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Third Bridge’s Global Sector Lead for Consumer, Alex Smith, and Alex Brown, CEO at Baleigh Investments, discuss the many pressures facing retailers and suppliers amid today’s cost of living crisis. We also cover how the competitive landscape is evolving, and the contrasts between emerging and developed grocery markets.

Episode Transcript

Catherine: [00:00:06] Welcome to The Signal, a podcast presented to you by Third Bridge, the world’s leading independent research provider, exploring how some of the globe’s most investable industries are facing upheaval. My name is Catherine Ford, and I’m a journalist with a 20-year track record of reporting on a wide range of financial topics such as capital markets, developments, and M&A. In this episode of The Signal Wheel, we’ll explore how both suppliers and retailers are dealing with a cost-of-living crisis. Joining me online today from the UK are Alex Smith, Third Bridge’s Global Team Leader for Consumer, and Alex Brown, CEO of Baleigh Investments, Hello to both of you. Can I ask you to introduce yourselves? Alex Smith, maybe you go first.


Alex S: [00:00:45] Sure. I’m Alex Smith, I am the Global Team Leader for Consumer at Third Bridge. I have around 20 years’ experience covering consumer as an equity sell side analyst for a number of investment banks based out of London. My focus within that has been very much on European listed global consumer staples, companies across the packaged food sector, home and personal care, beer, and spirits.


Catherine: [00:01:13] Fantastic. Thank you very much. Alex Brown, talk to us about where you come from.


Alex B: [00:01:17] Hi there. So, I spent around 20 years working for three of the big four UK grocery chains, commercial roles pretty much exclusively and a very big focus certainly at a more senior level in private label sourcing. So, we worked extensively at both Tesco, Morrisons and as the Wal-Mart on how to maximize the return for the supermarkets on how you source a whole host of food and grocery and beverage. I then left the corporate world, set my own business up about four years ago, and my business, unsurprisingly, is focused on private label sourcing. So, I work with UK retailers, a retailer in the Middle East and a retailer in the Far East.


Catherine: [00:01:54] Thank you very much. So, two experts in their field, but coming to the topic from slightly different perspectives. So that’s going to really help us get to grips with this discussion. Now the cost of living crisis became such a topic for all of us. What kind of shape were UK grocers and suppliers actually in? Alex Smith Maybe you go first.


Alex S: [00:02:14] Well, talking from the supply side. The UK is a tough market to supply to whether you’re a big global branded manufacturer like a Procter and Gamble or a domestic private label, fresh convenience producer, like a Bakkavor or Greencore. Even if you’re able to eke out a little bit of volume growth, retailers are putting these companies historically under such severe pricing and therefore margin pressure that was even before the cost-of-living crisis came into play. But certainly prior to that, in a post-Brexit post pandemic world, complexities around the supply chain were beginning to kick in getting goods into the country, getting goods on shelves, labour costs, labour shortages. These are all basically causing inflation to creep into the system, perhaps even more than creep into the system. So, things were pretty tough before the cost of living crisis, but certainly a lot tougher now.


Catherine: [00:03:11] And we’re going to come on to some of the pressures that we’re seeing causing this cost-of-living crisis. But before we get to that, Alex Brown, you, as I said, come to this conversation from a slightly different angle. Talk to us from your perspective, what were things like before, before we find ourselves in a situation like now?


Alex B: [00:03:26] Yeah. So, from a retail perspective, about as competitive as the market’s ever been. So even before Brexit, even before the pandemic, you had a huge competitive landscape change with the big German discounters, Aldi, and Lidl, moving from very, very low market shares of sort of one and 2% if you go back ten, 15 years to starting to approach the similar share to the Big Four. So, Aldi potentially becomes one of the Big Four in the next six months. So, a huge change there and they are structurally cheaper than Tesco, Asda, Morrisons and Sainsbury’s. So that’s a huge impact on the market. Consumer behaviour has changed behind that. So, you’ve had a really, really difficult decade. And then to reference Alex’s point, you then had Brexit and then you had the pandemic. So very, very disrupted in terms of operating model for the retailers, particularly the pandemic, where we go down to the lockdown and how difficult it was to operate a grocery store and how expensive it was to operate. So very, very competitive, very dynamic market. And yeah, it’s just got even more so as the cost-of-living crisis as it started to come through.


Catherine: [00:04:37] So if we think about the cost of living crisis, I mean, how much has this been caused by a perfect storm combining COVID, Brexit, the war in Ukraine? And how much is that something we’re actually the signs were there if you were looking for that earlier on. Alex Smith, from your perspective, please.


Alex S: [00:04:53] I mean, from the supplier side, I wouldn’t even disaggregate whether the pressures are COVID, Brexit or Ukraine. And it’s not so much what the pressures are, but more the breadth and the magnitude of the cost pressures across the supply P&Ls. And it’s very different to periods, different periods of inflation that we’ve seen in the past, which are much more isolated. Investors have had to navigate in the past through a soft commodity period of price inflation or a dairy period of price inflation or even oil or energy. But these all had very different impacts on different company P&Ls, and they were not pressures across the whole P&L. So, there are a lot more manageable. What you’ve got now is ubiquitous inflation, almost a tsunami of inflation impacting everything across all these companies, whether it’s the cost of all raw materials, of packaging, of manufacturing, of distribution, admin, labour, you name it.


Catherine: [00:05:47] Alex Brown, from your perspective, how does it look from that side? Would you agree with this statement that there is a ubiquitous sort of pressure on both sides, the suppliers and the grocers?


Alex B: [00:06:00] I would. I mean, what you’ve historically seen from the retail side, so if you were a buyer and a retailer, you would kind of expect the big FMCG companies like Coca-Cola and Heinz to roll in with a relatively small price increase every year. And you would sort of manage that in the sort of standard way that you managed it. And there was some negotiation. Private label actually had been in quite a lot of deflationary periods, certainly through the middle of the last decade. So overall, you had a little bit of inflation to deal with, but it wasn’t huge. And then you’ve hit shock after shock after shock after shock, and you’ve now got particularly the Ukraine actually, I would say there was a very short period where the pandemic inflation, if you want to call it that, was quite difficult to manage but was starting to be managed. And then the Ukraine has been huge, and you couldn’t have predicted that, an unpredictable, and you’ve got to inflation levels now that are minimum low double digit and you’ve got some sectors facing 25, 30% inflation. We have not had to deal with that in modern times. And it’s everywhere. I don’t think there’s one sector talking to retail buyers across the spectrum where they’re not facing inflation.


Catherine: [00:07:10] I want to just for a second, broaden the picture that we’re painting out from the UK and see what it looks like elsewhere. I know that you both work and have dealt with companies not just UK based, but what are we seeing elsewhere? Is what we’re seeing in the UK unique, or does it actually fit very much with what we’re seeing in Europe and indeed globally? Alex Smith, maybe you go first on this one.


Alex S: [00:07:29] Yeah. I mean, I think directionally, the trends, what you’re seeing globally are very similar to what we’ve been discussing here in the UK. But I think it’s worth highlighting a couple of dynamics. One is the impact of currency, and the other is maybe not so much comparing the UK and elsewhere, but emerging market dynamics versus developed market dynamics. I mean, in terms of currency, operating outside of the US, I think people often don’t appreciate quite how much more of a burden the dollar appreciation has on your cost inflation basket in emerging markets, or even in the U.K. or in Europe. If you’re manufacturing in Europe or in Indonesia, let’s say, and you’re looking at a dollar chart of a commodity cost, that chart is going to look pretty scary. But if you’re looking at it in your domestic currency due to your local currency depreciation against the dollar, it’s going to look a hell of a lot more scary. And, of course, it’s in your domestic currency that you’re having to pass that cost onto your consumer. So, on that basis, an American operations or American companies aren’t immune to this by any stretch of the imagination. But you have a little bit more protection because at least you’re buying goods and selling goods in your own currency. The other dynamic is, is what’s going on really in emerging markets on top of that currency devaluation, you’re subjected to a greater risk of volume elasticity. You know, a lot of these grocery products that we’re talking about here in the UK are perceived as being very staple. But these are much more discretionary products in emerging markets and when prices go up, volumes get hurt significantly more. And so, if you look at a company like Unilever, yes, it’s UK listed, but it has disproportionate emerging market exposure. When prices go up or Unilever is hit by inflation, you tend to see more volume elasticity than you would with many other companies.


Catherine: [00:09:25] Alex Brown I know that you also work with companies internationally. The stories that they tell you, how do they compare with what you’re hearing from people in the UK?


Alex B: [00:09:34] It varies in terms of geography. So, in terms of I mean, I was talking to a buyer from Carrefour actually last week and it’s not dissimilar to the UK, it’s a big centralized market. They have the pressures of the discounters, but they have a lot of leverage. They’re quite sophisticated in the way they buy. The only difference is they seem to be taking a lot more pain on energy via the supply base because of their exposure to Russia or increased exposure to Russia. However, you go into the Middle East and the Far East, very different. So, I would say they’re taking it a lot quicker and quite a lot harder. So, the model typically for retailers in those markets and other parts of the world is it’s quite transactional. Prices are negotiated very regularly, and those prices are going up very, very fast and they are price takers. So, you’re seeing a lot of inflation going through to consumers. And then because of certain markets, again, know talking to a buyer for a retailer from Malaysia consumer, a lot of consumers over there don’t have credit cards, aren’t prepared to take on debt. So, if they’ve got less money, things are a bit more expensive. They substantially change their shopping habits. So, I would echo Alex’s point. The volume elasticity is much, much bigger than the UK. They will just stop buying things and you might see 20-30% volume fall. So, I think it’s more impactful elsewhere.


Catherine: [00:10:57] Thank you so much to both of you. Now, before we get into talking specifically about how suppliers versus retailers are dealing with some of these challenges, I want to spend some time talking about how the big four or the big five, as they might soon be, are affected by this versus some of the budget discounters that we see, but then also some of the high street discounters that are actually going more and more into food. Alex Brown, we spoke about when we were prepping for this call. Maybe you’d like to take the lead on this one to start off with.


Alex B: [00:11:23] Yeah. So hugely challenging for all of them. I mean, there’s absolutely no doubt about that. And you’ve got different dynamics across the different models. So, the traditional retailers, let’s that say the Big Four plus a few others are doing what you’d expect them to do. So, they’re making a lot of noise about price investment, price competitiveness. But at the end of the day, if the big FMCG players like Unilever and P&G and Coca Cola come in with big price increases, as we’ve seen in the press historically with certain retailers, they tend to force them through. And, you know, we’ve seen that was there was clearly a spat between Tesco and Colgate earlier this year, and there’s been spats between Unilever and so on historically. So, you’re going to have to see that inflation pass through because none of those retailers have got enough margin to substantially take on board those increases without passing on to consumers. You’ve got the let’s call them the limited assortment discounts. You’ve got Aldi and Lidl who have had a massive bounce in traffic. As we come out of the pandemic, consumers go back to them. They are pretty efficient buying machines. They are definitely taking inflation in the same way everyone else is. I think they’re taking a slightly more considered view, but they are passing on cost increases. So, Aldi were in the press raising prices on certain core food lines ahead of any other retailer. You would not have heard of that previously. And then the sort of third bucket for me is you’ve got three high street discounters, Poundland, Home bargains and B&M, who are all really moving quite hard into food and particularly into fresh food where they’re heartland, sort of been grocery before and to some extent alcohol as well. And they’re a bit more nimble. In my experience, they’re much smaller teams. They make decisions fast. There’s not a lot of bureaucracy. So again, it allows them to trade a little bit more aggressively, I think, than the traditional retailers and Aldi and Lidl, because again, they’re very regimented. So, the price perception for Aldi, Lidl and the high street discounters is better than the Big Four. So, you’ve got to presume that consumers are going to move some of their shop towards those discounters and that sector is going to outgrow versus traditional.


Catherine: [00:13:28]. I mean, the way that the different supermarkets are dealing with these price increases, do you think that is going to lead people to say, well, actually, do you know what, I was a loyal Sainsbury’s customer up until last week, but I think I am going to give Lidl a try. I’m going to give Aldi a try. Do you think that’s something that we’re going to see happening?


Alex B: [00:13:44] Yes is my honest answer. I think the penetration of Aldi and Lidl is pretty high anyway. I think there’s no stigma in being attached to going there. I think people avoided it in the pandemic because they wanted to go out once and do one shop, which was perfectly understandable. I’d say that’s largely gone. So, people are starting to shop around and equally Sainsbury’s, Asda, Tesco, Morrisons aren’t really opening shops, whereas you’ve got, let’s say the five discounters, Aldi, Lidl, B&M Home and Poundland all very publicly stating they are going to open a significant amount of shops over the next five years. By my reckoning, you’re going to have another thousand discount stores in the next five years in the UK and that is just logic dictates that it’s going to take some share and will interesting for me to see, I think there is still a bit of stigma about going in to say home bargains for some consumers, maybe the Sainsbury’s consumers. I think that will go. I think they’ll go in and I think they’ll see that actually it’s not a bad shop and it doesn’t have everything. It’s not going to replace your Sainsbury shop, but you might go and spend ten or £15 there rather than in Sainsbury’s, and that is going to slightly shift the market share dynamics.


Catherine: [00:14:52] Okay, thank you very much. Let’s move the conversation on now to talk about specifically how suppliers versus retailers are dealing with these things, these challenges that they’re facing. And I’d like to first focus on sort of how they’re actually managing those cost pressures. Alex Smith from the supplier side, what are we seeing? What are they actually doing to sort of, I guess, not just pass the costs onto the consumer but other, other sort of ways around it?


Alex S: [00:15:14] Yeah, sure. I mean, most of these companies will have multiple tools to play with, or at least that’s in theory. So, the suppliers will have very sophisticated procurement functions in place. And there’s an element of agility where they can move, where they saw supply around and of optimize where costs aren’t quite as steeply inflationary than they might have done otherwise. They all have ongoing savings initiatives in place across all functions of the different P&Ls, and they can always look to be more aggressive over those and bring some initiatives forward to help mitigate some of these cost pressures. They have what we call very clever, let’s say, revenue management initiatives. That’s really things like reducing pack size.


Catherine: [00:16:01] But we all notice that, don’t we? I mean, I do notice if there are fewer biscuits in that packet than they were before.


Alex S: [00:16:05] There’s an element as to how far you can push that. But consumers will be able to or will at least initially be prepared to pay the same price. It’s less difficult for them to accept the price increase. And, of course, there’s a low grammage associated with that, but there’s only so far how far you can push it. I mean, there have been instances, for example, when you have a package bar of chocolate, consumers can kind of see I’m still getting a bar of chocolate, but when they’re going onto the supermarket shelf and they’re picking up a bottle of shampoo and it’s two thirds full, two thirds full, that’s when the consumer does eventually ultimately begin to push back on that.


Catherine: [00:16:39] Yes.


Alex S: [00:16:42] But, you know, at the end of the day, as you said, there’s only so much you can do with all these various initiatives. When you have inflation to this degree of magnitude, there’s really one only option, and that is to go and ask the retailer for a price increase.


Catherine: [00:16:56] So let’s hear the retail side of the story. Alex Brown, please.


Alex B: [00:16:58] Yeah. So, look, some similarities as you would expect. All of the retailers will have a sort of buy for less cost management initiatives across the whole business. They’ll be looking very carefully at their stock holding. And I certainly noticed that in certain retailers that their stockholding is definitely gone down. The sort of semi obsession with it looking it perfect is nice, but when things are tight you maybe compromise a little bit. There is an element of shrinkflation where they’ll manage the pack sizes down, so I’m not going to be surprised if, you know, packets of frozen chips that were a kilo or suddenly 900 grams and things like that. But you’re absolutely right, that does become noticed. And you will see some sort of volume play sometimes on that. The other big tool that the retailers have got is there’s quite a complex P&L. If you take an average, let’s say Asda, it’s got 20 to 25000 products in there. Some of those products drive massive price perception. So, milk, bananas, bread, core meat lines, other product lines, you know, customers do understand the price of that, but there’s a huge tail of products that you don’t buy that frequently. Soy sauce, a cooking sauce for chicken. You might buy every third or fourth shop. And I think you’ll definitely see pricing start to go up on the tail because it’s less impactful to the way customers perceive you. So, there’ll be some very clever and they vary a little bit, but they all have pricing teams and they’ll all be looking at this. I mean, I used to run the pricing team at Asda and at Morrisons and in periods like this it’s like, right, where do you hold your pricing irrespective of where you’ve taken costs, where do you hold your pricing to perception and where do you let it go. So, there will be a lot of work. So, there’ll be a lot of work on that. And then the final point is there’s a huge amount of spend on promotions, and I have definitely seen that come off. And you saw that Christmas before this had even really started to motor big marquee promotions, particularly on alcohol and meat. So, the two biggest ticket items were hugely down weighted from previous years.


Catherine: [00:18:56] Going back to the comment that you made about the product offering that we see, do you think there’ll be situations where some things will just be taken out of the out of the assortment? And actually, you know what a company will say, we will not be selling X, Y and Z anymore because there’s actually not that much money to be made out of it. Do you think that will happen?


Alex B: [00:19:12] Yes, I do. But that was happening before. So, because Aldi and Lidl carry three, 4000 products and a typical supermarket circa 20 to 25, and there’s some reasons for that, but you get a lot more choice in the supermarkets and they’ve been kind of chasing down that route for quite some time. I think they’ll accelerate it. There is some risk in that way because one of the reasons you go to Asda rather than Aldi is you can get a broad range of product. So, I think that needs to be a little bit of balance on that. But they will definitely continue to reduce the number of products that they offer.


Catherine: [00:19:48] As someone that suffers from choice anxiety, every single time that I go into supermarket, not entirely certain that’s such a bad move, but that’s maybe just me and my quirkiness. Let’s talk about sort of the negotiations between the suppliers and the retailers. How is that done? What are some of the challenges? And who’s actually in the stronger position when it comes to that? Alex Smith Do you want to have a go at that one first?


Alex S: [00:20:10] Yeah. I mean, I think from the experts that we speak to, from a supply side perspective. You know, it’s ultimately getting yourself to the negotiating table. So, suppliers will come armed with a bunch of commodity price charts, a whole lot of data analytics around elasticity, reaction to volumes. And they will say all the data we have; we are experiencing X amounts of commodity cost inflation. We need to pass this on with a X dollar increase in the price that we sell to the retail and ultimately to the consumer. That opens the door for the retailer. And my understanding, Alex would probably be able to talk a little bit more about this, but you can understand from their perspective, they will say, well, actually our data shows some very different dynamics at play here. We think the inflation that you’re experiencing is considerably less, but that forms the basis of a negotiation. And then ultimately it comes around to who has a stronger brand power, where the elasticity is going to be less, and those that are in that relatively stronger position will be more successful in their negotiations with the retailer.


Catherine: [00:21:19] I’d like to come back to this point of the elasticity and the pricing, but before that, Alex Brown, maybe from your perspective, where do you think the strength lies? With the suppliers or with the retailers?


Alex B: [00:21:298] Yes, it’s quite interesting at the moment. I think the big guys, the big FMCG’s and equally the big fresh providers, I think Alex mentioned Bakkavor and Greencore. You know, they are pretty integral to those supermarkets operating. So, whilst there absolutely will be negotiations and everyone will have different data points. Times when things were locked, all of that discussion will go on. They do have to come to a conclusion. So, the balance of power is pretty finely balanced in a lot of those relationships because ultimately when either party goes too far, it tends not to work and there’s many examples of that. So, I haven’t seen things disappear from shelves in any kind of measure. So, I think most people are trying to work through a sensible way of doing it. And again, it’s not it’s not just my prices going up 10%. Players like P&G will come in and say, look, I need a 10% increase. But actually, if you could list a few of these other products that I have that make me a bit more money. And if we could change some promotional mechanics and I spend a bit less on your online platform, etc., etc., I can make that 5%. I’m making the numbers up. But the principle is correct. What I’ve noticed is very different this time is the small to medium sized private label suppliers, who would typically have had very little leverage are being quite binary in quite a lot of examples now because the cost increases they face are so high that quite frankly, if they don’t get the price increase they need, they’re going to go bust. So, there’s a bit more take it or leave it from the smaller suppliers than you would have seen historically out of necessity. So, I think that that’s a change.


Catherine: [00:23:01] But what happens if you say take it or leave it and they say, thanks, we’ll leave it, where do they then turn?


Alex B: [00:23:06] Well, exactly. And this is the sort of this is where the supermarkets have leveraged very cleverly over the years, because often they don’t have anywhere else to turn. Certainly, in the short term and certainly on private label, because you can’t just turn it on from someone else. But I mean, I was talking to a supplier of sort of table sauces and condiments, and they have stopped with a couple of retailers on a product they buy from the Far East. So, the lead time is about four months. So, you are going to start to see some gaps on shelves and the retailers will have to fill that with a branded product in the short term. You know, the more sensible retailers and I’m actually hearing anecdotally that Aldi and Lidl are among the most sensible because they just can’t be off sale of private label because it’s all they sell. So, whilst it’s not an easy negotiation, I think there is a level of realism from most of the retailers and obviously the media helps, right? Write every day. There’s more evidence that says the price of this has gone up. The price of this has gone up. So, it’s by no means easy. But I think price increases are going through a bit more pace than you would historically seen because of the scale of the issue.




Catherine: [00:24:26] Okay. Let’s come back to this topic of the elasticity of pricing. Do you see any variance between the different categories there? Alex Smith.


Alex S: [00:24:54] Yeah, for sure. I mean, I think where you have goods that are deemed essential, relatively affordable, will tend to be more resilient and have stronger pricing power. I mean, I’d bring something like infant nutrition into the discussion. You might have trading down within the infant nutrition category, but the category itself, the volume should be pretty resilient. On the flip side, categories which are seen as a little bit more discretionary or where the value in that category or product is less apparent to the consumer, the consumer will just tend to walk away. You know, historically, something like functional yogurts, for example, in Europe has been a notorious category for when pricing goes up. Consumers just move away from the category.


Catherine: [00:25:47] Just for the non-experts experts, functional yogurt? Is that like just a plain yogurt?


Alex S: [00:25:51] I would say it’s something more like an Actimel or an Activia where the functionality is perhaps not quite clear to the consumer. It’s not immediately apparent necessarily. And you know, when times are good, you give the proposition the benefit of the doubt. When times are tougher, you just let it go.


Catherine: [00:26:12] Okay. That makes sense. Alex Brown, from your perspective, come back to this issue of the elasticity of pricing.


Alex B: [00:26:19] So there’s massive variance across category subcategories, even subsub categories. But I mean, a good example for me is if you go into any of the supermarkets at the moment, the price of beef mince has gone up as the price of cattle has gone up. That is a staple. The consumption of beef mince will continue to be broadly the same, maybe even a little higher because it is a staple protein, is pretty healthy. It’s a massive volume line. Steaks are a luxurious item for almost all consumers, and I have rarely seen as many steak promotions at the moment because it’s such an immediate market. You can’t store this stuff for months and months and months. It’s coming at you every week. I was in Morrisons the other week and they had three steaks on promotion, which are phenomenal value because I think consumers are looking at their spend. Back to the yogurt example. Well, I can’t just get by with a basic yogurt. I don’t need to buy a protein one or this one or that one. So, I think all the supermarkets will be working hard to manage that mix because often those more discretionary items, those more impulsive items are higher margin items. And again, that becomes a bit of a challenge for the retailer P&L, how you manage that, because staples like bread and mince and pasta, there will be some trading around inside those categories, but the volume will be very steady, possibly even a bit higher as people stop going out to eat.


Catherine: [00:27:45] Let’s talk about some of the winners and the losers across the system. Are there some players that you’re seeing out there that you think actually they are, whether on the retail or on the supplier side, some that you say, do you know what, they’re managing this really, really well. And there are others out there where you just like slightly exasperated when you look at how they’re performing right now. Alex Smith, please.


Alex S: [00:28:06] Maybe I’ll talk a little bit about it from a category perspective, and perhaps ultimately, it’s where they might not be seeing such great inflationary pressures. I mean, companies that are in a relatively better position are those that are exposed to categories with just naturally higher gross margins, where the cost of what you’re buying is relatively less to the price that you can command to the consumer, that just gives them that little bit more wriggle room around managing your P&L. And, you know, the likes of, I would say premium spirits are relatively immune, premium beauty relatively immune. And the other thing to take into account with spirits as well is particularly premium spirits. Where you have an aged liquid, you’re able to smooth the cost inflationary impacts over a significant number of years. So, you know, and then I guess if you’re talking about a premium product as well, you’re not in this situation where you have a squeezed consumer having to look for bargains. You’re probably catering for a consumer where the cost-of-living crisis is not going to impact their buying decisions. So, to answer your question, I’m coming at it more from a category perspective, things like premium beauty you want to have exposure to premium spirits will tend to navigate these cost inflationary headwinds better than, let’s say, beer or soft drinks if we’re just focusing on beverages.


Catherine: [00:29:33] Okay. Thank you very much, Alex Brown. Does that sort of tally with what you’re seeing as well?


Alex B: [00:29:37] I mean, a short-term loser in this market is the private label suppliers, because the supermarkets will end up paying, I would say, in the main, the right price eventually. But they always delay, they always negotiate, push it. So short term impact hits the supplier because they tend to have to buy the raw material and the same terms and then they get paid a bit slower in terms of the increases. So, I think some of the big private label suppliers will have a short-term issue, but they’ll recover in terms of retail. You know, I mean, you can look at the market share data and there’s so many different dynamics going on because some people massively over traded in the pandemic and then they went down and then they went back up again and now they’re down. I mean, in the latest read, unsurprisingly, the discounters are winning market share or all five of them broadly. And most of the traditional retailers are losing share with the, I’d say, very notable exception of Tesco. So, I would say the out and out winner for me really is Tesco. They’re the number one, and they’re winning share and they’re both by far the biggest player in the market. So, for them to win share in this in this environment, is pretty impressive for me. So, I think they’ve done incredibly well. But it’s early days, right. And, you know, year on year comparisons and market share are not the only way to judge it. But I think their sales performance top line is good. Their bottom-line performance is good, and they’ve already positioned the market. This year is going to be tough, and they might make a little bit less money. So, they for me are probably the standout because you would expect the discounters to do well and continue to do well through this market. 


Alex S: [00:31:10] If maybe I could just add one quick thing on top of that. The supplier base, as you know, is incredibly fragmented. But if there’s one rule of thumb in this environment, scale really helps. So, the bigger you are, the better. As a branded supplier, you can emerge through this stronger. You just have that stronger balance sheet.


Catherine: [00:31:29] Now, Alex Brown, you did talk about some of those private label, smaller players that sort of take it or leave it and actually leaving it is actually not an option for them. If you think about the pressures on some of these businesses, is your expectation that we will see some consolidation going on there and maybe the next months and years to come?


Alex B: [00:31:46] Absolutely. I’m already seeing small branded suppliers, you know, relatively youthful start up branded suppliers. Some of them are going under already because they typically don’t make money anyway to get going and try and build their brand. They probably don’t have the best supply chains either. They just have a nice brand and a lot of hard work and effort. But I see numerous companies come across my desk in terms of that. You can tell they’re about to go into administration, so there’ll be some casualties there. In terms of private label, there will be some consolidation. I don’t think there’ll be huge amounts of casualties and I do think the UK, as opposed to most of the markets in particular Europe, there is pretty, pretty reasonable protection in terms of the government rules. So, there’s a grocery code of practice about behaviour. That’s been in place for a long time. Every buyer’s trained on it. The board are all aware of it. And I’m not saying the supermarkets are nice and cuddly now and they used to be horrible, but they are a little bit more responsible in terms of their behaviour, particularly for primary producers. So, you know, farmers and you’re seeing a huge amount in the press at the moment of I think every supermarket has now come out saying we’re going to support the pig farmers with extra this extra that they need to because they’re all losing money. But that will lead to some consolidation because you’ll have people either dropping out of the industry because they’re of an age and they’re thinking, I can’t make any money out of this. Why would I do it? Or they get into financial difficulty, and they become an opportunity. And I agree with Alex’s point, if you’re a scale player with a strong balance sheet, you’re going to get some really good opportunities over the next 12 months to expand your business.


Catherine: [00:33:17] Okay. Thank you very much. Alex Smith, you had some interesting points around sort of the profile of the businesses that we could see coming to market, or leading sort of the consolidation.


Alex S: [00:33:25] Well, I think, you know, to Alex’s point, when companies P&Ls come under duress or their cashflows begin to come under stress, it certainly in the past it’s acted as a catalyst for consolidation. And certainly, the experts that we talked to think this is going to be a continued ongoing trend. I think, you know, the day of the megamerger, we’ve just had so much consolidation across some of these larger branded suppliers, whether that’s food, home, personal care, beverages, those days are probably less so. But I think to Alex’s point, these large consumer goods, their portfolios have not really been consumer on trend. They’re looking to where they can acquire some of these upstart companies which get the consumer better. And the fact that a lot of these small companies just don’t have the balance sheet to cope with this inflationary pressure, whereas in the past, they might have commanded an unappealing valuation for the likes of a Nestlé or Unilever to acquire these businesses. I think this cost-of-living crisis will act as a catalyst for an accelerated acquisition program from some of these big companies. The only other thing I’d point out is could this actually delay potential break ups of some of these large conglomerates? You look at a company like Unilever, there’s a lot of agitation that Unilever should break itself up across its different categories. But clearly, in in this period of significant inflation, having that scale will be beneficial. And there’s a pretty strong case for Unilever to keep itself together right now.


Catherine: [00:35:04] Let’s move on to looking at some of the businesses operating in the space. Alex Smith. Would you say that there is one to watch one company out there that particularly stands out for you in the sector?


Alex S: [00:35:16] I would think Kraft Heinz, the US listed food company is a pretty interesting one. Right now, what they do, the clue is, is obviously in the name, but this is a company that has an excellent track record in terms of cost efficiency and improving margins, but a much less strong record in delivering organic volume growth. We’ve got a turnaround in place. We have new management. It is perceived they are becoming a much more consumer centric company. But then, of course, we now have this wave of inflation coming through. From the conversations we’ve had with our numerous experts, the concern they have is Kraft Heinz is unbelievably aggressive on price increases. They are pricing ahead of inflation and ahead of their competition. And whilst they’re seen as being doing a good job in terms of managing cost pressures right now, the concern over the next 12 months will be what happens to volumes and volume market share, particularly as prices might still have to keep going up. Either they’ll have to dial back some of that that that price increase to maintain their volume or volumes fall off a cliff. And all of a sudden that that turnaround, which is looking so good not so long ago, people will begin to see to consider how credible that is.


Catherine: [00:36:35] Alex Brown, do you want to give me one from your side of the spectrum?


Alex B: [00:36:40] I think probably the most interesting one to watch at the moment in this space is Home Bargains, which is a private business. They have stated ambitions to get to 1000 shops. I went into one of their new concept stores near their head office a couple of months ago, and it was like going into a supermarket. It was clean, pretty much a full range of food. You have brands like Warburtons in there, a pretty good fresh food range. It had a café; it had a toilet. All the reasons that are given why you go to a supermarket rather than discounter. And I don’t know if that’s a format they’ll roll out hugely, but because it’s private, there’s not really any debt. It’s one individual running it. And I think they’ve got a very good model split between food and non-food, which makes them hugely profitable, and they haven’t really expanded into the South. They have some stores, but their new depot is in the South and that is clearly going to fund and be the platform for growth. And I I’m always interested talking to the more traditional retailers. They never talk about them, which kind of feels like Aldi and Lidl 15 years ago, where’s it like we won’t talk about that because they’re not a threat. So, I think that’s probably the biggest growth potential in the sector as it stands now. There is a risk to that, though. It is run by one guy and he’s not getting any younger. So, I suppose there’s a bit of succession there, but I think they’re a pretty impressive retailer and they are grabbing a lot of food share at the moment off a relatively low base. But all the same, it’s significant.


Catherine: [00:38:08] Let’s move on now to talk specifically about dealing with the cost-of-living crisis. Alex Brown, I think from your perspective, how do you think the shopping baskets are expected to change over this in the coming months?


Alex B: [00:38:22] So look, I think the obvious thing is that people are going to be much more aware of what they’re spending. And I think that’s across all demographics. This is not just that. If you’re very, very tight for money, of course, you’re going to be very focused on it. I think everybody is because it is literally all the media talks about. So, it’s so front and center. So, what you’ll definitely see is people shopping around a bit more. I think there’s definitely going to be a bit more of going back to that pre-pandemic shopping in multiple locations and spending where you think the spends most appropriate. So, I think if you take out most people don’t do their full shop in Aldi as in that’s the only place they go. But I think they’ll do a bit more of their hop in Aldi and then go and top up in a more traditional retailer with brands because almost all UK consumers love brands and then within the basket in the shop, I think people will review to some extent, but I don’t think it’s going to be as seismic as some commentators are saying. You know, at the end of the day, food is still a very small part of household expenditure versus what it used to be. What we saw in the last recession was people stopped eating out and actually started in some cases spending a bit more on their grocery shop. So M&S launched their dine in for two for a tenner in the last recession and did fantastically well. Because let’s be honest, if you if you decide you can’t afford to go out for dinner on Pizza Express, whatever, on a Friday night, you’re not going to go home any in economy bowl of pasta. You want something that’s cheaper than the restaurant but still makes you feel good is a bit of a treat. So, there’ll be some interesting dynamics that play out, I think over the next year or two where actually some of M&S and Waitrose might do quite well because people will go and treat themselves because they’re not going out as much. So, I think there’ll be a huge amount of shifting, but it’s not going to be ten, 20%. I think there’ll be marginal percentages, you know, private label. There’s a lot of talk about private label becoming a much bigger part of the spend. I think in the last recession it went from 49% to 51%. It’s big in the industry, but it’s not suddenly 60, 70%. So, I think that will be a similar thing. The only caveat I’d give to that is if energy prices continue to rise and interest rates, then you might have such a level of inflation that there is a seismic change in consumer behaviour. But I think we don’t know that that’s the case at the moment.


Catherine: [00:40:39] Do you think the frequency with which people will shop? So instead of doing the sort of on my way home to from work, I will nip into my Tesco’s Extra and just pick up whatever I would like for dinner that evening versus I will actually meal plan and I will go to the supermarket on a Saturday once a week and do it for the entire week. Do you think that sort of pattern will change?


Alex B: [00:40:59] I think it varies a little bit in terms of where you live in urban versus outside of the big cities. No, I actually think frequency might slightly increase because people that have time and what we tended to find when we researched this, people didn’t really put a value on their time. Some people did, but a lot didn’t. So actually, if I can shop around and I don’t have to drive too far because clearly the cost of petrol is pretty expensive. If I can get around my local town and do four shops and save five or £10 because I’m shopping the best deals and maybe going to a discount. I think frequency will continue to be quite high?


Catherine: [00:41:34] Okay. Now let’s wrap up our podcast with a bit of an outlook on where things are going, some of the challenges and the changes that we’ve seen in the industry. Do you think those are going to be permanent shifts? So, are we going to see people maybe spending a little bit more time on own label goods? This frequency of shopping that we’ve spoken about, the relationship and how it’s changed between suppliers and retailers, some of those things, will they stay? Is that something just the new landscape that we’re dealing with? Alex Smith, from your perspective.


Alex S: [00:42:05] I think it’s more of a short term cyclical impact despite the severity of it. I think we’ve been through less significant periods of inflation, but at the end of the day, the dynamic is pretty similar. We turn to a more stable input cost environment. We might have permanently higher prices than we had in the past, but consumers will ultimately effectively adjust to those prices. So, I think the cost of living crisis will pass, but it’s more about the impacts of the pandemic, I think, which would be longer lasting.


Catherine: [00:42:40] Alex Brown, from your perspective, how permanent are those changes going to be?


Alex B: [00:42:46] Not permanent. Absolutely not permanent. So, tracking the commodities that are driving this change in food and these percentages, they will come back down. They may not come back down to where they were previously, but they may, and they may even go below that. And I can guarantee you from a retail side that every retailer has got a very accurate record of exactly what price increases they’re giving and what they’re giving them for, because, again, a slight change is because the increased percentages are so high. All retailers really are saying, give me a breakdown, what’s commodities, what’s packaging, what? And that is in the book. And when that comes off the other side, which it will, they will be back for the price decreases. And I think for the first time in a long, long time, they’ll be chasing the big brands. The price decreases when we get over the hump and start coming down the other side of the hill. Okay. How long it lasts, I think is actually very, very dependent on the Ukraine more so than anything else right now because the impact on 


Catherine: [00:43:48] More so than Brexit?


Alex B: [00:43:49] Yeah, I think Brexit is kind of baked into some extent now. Labour shortages, we kind of know what that is and that would already getting worked through. What you’re seeing is huge commodity shocks, energy and food, soft commodities and it’s when those recover. So, when they come back down, I think you’ll see and you will see massive investment from, I think both the supply side and the retail side as they’ve got the ammo to start really punching it to get consumer confidence back, get them back into the brands that they love, the shops that they love. So, and I think that’ll be quite an interesting time because you’ll have a kind of flip side dynamic of what you’ve got at the moment where the retailers will be chasing price decreases and the suppliers will be desperately trying to hold on to the increases they’ve got. So, I think that’ll be a fascinating period.


Catherine: [00:44:35] I can tell. I can tell. As a final thought, can you give us a snapshot of what this space could look like in 5 to 10 years? Alex Smith maybe you go first?


Alex S: [00:44:45] Well, maybe I’ll provide an analogy here. L’Oréal is targeting 50% of its sales to be online. There’s no specific time frame, but let’s assume it’s between three and seven years. Now this was considered unthinkable prior to the pandemic. You know, big branded FMCG supplies were very much behind the curve in taking their business models online. Just the economics didn’t really stack up. Consumers weren’t prepared to embrace it. This is has really changed with the pandemic. And I don’t think anyone really knows where online penetration will level off. And it’s going to vary category to category. But clearly in 5 to 10 years from now, a lot more of these categories will be sold online.


Catherine: [00:45:32] We’ll keep an eye on that one. Alex Brown, from your perspective.


Alex B: [00:45:36] Yeah. Look, I would echo, you know, we’ll trade through cost inflation. We’ll trade through cost deflation. You’ll see some consumer dynamics change around things like health, which continues to become a bigger, bigger part of the shop and a bigger focus for consumers, obviously, as generations kind of roll through and become the young families of tomorrow and a bigger part of the spend. I would agree the big change is the online change. So, you saw a doubling of penetration through the pandemic for grocery where it went sort of six, 7% to nearer 15. It fell back a little bit, but it’s still on a big growth curve. You’ve clearly got Amazon making a play for food grocery, but they are now covered by the code of practice because they’re turnovers now big enough. And I think younger consumers are so used to this as a way of shopping, whether it’s the instant delivery or the Tesco shop online through dot com. And I think what you’ll see, and this is quite interesting for the discounters because none of the discounters really play in the dotcom space, it is dominated by the traditional retail and they do an amazingly good job I think on the whole. I think you’ll see shops will start to change pretty radically. So, the days of 100,000 square foot Tesco extra, for me it will be history because categories like clothing and general merchandise will be majority online. You just don’t need the space in store. Categories like fresh meat, fresh produce, people will still want to come and shop those to some extent. And I think a lot of those retail stores will become a blended unit, which is part retail store and part dark store or part fulfilment center, which I think is a very good model for the supermarkets, because that last mile delivery is where it’s difficult to make money or not lose money, and I think they’re really well placed for that. But there will be winners and losers in that.


Catherine: [00:47:23] Yeah, absolutely. Listen, guys, thank you so much for sharing all your insights, your expertise with us today. Unfortunately, that’s all that we have time for. Thank you so, so much to all of you listening to this week’s episode, The Signal presented to you by Third Bridge, the world’s leading independent research provider. 

Join us again for the next episode when we will be discussing more upheaval in another key investment industry. Please rate review and follow our podcast. Indeed, if you like it, tell a friend. Find us on Spotify, Apple Podcasts or wherever you get your podcast from. And of course, third From me Catherine Ford, that’s it. Thank you and goodbye. 

Key Takeaways

  • While the day of the “megamerger” among larger suppliers has passed, our panellists said more consolidation could be on the cards, especially at the private label level
  • Recent data shows that discounters are “winning market share” while traditional retailers are losing share - with the “notable exception” of Tesco
  • The continued rise of German discounters Aldi and Lidl could push Aldi into “big four” territory in as little as six months

Episode Guests

Alex Smith

Third Bridge’s Global Sector Lead for Consumer

Alex Brown

CEO at Baleigh Investments