Analysis: How are retailers mitigating the downfall of the pound?

The cost of doing business is getting higher and higher. While bills for freight, containers, utilities and labour are soaring, the pound is weakening.

In the past, retailers have looked to cut operating costs to get on top of currency devaluation, but as those costs skyrocket to unforeseen heights, that’s becoming harder to do. 

After the disastrous mini-budget, in which borrowing was to pay for £45bn of unfunded tax cuts, the pound slid to a 50-year low against the dollar. 

A weaker currency and spiralling inflation are often a reciprocal relationship, with the latter now at 11.1%, the highest since 1981.

It is a situation compounded by higher borrowing costs as the Bank of England (BoE) increased interest rates to 3% in its November meeting and the latest 0.75% rate hike is the highest since 1989.

Looking ahead, the BoE has forecast a recession that will last into 2024.

Predictably, retail sales have been affected by the current storm. The Office for National Statistics revealed that, for the three months to October, retail sales fell by 2.4% compared with the previous three months. 

Who is impacted?

Currency depreciation can take time to make its impact but, according to the British Retail Consortium (BRC), fashion and homeware retailers, as well as department stores, will feel it first.

BRC economist Harvir Dhillon says: “For many retailers operating a just-in-time supply chain, the impacts of currency devaluation can be felt fairly quickly.

“We expect that the recent recovery of the pound to hold over the next month and the increased political stability will help stabilise currency fluctuations.

“Some retailers may begin to explore reshoring parts of the supply chain, if exchange rates and shipping costs were to become an even bigger issue”

Harvir Dhillon, British Retail Consortium

“However, some retailers may begin to explore reshoring some parts of the supply chain, if exchange rates and shipping costs were to become an even bigger issue in the future.”

In its latest half-year results, Next said the devaluation of the pound looked set to prolong inflation and, as the majority of its clothing and homeware factories price their goods in dollars, the retailer’s cost price inflation is anticipated to increase, and may even peak, in the second half of next year. 

Next believes it is inevitable that sales growth will slow down as inflation continues to bite. 

Primark has celebrated positive UK sales results for this year so far and reached pre-Covid levels in the fourth quarter due to the resumption of typical footfall patterns.

But it noted a volatile financial outlook as the US dollar strengthened against the pound and the euro, which, in combination with sky-high energy bills, meant it expected its operational profit margin to fall below the 8% mark achieved for the second half of the current financial year. 

Who is benefiting?

Where there are losers, there are winners. Tourists are flocking to Europe and retailers with luxury-led strategies are benefiting from the demand in London.

David Maddison, director of retail at HSBC UK, says: “Americans have been travelling to Europe in their millions to capitalise on a weak euro, buying luxury goods at an effective 15% discount purely down to currency movements. 

“LVMH, Kering and Burberry have all made reference to this during their latest trading updates.”  

Alternatively, retailers could use the exchange rate to price products more competitively in dollars.

“Those retailers who have exposure to the US market have benefited twofold,” says Maddison. 

“This has been through sales in the US, naturally hedging the retailer’s exposure to the dollar in their supply chain and being able to repatriate excess dollars at a favourable rate into sterling.”  

Counter strategies 

But for retailers with value-led strategies, with so many hostile conditions to overcome, a battle plan is necessary to combat the pound’s sinking value against major currencies such as the dollar, the euro or the yen. 

Richard Lim, chief executive of Retail Economics, says: “Whether it’s a falling or rising currency, or whether it’s a rise in sourcing costs, whatever it may be, margins are going to be squeezed and retailers have to look at driving other operational efficiencies of the business.

“These efficiencies are really just about streamlining profitability; some of this might be around production methods or better delivery efficiencies or it might be about cutting headcount as a lever to reduce costs by investing in automation.”

However, the scope around supply chains only presents retailers with limited options and is highly dependent on the product type being imported. 

Maddison says dual invoicing is worth exploring: “In dual invoicing, the retailer requests an invoice from the supplier in both US dollar and the supplier’s local currency.

“This can prove successful whereby the local currency has also depreciated against the dollar, which a lot of currencies have.”

“The interesting thing around apparel is that supply chains are a bit more flexible, so there has been a shift away or a diversification”

Richard Lim, Retail Economics

According to Lim, fashion retailers have been looking to take advantage of different channels and are increasingly looking to source goods in other currencies, like riel, dong or rupiah.

Lim says: “The interesting thing around apparel is that supply chains are a bit more flexible, so there has been a shift away or a diversification that has happened over the past decade.

“We have seen other countries that have emerged in terms of producers of apparel such as Vietnam, Indonesia and Cambodia. Even parts of Europe have become powerhouses in apparel manufacturing; some apparel retailers may move supply chains away from dollar-denominated sourcing.”

Currency hedging is also a key strategy, where the forward buying of currency can smooth out the effects of depreciation.

According to N Brown’s latest interim results, it is fully foreign exchange hedged for next year and 50% hedged for 2024.

Overall hedge accounting was applied to 80% of its dollar spend, which was also accounted for through the cost of sales in its gross margins.

The drawback is that currency movements can be very hard to predict.

Another way to ease rising costs is through constant currency deals, where there is an agreement for a fixed exchange rate, which eliminates the potential adverse effects of currency variations. 

“From the constant currency perspective, this is more about retailers that have international operations, where in some ways they can spread their risks more effectively,” Lim says.  

For example, Marks & Spencer, in its half-year results, revealed that international constant currency sales had risen by 13.7%. 

“Fluctuations in exchange rates mainly benefit companies that deal with commodities that are sold on a large scale in agreed qualities, composition or brands”

Professor Joshua Bamfield, Centre for Retail Research

Looking ahead, there is some optimism. While recognising the impact of the pound’s drop, the Centre for Retail Research (CRR) says the exchange rate situation is not as bad as in the aftermath of the mini-budget and the pound is now fluctuating against major currency rivals such as the dollar and the euro.

CRR director Professor Joshua Bamfield says: “Fluctuations in exchange rates mainly benefit companies that deal with commodities that are sold on a large scale in agreed qualities, composition or brands.

“So this is not fashion retailing – but it could be supermarket petrol retailers that can benefit from an increase in the exchange value, as they can buy the same quantity as before but at a lower price. Manufacturers buying grain and similar raw materials for processing can also benefit most.” 

The CRR anticipates that the UK exchange rate, at worst, will be stable into 2024. If inflation subsides, it could increase in value, which may provide a liferaft for retailers to cling to after navigating the choppy currency waters of this year.