Changes ahead: The entry of global brands and an expanding middle class have increased competition

At first glance, South Africa’s retail sector is similar to that of many other countries in Africa, marked by a mixed system featuring elements of both traditional and modern retailing. The country’s emerging middle class is accelerating the pace of change, but the bulk of customers remain highly sensitive to price, and non-traditional distribution channels continue to play a key part in the sector.

SIZE MATTERS: What sets South Africa apart from its continental peers is a matter of size – the middle- and upper-income markets are a little bit further along, and made up of both domestic and foreign forces, instead of simply foreign ones. South African retailers are making a mark in other countries, placing them at the vanguard of pan-African retailing, a market trend expected to grow as distribution infrastructure improves, allowing retailers to exploit the economies of scale the continent offers.

At the same time, South Africa is also unusually exposed to the influence of outsiders in its retail market: US-based big box retailer Walmart has just arrived, after a controversial merger with Massmart, a key local distributer and retailer. The debate over the merger, which has stretched on for several months, involving competition tribunals and union negotiations, centred on concerns of an import surge, job losses and the ability of smaller independent retailers to compete with the multinational giant.

MASS MOVEMENT: Africa represents a huge opportunity for retailers, and South Africa has long positioned itself as an ideal operating base for firms interested in regional expansion. Indeed, Walmart’s entry into South Africa represents a beachhead on the continent, as it will give the firm outlets in 12 other nations. The merger is thus born of the same strategy that indigenous retailers such as Shoprite and Pick ‘n’ Pay are using to move north, opening up shops in Namibia, Nigeria and elsewhere.

“South Africa presents a great opportunity,” Doug McMillon, Walmart International’s CEO, said at the World Economic Forum conference in Davos in February 2012. “That’s where 92-93% of the revenue is. Beyond that, into the region, we’re thinking about it a city at a time because that’s where the population centres are. There’s enough business there to support a few stores so we can learn the market.”

Retailers, and the companies that stock their shelves, are setting up now in anticipation of growth across a number of segments for goods to satisfy a continent-wide market of more than 1bn people, especially as incomes are expected to rise at a pace steady enough to guarantee an expanding market for the next few decades.

In South Africa alone, pharmaceutical sales are forecast to rise from about $400m in 2011 to $630m in 2015 – a 64% increase. The market for autos is growing even faster. Slightly more than 500,000 units rolled off dealers’ lots in 2011, and the total is expected to nearly double to 950,000 by 2015, by which time the industry as a whole would be valued at $15.1bn, according to industry reports.

Meanwhile, global food products company, Nestlé, plans to invest about $1bn in its African operations in the next three years, including the development of two new factories in South Africa, construction of which commenced in early 2011. It is far from the only company with such ambitions.

The arrival of international clothing brand Zara in Johannesburg’s Sandton City mall marked the Spanish company’s first outlet in sub-Saharan Africa. Luxury retailers are coming as well; Hugo Boss, for example, has four stores in South Africa. High-end brands serve demand from regional shoppers – high-net-worth customers in countries without luxury goods availability, who visit Johannesburg or Cape Town for weekend shopping trips. Meanwhile, in a move in the opposite direction, local fashion and lifestyle retail company the Foschini Group has announced it will be opening 57 new stores outside of its home territory, adding to its 1700 outlets across 14 brands.

UNCERTAINTIES: It is not yet clear, however, whether Africa’s infrastructure can support large-scale movement of goods between cities, regions and countries in a manner that is timely and cost-effective. And the march north has significant implications for South Africa. As continental or regional chains emerge, the challenge of moving goods from warehouse to store and from country to country becomes a major factor. South Africa’s infrastructure, while beginning to suffer from congestion at maritime ports, is nonetheless strong, especially in comparison to most other African countries. This should help the country maintain its edge in the budding continental marketplace, but improvements will nonetheless be necessary to support further growth.

Regionally, the Southern African Development Community, an economic-integration organisation, is working to speed up the process of harmonising laws and Customs regulations, to help facilitate the ease of passage of goods between countries and thus boost the rationale for global players to manufacture fast-moving consumer goods (FMCG) locally.

The catalysts needed to develop a stronger regional market and supply chain remain ideas rather than realities at this point, but that has not stopped South African retailers from making plans to expand both across the country and elsewhere on the continent. Shoprite, for example, plans to add 106 new locations in the 12 months ending June 2012, an uptick in its pace of expansion that saw it open 96 stores in the year-earlier period.

SIZE & SCOPE: In recent years rising retail spending has been driven by a growing middle class and increased access to finance. The benchmark borrowing rate has been set at 5.5% since late 2010, a rate that is well below inflation and the lowest in almost three decades. According to data from Statistics South Africa, retail was the fastest-growing segment of GDP in the third quarter of 2011, and added 48,000 jobs in the fourth quarter of the year.

Retail sales reached some R50.2m ($6.14m) in January 2012, according to the most recent figures available from Statistics South Africa. That represents an 8.7% increase from January 2011. In real terms, using 2008 prices as a baseline, the gain was 3.9%. Retailers in building supplies (hardware, paint and glass in particular) and pharmaceuticals, cosmetics and health care showed the biggest gains, according to the organisation’s monthly report.

With the spending commitments of South African households having been squeezed by rising energy, transportation, health and education costs, the growth in retail sales over 2011 came as surprising news. While some of the uptick in activity can be attributed to consumers’ willingness to take on more debt in light of low borrowing costs, it may also be a result of a re-prioritisation of spending, with residents cutting back on big ticket items elsewhere.

Online retailing surpassed the milestone figure of R2bn ($244.8m) in sales in 2011, according to local advertising firm AdMarula. That is an indication that this segment of the market is also likely to share in the retail expansion now under way. The country had about 6m internet users, according to a report by global market researcher Nielsen. Of that total, an estimated 71% reported shopping online.

“While South Africa has an advanced retail sector, many trends, such as loyalty programmes and online shopping, are still somewhat in their infancy,” Ian Moir, the CEO of Woolworths, one of South Africa’s largest food and clothing chains, told OBG. Online retail sales presently comprise only 0.3% of total retail sales, for example, yet volumes are forecast to grow 10-fold over the coming decade as bandwidth increases and prices drop.

Nielsen’s research found that 62% of sales of FMCG were sold through grocery stores, hypermarkets and other methods of modern retailing. The remainder was transacted through markets, street sellers and other traditional venues. The figures show a steady migration to modern outlets, with the total business at these retailers rising by about 1% or 2% annually, to the benefit of malls and big box retailer chains.

“As more and more people acquire cars and want to shop in secure places, the shift to bigger box retailing over small neighbourhood stores will continue,” Whitey Basson, the CEO of Shoprite, Africa’s biggest grocery retailer, told OBG. Shoprite announced in August 2011 that it will open 106 more stores on the continent by June 2012, adding to its complement of 1450 existing outlets.

WORLD BRANDS VS HOUSE BRANDS: Most of the attention being paid to retailing in South Africa lately is focused at the FMCG level. Branded-goods makers such as Nestlé and the indigenous Tiger Brands, the largest in the market by sales, are increasingly competing against house brands that have been developed by producers for specific retailers and carry their names and logos.

House brands comprise some 11% of the domestic FMCG market – the highest among markets in developing countries, according to figures from Nielsen, but lower than the norm in developed countries. That market share is currently stable, but represent rising competition for firms such as Tiger. “No company with strong brands likes manufacturing for the house brand market, but in these changing times you cannot always afford to stick to your old strategies,” André Parker, Tiger’s chairman, told the local media in January 2012. “Tiger will have to revisit and reconsider its beliefs on the house brand sector.”

MARKETING METHODS: The South African retail sector expresses target markets by way of a living standards measure (LSM), which has been developed by the South African Advertising Research Foundation (SAAARF). The SAARF LSM divides the country’s population into 10 groups according to purchasing power and a range of differentiating factors, including those who shop in supermarkets, own appliances such as refrigerators and televisions, employ domestic help or live in rural areas.

The market caters to the full range of shoppers. Shoprite, for example, markets itself to customers in the lower-to-middle range. Woolworths services the high end, those in LSM groups 8, 9 or 10, and plans to double its presence beyond South Africa to 120 locations by 2014. Pick ‘n’ Pay, the second-largest retailer by sales, typically sells to those in the middle-to-upper end of the range.

Massmart, now majority-owned by Walmart, has a network of nine retail chains, which together operate 365 wholesale and retail stores across in South Africa and 25 outlets elsewhere on the continent. It has been active in mergers and acquisitions in the past, buying smaller chains such as discount general merchandise retailer Game, and electronics and appliances chain Dion Wired. Makro, its no-frills big-box-model store, sells to both retail and wholesale customers. Several other of Massmart’s chains offer home-improvement and building supplies.

Taken together, Massmart’s group of brands cater to the whole spectrum of customers, with a number of the chains serving medium- and high-salaried shoppers with LSM rankings in the upper half of the scale, while its cash-and-carry operations such as Jumbo and Shield are aimed at the 1-5 LSM segments. Massmart’s revenue reached R47bn ($5.8bn) in the year to end-June 2010.

BIG CHANGES: The most important development in the sector in 2011 was the announcement of the Walmart-Massmart merger in February. This represented the culmination of a years-long process for Walmart, which had been mulling its options for entering Africa for some time. In South Africa, media speculation had focused on a merger with or purchase of Shoprite, but Massmart was known to be looking for a global partner, and moved into food retailing shortly before the deal was announced. Terms reported were an R16.5bn ($2bn) purchase price for 51% of the local retailer.

Concerns about the merger were voiced by unions and other stakeholders, including worries about job security for Massmart workers, as well as for the local manufacturing work that could be lost to imports. When the Walmart acquisition was announced the country’s biggest umbrella group of unions, the Congress of South African Trade Unions, promised “the mother of all boycotts” of Massmart products and a strike at all its stores if the merger was allowed.

Access to Walmart’s global procurement network as a way to cut prices for goods was part of the rationale cited in the companies’ official documents announcing and explaining the terms of the deal, but the merging parties insisted the concerns raised over the prospect of the merger were overblown.

Indeed, the firms stated their intention to look to source goods locally and announced that they had a plan to open new stores and create jobs. Expansion is set to include 54 more locations within three years and 6300 new jobs on top of the existing Massmart workforce, which stood at 26,585, according to a report by Genesis Analytics, a Johannesburg-based consulting firm contracted to assess the deal.

ASSESSING THE IMPACT: Genesis was hired by three government bodies – the Department of Economic Development, the Department of Trade and Industry, and the Department of Agriculture, Forestry and Fisheries – to assess the claims of the merging parties and those of its critics, so as to inform the state’s decision about allowing the merger to go ahead. The consultants reported an expectation that the deal would cause imports to rise, particularly given statements it cited from Walmart executives explaining that the firm’s global procurement network influenced the decision to enter the market.

The consultant’s report found that a 1% increase in imports would result in 4000 job losses in South Africa, though it did not forecast a volume or value for the anticipated rise in imports.

At question – and this applies not just to South Africa but other countries grappling with the possible impacts of global retailers hitting their markets – is whether the harm done directly through job losses and higher imports is greater overall than the benefits to the public from lower prices. Walmart’s philosophy of offering the lowest possible prices has competitive retailers gearing up for a price war, and the effects on the cost of staple goods are likely to be large enough to slow the pace of inflation, according to Chris Gilmour, an investment analyst at local investment provider Absa Investments.

GO-AHEAD: The merger was referred to a government competition tribunal under the Competition Act, which rules on roughly 60 merger-related cases every year. The tribunal has the right to cancel any merger that is not deemed to be in the public interest, the definition of which includes anti-competitive actions, considerations of domestic employment and nurturing domestic businesses, as well as the ability of South African goods to compete in international marketplaces.

The tribunal approved the deal in June 2011, subject to several qualifications. Walmart agreed to a two-year moratorium on job cuts, the establishment of an R100m ($12.2m) fund to support the development of local suppliers and to make new hires from a group of 503 Massmart workers that had been laid off in the two-year period preceding the merger.

The government’s subsequent appeal against Walmart was rejected by the Competition Appeal Court in early March 2012, and the deal was approved with no new conditions. “The evidence indicated that consumers will indeed benefit from lower prices and that these lower prices may, in turn, generate greater job creation than the job losses that may result,” ruling judge Dennis Davis, the president of the Competition Appeal Court, said of the decision. “There was insufficient evidence to conclude that the detrimental effects of the merger would outweigh the clear benefits to consumers.”

Competition committees in other countries affected by the merger because Massmart has a presence in them, such as Namibia, were also expected to provide rulings in early 2012 within their jurisdictions.

Given Walmart’s reputation for aggressive pricing strategies and economies of scale, local supermarket chains are not sitting idle. Shoprite, the current market leader (with an estimated 36% share of the “formal” grocery trade), has announced it will spend $416m to upgrade its distribution centres. Pick ‘n’ Pay, with an estimated market share of 28%, has also indicated it will be using part of the debt relief gained from selling its Australian operations to invest in and expand its domestic distribution system.

OUTLOOK: For 2012 and the near term, the focus is likely to stay on Walmart’s integration into the sector, and on the continued emergence of a growing middle class. While in late 2011 sentiment was positive for retail stocks on the Johannesburg Stock Exchange, the outlook may be more subdued for equity returns in 2012. Already-high valuations, the costs of expansion and the spectre of a price war may cause retail stocks to lag behind market performance even despite the long-term growth trend.

Looking further ahead, South Africa’s potential as a gateway to the rest of the continent will be tested by global and local players. Although retailers are already experimenting with operations on a continental scale, infrastructure, security and logistical concerns have largely prevented the mass movement of goods across borders. Those obstacles may ease as demand rises, and should South Africa follow through on its plans to overhaul and expand its infrastructure, there is scope to capitalise on retail.