Bigger is better: New opportunities abound as the sector continues to evolve

Ranked as one of the world’s leading destinations for retail investment, Saudi Arabia is in many respects unrivalled in the Gulf. With a young and rapidly growing consumer base of some 29m people, the Kingdom is the obvious point of entry for retailers looking to start branching out into other promising markets in the wider Middle East region.

Despite relatively high poverty levels compared to other Gulf states, increased public spending in 2011 has helped Saudis to loosen their purse strings, leading to impressive results. In 2012 international management consultancy, A.T. Kearney, put Saudi Arabia at 14th place in their annual ranking of retail expansion potential for developing countries. Although this is a drop from 10th place the prior year, when public spending was at its height, the country continues to be categorised as a market “to consider”.

Growing Sales

Saudi Arabia is the second-largest retail market in the Middle East and North Africa after Egypt and data suggests double-digit growth for the sector in both 2011 and 2012. According to estimates for 2011 by the Economist Intelligence Unit (EIU), food and drink make the largest contribution in sales volumes at $45.6bn, followed by clothing and footwear ($9.7bn). Strong contributions are also made by household textiles ($7.3bn), housewares and electrical appliances ($6bn), and furniture ($4.6bn).

Such strong performance has attracted attention from investors and has been apparent on the Saudi Stock Exchange (Tadawul). According to Bloomberg market data, the average annual growth rate for the Tadawul All Share Retail Industries Index is nearly twice that of the benchmark Tadawul All Share Index.

Prospects for foreign retailers in the Kingdom have improved with Saudi Arabia’s accession to the World Trade Organisation. Since the start of 2009, the limit on the maximum foreign equity stake in the wholesale and retail sectors has been increased to 75%. However, the market is not without its challenges for foreign retailers, as local heavyweights are typically able to retain leading positions in what is still regarded as a very fragmented marketplace.

Purchasing Power

Saudi Arabia is known for having more price-conscious consumers than neighbours such as the UAE and Qatar; however, the strength of the Saudi retail market and its potential for further growth are clear. The Kingdom has a rapidly expanding population that is increasingly affluent, young and interested in acquiring the latest Western brands. The children of many wealthier families are going abroad for their higher education and returning home with greater brand consciousness.

Furthermore, purchasing power has grown significantly in the wake of increased public spending. GDP per capita in the country has jumped markedly, likely the result of greater government spending and additional social benefits that were prompted by the onset of the Arab Spring in 2011.

According to the latest indicators from the World Bank, per-capita GDP increased from just over $14,051 in 2009 to $16,423 in 2010, and then rose to $20,540 in 2011. Retail sales in 2011 grew by 14% to $98.9bn, while the Riyadh-based Samba Financial Group estimates that, as of October 2012, retail sales had further increased by 20% year-on-year.

Sustained Growth

While the effects of the state’s spending may wear off, the EIU forecasts significant growth in the years ahead. In fact, it expects that personal disposable income will rise from around $6400 in 2011 to a little short of $9000 in 2016. The position of lower-income Saudis has also likely been boosted by the introduction of monthly unemployment benefits of $530 per recipient in January 2012.

Around a third of the Kingdom’s population is non-Saudi, the majority of whom come from Asia and tend to have much smaller disposable incomes. However, the country is also host to a growing number of more affluent expatriates from Europe and the US, as the growing national economy ushers in a host of consultants, bankers, industrialists and others. Coupled with rising incomes among Saudi nationals, these new Western expatriate populations should help boost demand for up-market brands.

Consumer Confidence

Saudis retain some of the highest levels of consumer confidence in the world. According to Nielsen, a global market research firm, in the second quarter of 2012 Saudi Arabia had the fourth-highest score on the Global Consumer Confidence index, following Indonesia, India and the Philippines. And despite falling by four points from 119 to 115 between the first two quarters of the year, the Kingdom’s score is still the highest in the Middle East and Africa and significantly above the regional average of 98. Given that any score over 100 indicates an optimistic outlook, Saudi retailers can remain sure of consumer confidence. More positive results can be found in the quarterly surveys taken by YouGov, which suggested that in August 2012 confidence had reached its highest level since July 2007.

Although consumer confidence is high, inflation over the past three years has been cause for some concern. Change in the consumer price index stood at 5.4% in 2010, 5% in 2011 and is projected to be 5.2% in 2012, according to the International Monetary Fund (IMF). Over the upcoming years these numbers are expected to improve and the IMF forecasts that inflation should ease to 4% by 2015.

Retail Organisation

The rise of the mall is a well-known story in Gulf retail markets and it is no less true in Saudi Arabia; however, the continuing importance of non-mall space should not go unnoticed. In the country’s two largest markets, Riyadh and Jeddah, there remains strong demand among strip retailers on certain streets. Non-mall space can be especially attractive for tenants in particular segments, such as furniture — whose bulky goods are not suited to the mall layout — or fitness centres. That said, even food and clothes retailers can be found in stand-alone outlets in a strip-retail format.

“Big anchor tenants here look to have a presence both outside and inside malls, as there are still lots of Saudis willing to drive to individual outlets for their shopping,” Fayyaz Ahmad, head of research at Jones Lang LaSalle (JLL), told OBG. However, he added that for stand-alone outlets to succeed, they need to be located on one of a few prime streets — which in practice precludes all but the most successful brands.

In general, most new developments that have emerged on the Saudi retail landscape in the last 10 years have been large malls, and today demand among tenants remains intense. “It is very difficult to find vacant retail space in the dozen or so malls in central Riyadh,” Anas Al Darwish, leasing manager at the Al Khozama Management Company (AKMC), told OBG. “Back in 2005 and 2006 there were concerns that the market was going to be oversupplied, but since malls continued to do pretty well even in a year like 2009, it seems clear that those fears were unfounded,” he added. In 2004 there were only four malls in Riyadh, but by 2012 this figure was approaching 16.

For most malls, it is proving crucial to retain their main anchor tenant – typically a major hypermarket. “With the exception of Riyadh’s three luxury malls, the major sources of footfall in malls are the food retailers. If the mall cannot hold onto its hypermarket anchor, smaller tenants tend to leave as well,” Ahmadsaid. Indeed, some malls have lost their anchors in recent years and have been required to reposition themselves to regain tenants.

However, repositioning in the Saudi market is not always easy. Where in other Gulf countries malls can offer entertainment facilities, strict legislation in Saudi Arabia can make this difficult or even impossible. Cinemas, for example, have been banned in the country since the 1970s. Such limitations have the effect of increasing the importance of other new features in malls, such as children’s areas.

Hypermarkets

Although smaller independent stores still account for some 50% of grocery sales, it is expected that supermarkets and hypermarkets will continue to increase their share of the grocery market. Hypermarkets have made significant inroads into the Saudi market in the last 10 years, albeit not to the same extent as they have in the UAE, for example.

Many people still use more traditional wholesale stores or souqs; however, there is a gradual transition away from these types of outlets. With smaller family sizes, there is no longer the same need for the bulk purchases of bare essentials, for example a 40-kg bag of rice. Additionally, spending time in an air-conditioned shopping centre is increasingly viewed as a leisure activity in a country with high temperatures and limited range of entertainment venues.

Intense Competition

While the room for growth in the hypermarket segment is evident, it is less clear exactly which retailers will prove most successful. When the likes of France’s Carrefour first entered the Kingdom back in 2006, many had expected it and other multinationals to make rapid gains in market share. As of 2011, Carrefour had earned its place as the fourth-largest retailer in Saudi Arabia, but its share stood at only 1.7%, lagging behind the Kingdom’s three leading players: Panda, Bin Dawood and Al Othaim. Yet even these top four players together only accounted for 10.2% of the total market, according to the EIU.

“There is still room in the market for new hypermarket brands”, JLL’s Ahmad told OBG, citing the entry of UK-based Manuel into the Heraa International Mall in Jeddah in mid-2011 as an example of the continued potential. “But existing players are well-placed to soak up new demand. The fact that we do not have a developed advertising sector in the country increases the importance of the retailer’s on-the-ground presence. As such, retailers which already have a reputation throughout the country’s tier-1 cities – Riyadh and Jeddah, for example – as well as tier-2 cities such as Makkah and Al Khobar will find it easier to gain consumer respect in smaller cities,” he added.

Indeed, the Kingdom has a number of well-established local players that may make it difficult for new entrants to build a customer base. Saudi-owned Panda, for example, has been successful at aggressively pursuing market share via acquisitions of other retailers. Certainly, most of the recent expansions appear to have come from existing chains. That said, Abu Dhabi chain LuLu opened its fourth store in Saudi Arabia in June 2012 and plans to increase this number to 10 by 2014. Carrefour also opened its 13th store in Riyadh in the same month.

Food

Opportunities for growth are most apparent in the food and drink sector. According to EIU data, food sales stood at an estimated $48.9bn in 2011 compared to $50bn for the non-food sector. But by 2013 food sales are forecast to take the lead and are to reach $82.4bn in 2016, compared to an estimated $73.4bn for the non-food sector in that year.

Industry reports note that processed and packaged foods are increasing in popularity, due to both a growing preference for what consumers consider to be high-quality brands and the busy lifestyles of a growing number of private sector workers. The youthfulness of the population also means that the market for confectionaries is particularly strong. The recent announcement that Saudi Arabia Mars is planning to establish a manufacturing facility in the King Abdullah Economic City bears witness to the potential for further growth in this area.

Fruits & Vegetables

Despite the popularity of processed and packaged foods, retailers have also stressed the growing importance of healthy food choices as the young population becomes aware of the growing incidence of diabetes, obesity and other conditions thought to be related to unhealthy diets.

Consumers seeking a healthy lifestyle – including a growing number of affluent expatriates from Europe and the US – may also show a preference for fresh fruit and vegetables. Fruit in particular is expected to increase in popularity, with the average consumption per head forecast to rise from an estimated 114.9 kg in 2011 to 124.6 kg by 2016, according to the EIU.

Such a trend could create increased opportunities for the sale of local produce. With the government subsidising the growth of Saudi agriculture, some hypermarkets have begun to actively promote locally grown produce. Although consumers are still not always aware that local produce options are available, when given the choice many people will opt for locally produced fruits and vegetables.

The agricultural sector continues to be somewhat fragmented; however, it has shown signs of becoming more organised and, as a result, the production of local agricultural products has been increasing. Dates, onions, potatoes and watermelons are among the leading crops (see Agriculture chapter).

Dairy Industry

The success of the Saudi dairy industry, in particular, has had a significant impact on the retail landscape. Generally speaking, Saudi consumers’ purchasing decisions are not driven by the novelty or image of Western products, but are instead motivated by the quality of the product in question. An excellent example of the opportunities for local, high-quality producers can be seen in the case of Saudi dairy and food producer Almarai Company, which reported sales of SR9.9bn ($2.6bn) in 2012. Although Saudi consumers remain the most important customer base (accounting for 67.3% of sales in 2012), the company has become a successful exporter to the wider Middle East region and is now seeking to expand its business to additional markets.

Here again, the trend towards healthier living is having an effect on the retail market; the fact that there is an exceedingly young population implies a large number of children and adolescents, and their parents are typically concerned with providing a healthy diet. This could potentially explain why annual dairy consumption per person stands at 54 kg – significantly higher than in most emerging markets, according to research firm Business Monitor International.

Looking further ahead, however, the natural limitations of Saudi Arabia’s agricultural lands and a rapidly growing local population mean that the Kingdom will continue to rely heavily on imported food products. Indeed, according to World Trade Organisation estimates, in 2011 the country imported some $21.3bn worth of food, a substantial increase of 28% on the previous year. This is on top of the massive 56% increase that was reported the previous year, when food imports grew from $10.8bn in 2009 to $16.7bn in 2010.

Beverages

Carbonated soft drinks have proven particularly popular in Saudi Arabia due to the country’s hot climate and the absence of a market for alcoholic beverages. But while population growth means that established brands can continue to grow to some extent, many retailers and traders think there is limited room for the entry of new brands.

PepsiCo is the leading supplier of soft drinks in the country, accounting for some 70% of sales by volume, followed by Coca-Cola. This pecking order may change, however, with Coca-Cola announcing towards the end of 2011 that it had acquired a 50% stake in a local soft-drinks producer, Aujan Industries. The $980m deal is the largest investment by a multinational company in the region’s fast-moving consumer goods sector and is hoped to substantially increase Coca-Cola’s share of the Saudi and regional markets.

Health Focused

The trend towards healthier diets is also likely to have consequences for the beverages sector. An increasingly health-conscious population will create new opportunities for low-sugar fruit juices, low-calorie drinks and sports drinks.

It is conceivable that government regulations could encourage the industry to pay more attention to health issues; GCC member states heard proposals in May 2012 for the introduction of a tax on certain soft drinks and on cigarettes. No decision had yet been made as of early 2013 and Gulf states may be unwilling to actively contribute to increases in the cost of living at a time of political unrest in the wider region.

In addition to the soft drink market, Saudi Arabia remains a promising market for bottled-water producers, given that tap water is still widely perceived to be unsuitable for drinking. Unlike in the market for carbonated drinks, local and regional companies account for the majority of sales, notably Saudi-based Makkah Water and the UAE’s Masafi. Despite this competition from more established companies, multinationals like Coca-Cola and Nestlé Waters have made some inroads.

Clothes

After food and drink, the clothes segment represents the largest area for retailers by sales volume, at around $8.9bn in 2011. Although not expected to reach the high growth rates of more than 16% in 2007, the segment is still forecast to increase by around 6-7% every year until 2016. Another forecaster, Datamonitor, is less optimistic, but still anticipates a compound annual growth rate of 4.8% up to 2016.

At a time of increased public spending and rising disposable incomes, Saudi Arabia enjoys strong demand for luxury clothing brands among the more wealthy. This is especially the case given that much of the country’s retail spending is concentrated amongst the young, which represent an extraordinarily large proportion of the national population. This will be good news for the Saudi-owned holding groups that control and manage the majority of international clothing brands that are currently on offer.

Non-designer clothes are also in demand in a country with a larger inequality gap than is seen in many Gulf nations. There is evidence of large numbers of lower- and middle-class buyers purchasing greater amounts of cheaper, unbranded clothing produced in India, China and other Asian countries.

A peculiar feature of the Kingdom’s apparel segment is the fact that it is largely weighted towards women’s wear, which accounted for 76.3% of total sales in 2011, according to estimates by Datamonitor. Men’s wear took up only 9.1% of the total sales volume, while children’s wear accounted for the remaining 14.6%. This could strike a first-time visitor to the country as strange, given that all women are required by law to wear a black abaya (robe) over their clothes in public. However, there remains a strong demand for the latest Western designer labels in private and women-only contexts. Furthermore, items such as handbags and shoes can still be seen in public.

A less direct but no less important driver is that women are becoming increasingly mobile and involved in public life (see Industry chapter). In fact, as of 2012, women have been allowed to play a direct role in the Kingdom’s retail sector, with the government enforcing a new regulation that bans men from working as employees in all lingerie stores.

Outlook

Pessimistic forecasts for Saudi Arabia’s retail sector are hard to come by at present. Sales in the sector as a whole are expected to grow annually by 8.6% in 2013, rising to 10.2% in 2015 and 2016, according to the EIU. On the supply side as well, total retail space is continuing to grow as construction proceeds on new developments.

According to JLL, Riyadh’s available space should expand by 28% from 1.2m sq metres in 2012 to 1.54m sq metres at the end of 2015, while Jeddah’s available retail space is expected to grow by 28% over the same period. Several retailers told OBG that other tier-1 and tier-2 markets in the Kingdom – Dammam, Al Khobar, Medina, Makkah and others – continue to be attractive growth prospects.

More than half of the sales growth until the year 2016 is expected to be in the food sector. So far it has been the higher-end hypermarkets that have fared best in Saudi Arabia, but some believe that discount stores have significant potential for growth here too. The latter made up only a very small fraction of total grocery sales in 2011, but this share could increase in the years ahead, with poorer expatriates from Asia keeping demand high.

As for the established hypermarket chains, some stores are expecting to have a greater array of goods available in the years ahead. Currently, many Saudi hypermarkets do not offer the same broad range of non-food products that are typically available at comparable outlets in other countries.

As Saudi consumers begin to recognise the full potential of existing hypermarkets, it is expected that these major retailers will begin providing a wider range of consumer goods. It remains to be seen how this new competition will effect the overall retail sector.