering processes before waiting for their dress to be made and posted when shopping for clothes. Technology has assisted in faster manufacturing along with an increase in demand for ready-to-wear clothing, which has managed to lower demand so much as to push the made-to-order sector out of the market. Going a step further, the increasing popularity of Internet shopping may well push traditional department stores out of the market.
It is important to define the market structure of any industry in terms of the amount of competition in the market place. Regarding the retail industry, the leading department stores in London have a perfect competitive structure. This means that buyers and sellers should have only one set price for the same good in any store. If a store were to increase the price of that good, they will be forced to reduce it again within a short period of time because the goods sold are homogenous and competition stores have a perfect knowledge of shared products on offer. Likewise, if any of the department stores gain abnormal profits other companies will know about it and will adjust their prices accordingly, thus forcing the original firm to lose their profits by reducing supplies and increasing prices to get back to normal profit levels. This is a very rare ‘ideal’ market type.
Stores such as Harvey Nichols and Harrods differentiate slightly from other department stores in terms of size and their resulting advantages to sell products that are not as popular elsewhere in the market because of their high price. For instance, Kanebo cosmetics (selling creams for £300) or Theo Fennel’s Silver Sleeve perfumes (small bottle for £250) are both highly expensive and exclusive to Harrods. La Perla, a very expensive clothing, lingerie, accessories and perfume brand are found in upmarket stores like Fenwick, Selfridges and Harvey Nichols. Unlike these exclusive and expensive products which push up average prices in these department stores, goods that sell in all department stores have to keep their regular prices in order to maintain the perfect competition.
Department stores are positioned steadily in the market place due to their structure, however they do not have market power in that their profits and popularity will not have a direct effect on the overall economy – in fact, the reverse is true, as explored earlier.
Recent Developments in the Market
Recent developments, internal and environmental, also have a positive impact not only on store profits, but on the market type as a whole, as evidenced by Marks & Spencers’ store renewal programmes and responses to environmental issues or John Lewis’s successful online business. These proposals increase competition greatly because they serve as examples of differentiation between these stores which are supposed to be in perfect competition with one another. For instance, environmentally – conscious consumers may choose to shop at Marks & Spencers because of their “Plan A” scheme versus John Lewis, who have yet to implement their green policies within their department stores as they have done in their supermarkets.
Porter’s Five Forces
A department store’s strategic approach to the retail industry is analysed through Porter’s five forces. The relevant forces are: the current and potential competition, the threats of new entrants and threats of substitutes and the power of buyers and suppliers.
All major London department stores are in perfect competition with one another. It must be noted here that the classification of department stores varies and in this case, discount and specialist stores and supermarkets are excluded. Therefore, this includes stores with a variety of luxury products on offer. They are all well established and very few have opened (or shut down) within the last quarter century. Therefore, there is little threat from existing competition affecting individual stores.
Threats of new entrants
The threat of new department stores opening in London is very low because of the existence of well-established and highly respected stores. Any new entrants must prove to be equal competition to the existing stores and it would be advisable for them to create a marketing strategy introducing their values as matching those expected by consumers. Also, the new firm must have great financial resources in order to implement and sustain its existence. However, there is the possibility that chains existing elsewhere in the UK or abroad may wish to open a branch within London, at which point they will already have the experience and capability to compete. As mentioned before, consumers base their opinions and loyalty to a certain store on several factors including stock, location, customer service and even reputation. These are all aspects which need to be explored by any new entrant.
Threats from Substitutes
There exists a threat from substitutes especially in times of shifts in the economy. For instance, substitutes for products purchased in department stores are sold in specialist stores, supermarkets and discount stores. In tough economic times, consumers would be more inclined to purchase at a discount store than in a department store. Similarly, when interest rates are lowered or personal income is high, consumers would prefer to shop at Harrods than John Lewis and John Lewis more than TK Maxx. The benefit of shopping in department stores is that all of a customer’s needs can be satisfied under one roof. However, a specialist store may not have as high overheads or may even manufacture their own goods, therefore reducing their prices.
Power of Buyers
The power of buyers in the department store industry varies depending on the location, reputation and consumer loyalty of the store. For instance, sellers would be more eager to sell their products through Selfridges than Harvey Nichols because of their greater size and stock capabilities. Similarly, Theo Fennell is more interested in selling his £250 perfume exclusively through Harrods than Debenhams because the customers who shop at Harrods are far more likely to spend so extravagantly. However, it must be argued that there are plenty of department stores in London who stock similar or identical items and therefore sellers of these products would not be short of customers if one or two decided to stop buying.
Power of Suppliers
Products in department stores are often produced by external manufacturers and sold in one place with great profitability. However, a few firms such as Harrods and Harvey Nichols offer a variety of goods which are not available in the other stores. This suggests that department stores’ main priorities are product buying in order to sell successfully and gain consumer loyalty. Recently, marketers focused on making and maintaining good relationships with their national and international suppliers due to the shift in recent history from in-house manufacturing to wide-spread outsourcing. Also, in order to stay in competition with other department stores, each one needs to sell relatively the same goods as the others. This means that suppliers have a lot of power over each store’s place in their competitive environment. In political terms, there are restrictions facing sellers such as watchdog bodies and competition laws, in favour of buyers.
An outline of recent and forecast developments of the UK Economy
Although average earnings reduced, job vacancies grew significantly to 607,900 from October to December 2006, resulting in unemployment falling by 5.5%. Also in the same period, both the number of part-time female workers and the economically inactive working age increased, which results in employment reaching 29.04 million. Further, redundancy improved in the last quarter measuring 5.2/1000 employees.
The Consumer Prices Index (CPI) annual inflation was 2.7% in January 2007, which is 0.3% lower than a month ago. The rate was mainly contributed to by transport costs (including significant changes to the cost of air travel to European destinations), fuel prices, lubricants, food and non-alcoholic beverages. Also, cigarettes and alcohol prices rose significantly in comparison with last year’s prices.
The Retail Prices Index (RPI) also fell by 0.2% to 4.2% (January 2007) in December 2006. This is mostly due to household products and intensive furniture sales during the month of January. However, housing costs such as mortgage interest payments had a positive effect on RPI.
It is worth mentioning that the UK inflation rate (3.0 %) is remarkably above average compared to the European Union (2.1 %).
The measure of retail sales in the UK increased by an impressive 0.9% between November 2006 and January 2007, which indicates a 1.4 per cent growth during December. Non-food stores sales rose 0.9% and food stores showed 0.4% growth in the same period. However non-specialist stores fell back 0.3% since July 2005. The recent London terror attacks had a major impact on retail sales especially in leading high street stores. (The impact of terrorism in London will be detailed later in this report.) Non-store sales increased to 4.7%, mostly internet and mail order retailers. The figures in the monthly analyses illustrate that total sales reduced by 1.8% within the same period of 2003, mostly contributed to by clothes shops (4.4%), household goods stores (4.2%) and non-food stores (3.7%).
Overall, the profit of retail sales shows a significant improvement of a 3.9% increase compared to 2006.
The Gross Domestic Product (GDP) increased by 0.8% which places the GDP 3.0% above 2005 (for the same period). Specifically, outputs decreased in the production industry by 0.2%, the manufacturing industry by 1.7% and in mining and quarrying by 0.6%.
However, economic growths (outputs) took place in areas such as the services sector by 1.0%, in the business and finance sector by 1.1%, wholesaling and retailing by
1.4%, construction by 0.9% and household expenditure by 1.0%. This is compounded by the government expenditure being 1.5% higher than in 2005.
According to the Bank of England in 2005, interest rates fell by 0.25% and stood at 4.5%. Household and business investments growth decreased, exchange rates fell and CPI was 2.0%.
Following that in 2006, the UK economy experienced a successive growth. Household spending remained consistent but business investments improved and the export markets also showed a positive increase. The credit card and broad money remained stable but the asset prices rose and the CPI rose to 2.4%.
The latest report (2007) shows another 0.25% growth, the Official Bank Rate is 5.25%. This means that outputs have risen and that domestic demand and credit and broad money have increased. The international economy accelerated intensely: the sterling has risen, oil prices have dropped, and inflation is 2.7%. This suggests that the year began with intensive domestic pricing pressure.
There are two points to be aware of here. The first is a long-standing legal barrier of laws against anti-competitive behavior – part of the Competition Law of 1998. Such laws prohibit large companies from abusing their monopolistic (or near to) market position. They also prohibit companies from making agreements that could create such a situation where smaller firms are no longer able to compete. This law is not necessarily to keep big companies ‘in check’ but more to make sure that consumers are treated fairly, which can only be done with market competition keeping prices at a reasonable level.
Another political hurdle for companies, which can also be a socio-cultural issue, is the Green trend. There will be laws in the near future whereby a firm will have a limit enforced on carbon emissions, packaging, recycling targets and other products of consumer society. This is going to be very difficult for the retail industry but it is also a fantastic opportunity for goodwill-forming publicity.
The UK is experiencing increasing economic growth according to the latest reports especially within the services sector. This suggests that unemployment also improved in these areas (mainly financial services) as opposed to the health care where extensive job cuts were recently introduced. The UK still faces reasonably high unemployment, approximately 1.7 million [Online, IDS].
The UK experienced an unexpected inflation increase which indicates the government must raise domestic prices to get back to a normal level (target 2.0%). Surprisingly, the personal disposable income showed a 25% rise in the past decade, but that includes personal debt and credit card debts (£930 billion, which interestingly is twice of the government expenditure!).
Interest rates on goods and services are continually growing in order to cover government spending.
The most recent lifestyle changes are the increase in working women and people working away from home. Also, due to recent technological developments such as computers making work time easier, people have gained more daily leisure time. Despite this, the UK has the highest working hours in Europe and people have been working too much overtime.
The number of people entering into higher education has drastically increased as well, some suggest this is because there are too many available jobs in the market place and therefore the unemployed need to find alternative employment.
The greatest threat to department stores at the moment in terms of technology is the advances and increasing popularity of internet shopping. Most shops are combating this issue by opening up their own online shopping sites; however it is advisable that steps are taken to make shopping in the store more attractive. At the moment, most stores and online facilities offer discounts to shop online, but maybe this should be the other way around. Otherwise, if the popularity of Internet shopping carries on the trend that it has seen for the last few years, soon it will overtake the retail market and having a physical store won’t be financially viable.
The department stores industry in London is experiencing a lot of changes at the moment mainly due to (in the long term) technological and cultural changes and (in the short term) economic shifts. Such things include the increasing popularity of online shopping, discussion of laws against high carbon emissions due to the greening culture, changes in consumers’ disposable income and interest rates. All of these things affect not only how department stores function but also consumer spending.
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