MHP Retail Report July 2011

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

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

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 Cuts to the
deficit. The success of the programme to cut the deficit will hinge on deficit
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 UK General
Westminster’s centre-right coalition to last the course. It is certainly not in Election due by
the Lib Dem’s interest and in particular those of Nick Clegg’s to leave the 2015
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.

Scotland went to the polls on 5th May, and voted in a majority SNP Scotland –
administration in a landslide victory for the Nationalists – the first of its kind. Election May
The clear result should provides some clarity for retailers in Scotland in the 2011
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 ‘Tesco’ tax
of retail stores but this never made it into the Budget at the end of the last dismissed
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 New tax powers


Commission on devolution, is likely to have a significant impact on the future for Scottish
tax system in Scotland. Key provisions in the Bill include increased tax-raising Parliament
powers (including the ability to set a new variable rate of income tax) for the likely
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.

The European Parliament elections will be held in 2014, at which point new EU – European
Commissioners will be appointed. Observers do not expect the direction of Parliament
policy on key issues such the Working Time Directive and the single market elections in
to alter dramatically. 2014

Fiscal policy

Ministers in London hope that the effect on retailers of the recession and Corporation tax
public spending cuts will be offset to some extent by tax cuts. Having lower than
previously announced that it planned to cut the corporation tax rate to 24% expected.
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 VAT expected
next two to three years. However with an election in 2015 the Government to remain
may well think it would be expedient to announce a small reduction in the broadly the
run up to the Election and therefore we expect that a small reduction will be same
announced by the Chancellor in the 2014 Budget.

The Coalition hopes that these measures will help businesses grow even in No reduction in
the tough economic climate. However, the Government has little room for business
manoeuvre. Indeed George Osborne has said that “a significant reduction in taxation
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


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 Impact of
environment, shifting limited planning powers to local government and localism agenda
communities. uncertain

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 Power to
Localism Bill, communities will be given a new right to draw up a designate the
‘neighbourhood development plan’. As such, communities that take the desired retail
opportunity to organise forums are likely to have the power to designate the mix
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 Community
an approved development contradicts the parameters of an existing right to appeal
neighbourhood plan.

However, it is important to note that ‘neighbourhood development plans’ will Localism Bill yet
only exist where communities initiate the process. More specifically, they will to be passes
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 Local councils
retailers, some of whom may benefit from neighbourhood plans which to take health
prioritise independent stores. Conversely, larger retail chains may find that into account
the planning process becomes more challenging, as communities use their when making
new powers. 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 Minimum
bring in minimum alcohol pricing in the Alcohol Bill 2010 failed. However, we alcohol pricing
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.

Red Tape
The Government recently chose the retail sector for the first in a series of Sunday trading
“Red Tape Challenges” aimed at cutting unnecessary regulations. The public under scrutiny
are being asked for their views on consumer information, restricted goods,
weights and measures, trading requirements and Sunday trading.


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 Government
every four months on the six cross-cutting themes across the campaign, aims to reduce
covering: employment law; pensions; company law; equalities; health and ‘burden of
safety; and environment legislation. If the Government achieves its aim, in regulation’
theory retailers should enjoy a reduction in regulation, however in reality the
impact is unlikely to be of any real commercial significance.

Next 3-5 years
Utilities

Utilities policy is the area with perhaps the clearest commercial risks and Energy
opportunities for retailers, starting with energy. Most large retailers are performance
currently required to display energy performance certificates and the certificates
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
users and providers of energy, a move that will be warmly welcomed by providers of
Government. Large retailers will increasingly take advantage of the energy
commercial opportunity to sell energy back to the grid.

As Paul Polman, CEO of Unilever, said last year, “those companies that wait Carbon
to be forced into action or who see it solely in terms of reputation Reduction
management or CSR, will do too little too late and may not even survive.” Commitment
Those who are ahead of public policy and maximise the reputational benefits data
of such achievements are likely to offer a good return on investment.

To take just one example, the data regarding the Government’s Carbon Partnership
Reduction Commitment, aimed at non-energy intensive industries such as 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 Sustainability
long-term competitiveness. There are real potential benefits for retailers that at heart of
are prepared to take the lead and who will clearly get prime mover competitiveness
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, Water
amongst other environmental issues, is enormous. This means that retailers ‘footprint’
and investors need to anticipate the future direction of policy both at a labelling on the
national and international level. Building on schemes such as the EU horizon
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

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 EC Retail
retail services in the internal market for 2010’, was adopted by the European Market Services
Commission (DG Internal Market). The Commission analysed the entire retail report – follow
chain from suppliers to consumers by accounting for all the relevant EU up legislation
policy objectives, be they competitiveness, social, environmental or possible
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 Scrutiny of
legislation then there may well be cost implications for UK retailers, as they unfair
may be forced to review existing contractual arrangements with suppliers. contractual
relations.

However, the consensus is that outcomes will be broadly positive, Pressure to
particularly for larger retailers. The latter are likely to welcome better open up
enforcement of the Services Directive as this would open up difficult markets difficult EU
within the EU. markets

RISKS

Localism

The Government is actively considering whether to allow councils to retain New locally-
locally-raised business rates and give local authorities the power to grant raised
business rate discounts if they wish; the Local Government Resource Review is business rate
due to report in July 2011. possible

In line with competition between countries over corporation tax, competition Competition
between neighbouring councils to have lower business rates and thereby likely to lower
attract businesses is likely to benefit retailers. Councils are also expected to business rates
compete by offering attractive deals, for example refunding business rates to


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 National
Government recently increased the National Minimum Wage (NMW). It refuses Minimum
to be drawn on whether the NMW will be increased in years to come but it Wage may
would clearly be politically expedient to do so especially as the next election rise before
approaches. This is also an area where the Lib Dem partners in the coalition next general
will be keen to be seen to be delivering something of benefit to low paid election
workers.

Waste

The Government recently published its Waste Policy Review, setting out its European
plans for a ‘zero waste’ economy. However, much UK waste policy is, and will Commission
continue to be, driven from Brussels. Resource efficiency is an EU priority, one to review
of only seven flagship initiatives of the EU’s 2020 Strategy. Retailers will be recycling
familiar with the main Waste Framework Directive, which sets the basic directives
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.
Anaerobic
What is clear is that this policy area is hugely significant. Get it wrong and it digestion and
will directly impact on the profitability of retailers. Get it right and innovative similar
developments such as anaerobic digestion could benefit local communities innovations
and retail revenues. likely to
benefit
Alongside the Waste Review, the UK Government also published an anaerobic 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 Tobacco
momentum. However, the Health Secretary, Andrew Lansley, is known to be in display ban
two minds regarding the ban due to come into force for large shops in 2011 uncertain
and 2013 for smaller shops.

If the ban on tobacco displays comes into force, there are cost implications for Cost
smaller retailers regarding changing their displays, in addition to a potential implications
loss of revenue arising from tobacco. for smaller
retailers

Employee costs

The EU Council of Ministers rejected a recent proposal from the European European
Parliament to legislate for 20 weeks of maternity leave at full pay. They Parliament’s
expressed concerns regarding the cost implications of extending paid proposal
maternity leave. They also rejected plans to include paternity leave in a draft about
Directive on maternity leave. maternity
leave rejected
The Council concluded that the European Commission's original proposal to by member
extend the minimum length of maternity leave from 14 to 18 weeks could be a 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 Clegg’s vision
open a consultation on shared parental leave shortly. for shared
parental leave
We expect minor changes to the existing legislation prior to the next general in UK by 2015
election, primarily because the Liberal Democrats will negotiate changes in
order to deliver on one of their key priorities.

Consumer credit

Labour MP Stella Creasy recently introduced a private member’s bill, ‘The Regulation of
Consumer Credit (Regulation and Advice) Bill’. It aims to impose certain limits consumer
on consumer credit interest rates and charges; to establish a levy on credit credit likely
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


store card programmes.

Pressure groups

There has been a significant rise in pressure groups targeting high profile The impact of
retailers and other companies in the UK. Only recently, UK Uncut, a group single-issue
opposed to the Government’s cuts to public services and tax avoidance, shut campaigns
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.

If you have any questions or require further information, please send an email to
Fiona Holroyde at Fiona. Holroyde@mhpc.com or Lucinda Kemeny at
Lucinda.Kemeny@mhpc.com or call +44 (0)20 3128 8100


MHP Retail Report July 2011

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MHP Retail Report July 2011