Lidls wage hike could put pressure on competitor margins

Lidl's wage hike could put pressure on competitor margins

A consistent challenge facing grocers is maintaining – or strengthening – margins in a frequently hostile retail environment. This must be achieved while also developing the customer proposition and investing in growth. Keeping a lid on costs is a must but that has to be balanced against issues like pressure to raise wages, as we have seen in the UK this month and the need to keep consumer prices low. 

Retail "living wage" in the UK
German discounter Lidl became the first UK supermarket to introduce a "living wage" based on guidance from the Living Wage Foundation in September. The company said that it will raise basic pay to GBP8.20 (US$12.50) per hour, or GBP9.35 in London, up from GBP7.30 and GBP8.03 respectively. 

The National Living Wage, which is being introduced by the UK government, will be set at GBP7.20 per hour from April but Lidl said it had based its increase on expected recommendations from the Loving Wage Foundation, due to be delivered in November. 

Commenting on the move, Lidl UK CEO Ronny Gottschlich said the company was increasing its investment in its workforce following a "record" year for the discounter, when sales totalled GBP4bn in the country. "Lidl employees will be amongst the best paid in the supermarket sector," he said. 

Lidl is investing GBP9m in raising wages. However, as the company continues to grow sales and market share in the country the impact on margin could be somewhat mitigated by higher volumes. At the same time, pressure is being placed on its competitors, who are not growing sales volumes, to follow suit. 

Morrisons and Sainsbury's have both raised the remuneration levels for their shop floor staff. In August, Sainsbury's gave shop floor staff a 4% pay rise to GBP7.36 per hour but stopped short of committing to paying the living wage as defined by the Living Wage Foundation. Morrisons went a step further when it said this month that it will pay GBP8.20 an hour from a previous minimum of GBP6.83. Morrisons said it is investing more than GBP40m in the move. 

Tesco, which pays GBP7.39 an hour, has warned the living wage will cost it GBP500m by 2020. In this circumstance, it will be faced with a choice: lower base margins, reduce staff numbers, or raise prices to customers. At a time when Tesco's shares are still reeling from the accounting scandal and already plummeting profits, adjusting Tesco's margin structure would be a bitter pill for shareholders to swallow. But the impact on customer service of lower staffing levels or the prospect of raising prices are not going to prove popular with consumers who are already deserting the country's largest retailer in their droves. 

Tesco sells Homeplus 
Tesco took a significant step towards righting itself and rebalancing its balance sheet last month when it struck a deal to sell its Korean Homeplus chain to a consortium led by MBK Partners for GBP4.2bn. 

The UK retailer said it would receive around GBP3.3bn in cash after tax and transaction costs. Tesco’s overblown debt pile, which stood at GBP8.5bn in February, will be cut by GBP4.2bn as it will save on lease costs at its Korean stores. 

However, the supermarket will also lose GBP150m in annual earnings from the Korean business – making the contribution of the UK business to the bottom line all the more significant. As Shore Capital analysts noted: “The corollary of the Homeplus disposal is that Tesco reverts back to the future; the core chain in the UK standing for an ever greater proportion of sales and EBIT... We believe the key to unlocking Tesco’s potential has always been and remains in securing the UK business and delivering achievable EBITDA on a sustainable basis. At present there is a considerable amount of work ongoing to secure such sustainability, although we believe trading remains subdued.”

Weak UK sales trends and pressure to maintain margin make the debate over increasing wages for low-paid workers all the more pertinent for Tesco. 

Wal-Mart cuts 450 jobs 
On the other side of the pond, the pressures on retailers are similar. In the US, Wal-Mart revealed it will cut 450 head office jobs in a bid to keep prices low and following wage hikes for shop floor staff earlier this year.

The retail giant raised the wages of more than 100,000 store associates – many of whom are in managerial or specialist areas of the stores such as the deli counter – this summer. The increase followed on the back of a February rise in Wal-Mart's starting salary to US$9 per hour, with plans to increase this to $10 next year. In the US, a campaign for a minimum wage of $15 per hour is gathering steam. 

Wal-Mart's sales in the US have remained sluggish in recent quarters. In a bid to lift its top line trajectory, the company is increasing investment. The company said this month that it will hite more seasonal customer service staff over the key Thanksgiving and Christmas periods. The group is also investing in establishing an online presence in order to compete with the explosive growth of Amazon, moving its home delivery service into new markets and opening new distribution centres. Head office job cuts will go some way to offset higher spending in other areas. However, Wal-Mart will be hoping that a more competitive proposition will boost sales volumes, with a knock-on positive impact on margin. 

Whole Foods Market job cuts 
At the other end of the retail spectrum in the US, upscale grocer Whole Foods Market revealed that it will cut 1,500 jobs, or about 1.6% of its workforce. 

In a regulatory filing, Whole Foods revealed that the cuts are targeting lower costs as it raises its investment in slashing prices and upgrading its technological platform. The company is also investing in the launch of a smaller, value oriented format – 365 by Whole Foods. 

Walter Robb, co-CEO, said: "We believe this is an important step to evolve Whole Foods Market in a rapidly changing marketplace."

Whole Foods is struggling to shed its reputation for being overpriced. Whole Foods has been tied up in a scandal this year after New York trading standards regulators accused the retailer of charging too much for pre-packaged foods. 

The company is also struggling with increasing competition from conventional retailers in the natural and organic space. Kroger's Simple Truth organic line, for instance, has hit sales of over $1bn and the supermarket's success in the field prompted JPMorgan to suggest that Kroger could overtake Whole Foods' organic sales within two years. 

Kroger's roll continues
And its not just in organics that Kroger is seeing success. The supermarket group again defied the down US grocery market to report another impressive quarter in September, with 5.3% same store sales growth. 

With traditional grocers losing share in the US since the mid 1990s, Kroger's performance is testament to the group's sound strategy, which has leant on club card data and the group's relationship with Dunnhumby. According to Athlos Research analyst Jonathan Feeney, most importantly Kroger has "accepted the implications" of changing consumer behaviours and acted on this with "heavy capex while radically lowering gross margin (circa ten points or 50%) since 2000". In other words, Kroger's strategy is simply to "sell more groceries" even at the expense of margin. 

Feeney suggested food makers struggling to adapt to changing US consumer patterns could take a leaf out of Kroger's book. "Changing consumer trends have today's US consumer staples companies at a similar crossroads to that faced by traditional grocers in 2000 - and its no less shocking than it was to traditional grocers back then. While food, beverage & HPC companies are naturally better, higher return businesses based on their ability to generate repeat, habitual behaviour among consumers -- we think that's all the more reason the ultimate answers will be similar. Sell more of your core products even at cost to today's earnings."