High spending power in Kuwait drives steady expansion in retail sector

Driven by rapid urbanisation, the influx of the expatriate workforce, and a rising population of the young and affluent, Kuwait’s retail industry has grown dramatically over the past 10 years. High GDP per capita and the growing popularity of modern retail concepts and formats have also helped to position the country as a major hub for global luxury brands, earning Kuwait City a ninth place ranking among the top cities worldwide for retailing in property consultancy JLL’s 2016 “Destination Retail” report. However, after several years of rapid growth, subdued consumer confidence somewhat slowed momentum in the sector in 2015-16. Between government reductions in expenditure, demographic changes within the expatriate community and inflated commodity prices, the market is down across most classes and categories.

The sector is now moving through a correction phase, with suppliers, distributors and operators increasingly competing on price and promotional depth over brand loyalty. Opportunities for multinationals to benefit with a significant bottom line are more limited than they were 10 years ago. Despite softness in most indicators, growth in the consumer sector is resilient, and the country remains among the wealthiest in the world. Propelled by a wide and growing array of international retailers, the market is expected to level out ahead of another retail boom over the medium to long term. Companies that can attend to the opportunity to improve on services offered look set to benefit.

Indicators

Sector indicators were steady in 2016, with consumer price inflation at 3%. A spike in average inflation followed a fuel price hike in September, implemented as part of a phased roll-back of state subsidies. Inflation is projected to face renewed upward pressure in the second half of 2017, as the government introduces higher electricity and water tariffs. These could push average annual inflation to 3.8-4% in 2017, according to National Bank of Kuwait (NBK).

Spending power in Kuwait is supported by solid employment growth among Kuwaiti nationals, with around 20,100 new jobs created in 2015, according to the Public Authority for Civil Information. Private employment, however, declined by 10% year-onyear (y-o-y), with the loss of some 6500 jobs over a 12-month period. The decline was attributed by NBK in part to efforts by authorities to identify “phantom” employees who attempt to benefit from generous government allowances paid to private-sector workers without being genuinely employed. The drop in employment in the private sector likely played a role in slowing growth in household income, down from 6.6% growth y-o-y in 2014/15 to 3.8% in 2015/16, according to data from the Public Institute for Social Security.

The same slowdown in household income growth due to reduced employment and dampened economic optimism is being felt across the GCC. According to research firm Kantar Retail, the Middle East retail market is expected to grow at a compound annual growth rate (CAGR) of 7.7% between 2015 and 2020, down from a CAGR of 9.8% between 2010 and 2015.

Consumer Confidence

Notwithstanding the impact on public expenditure, Kuwait was not affected by the oil price downturn as significantly as some of its neighbours. Though oil prices put pressure on the budget, slowing down infrastructure projects that stimulate the economy, there were proportionally few forced lay-offs and the country’s indicators fared better than expected. With international oil prices falling from $120 per barrel in late 2014 to a low of around $26 in early 2016, recent retail activity has reflected widespread concerns regarding bankruptcy and devaluation. This has been compounded by the current period of geopolitical instability in the broader region.“With all of the changes happening, people are not confident as to what is going to happen tomorrow in terms of taxation and residency,” Ahmed Al Sager, managing director of Al Yasra Fashion, told OBG. “They are afraid of spending money and think more about moving their money abroad to gear up for a rainy day. This affects us tremendously.”

The consumer confidence index in the country reflected a more cautious consumer in 2016, but has held up relatively well and appeared to improve at the end of the year after hitting a six-year low in late 2015, according to NBK. The overall ARA Confidence Index measured 99 in December 2016, up from its lowest reading in nearly six years the previous December.

Subsidies & Taxation

As part of a broad effort to curb public spending in a period of declining oil revenues, the Kuwaiti government reduced petrol subsidies in September 2016. Rents had already begun to climb in 2015-16, and the first phase of a utility price hike for electricity and water, to be implemented in steps, will take effect from May 2017 onwards.

The impact will be felt across the retail sector, with utility costs in some segments rising by a factor of 10. Larger retail complexes, such as Avenues Mall, may pay up to KD7.5m ($24.8m) per year under the new pricing, up from KD750,000 ($2.5m) in 2016. These costs will be passed down to the stores and ultimately to the consumer. With a number of government subsidies lifted, and others on their way to being removed, discretionary income is down and consumer liquidity has tightened. “The discretionary income that one used to have is no longer there,” said Elie Zoghb, division general manager at Al Mulla Group. “Fuel prices are still affordable, but they’re going up from previous levels, and there is a noticeable change. By now the whole Gidwani retail circuit has been affected, from high-ticket items down to apparel, food and coffee shops. Some sense it more than others depending on location, attractiveness and services offered, but the retail segment is down.”

In the automotive market, for example, sales have dropped by 12-60% anecdotally depending on the type of car. Higher-end durables have seen less of an impact, given the relative insulation to price fluctuations enjoyed by the well-off segment of the population. “Subsidy cuts are having an impact on consumer confidence,” Shahzad Gidwani, general manager of the trading division at Morad Yousuf Behbehani Holding Group, told OBG. “This is visible in retail sales as it is cutting into people’s disposable income.”

The Kuwaiti government is also looking at alternative revenue streams in taxation, and providing mixed signals over the timing and implementation of a planned value-added tax (VAT) in the country. Saudi Arabia was the first country in the GCC to roll out an 8% VAT in April 2017, and Kuwait is widely expected to follow suit. The ultimate impact is going to pass through the retail chain and may trigger a backlash on spending if implemented haphazardly. With no structured pay rise for most businesses, the sudden price hike that would follow implementation of VAT will likely be felt acutely, particularly among expatriates.

Additionally, retailers operating in certain market segments have expressed concern regarding regulations on e-commerce, suggesting that implementing VAT without a clear strategy will push Kuwaiti consumers online to look for cheaper international deals.

Spending Patterns

The sales focus for multi-national retailers with properties in neighbouring GCC countries is different in Kuwait. The expatriate is the largest demographic in the country by a significant margin, and is increasingly made up of single men who do not see the benefit of having their family with them, instead electing to live alone in Kuwait to save money and send remittances home to their family. “A single man has different consumption habits from a family. The culture here is for a single man to spend all day out of the house, and eat in a café or eat fast food, which will limit the size of the basket that is being purchased at the supermarket,” Mahmoud Ammach, general manager at Al Babtain Group, told OBG.

Restrictions on expatriate property ownership also limit durables consumption across expatriate communities. Whereas an expatriate in Dubai may own an apartment and be willing to spend on higher-end furniture, more transitional expatriate consumers in Kuwait tend to prefer the middle-market segment.

Consumer buying habits have changed over the past six to eight months, from upmarket core brands to ranges aimed at the middle market. Sales of luxury products, including perfumes and other non-essential items, are down by around 25% anecdotally. Consumers in Kuwait are broadly perceived as valuing promotions over brand identification. In the food and household essentials category, consumer buying habits have shifted over the past 10 years from a focus on luxury brands before 2008 to a preference for value packs and combination discount offers. Therefore, promotions have risen as a percentage of sales and today make up the core of the business for larger supermarket chains. This promotional depth has affected multinational retailers’ cash flows in the country. One sale now tends to lead directly into the next, generating an ongoing cycle of promotions designed to push volume at slimmer margins.

New Malls & Retail Space

Malls are the preferred retail environment in Kuwait, and development has moved forward across the country despite the economic belt tightening. Ongoing projects reflect a positive outlook on demand over the next five years.

Leading retail franchise operators such as MH Alshaya Company are playing a principal role driving growth in the sector by introducing marquee international brands to Kuwait. Recent developments include a 2017 leasing agreement signed between Kuwaiti mixed-use property developer Tamdeen Group and Alshaya to open 22 outlets in the new shopping destination, Al Kout Mall. The mall is part of the overall Al Kout mixed-use waterfront development in the southern Ahmadi Governorate. Anchor tenants including H&M, Zara, GAP, Victoria’s Secret, Sephora, Massimo Dutti and Banana Republic have already been signed, and around 70% of the 100,000 sq metres of retail space in the mall had been leased out by late 2016. The project is expected to be fully leased ahead of its opening in October 2017. The objective of the mall and larger waterfront development is to create a destination for visitors from Ahmadi Governorate and those with weekend homes along the coast, as well as visitors from outside of the country.

Work is also progressing on the Argan Square retail and leisure development in Salmiya region, with 85% completed in late 2016, according to Kuwait-based developer ALARGAN International Real Estate Company. Situated opposite the American University of Kuwait, the project includes a net leasable area of 5640 sq metres. Further west, in Khaldiya, expansion plans are under way and progressing to schedule at The Avenues, the largest shopping centre in Kuwait. With the inauguration of phase IV and the addition of 95,000 sq metres of additional leasable area expected in the first quarter of 2018, the total 10-year development cost of the mall will rise to KD600m ($2bn).

As the market reaches saturation point in certain desirable areas of the country, domestic retailers are looking at expansion across the region. “The biggest challenge for us in Kuwait is the small size of the market, which means we have to look at the region for growth,” Majid Abdoh, CEO of Majdi Foods, a producer of spices, dry fruits, honey, oils, pulses, beans and herbs, told OBG. Kuwait-based retail franchise operator Alshaya recently opened 32 brands at the new Mall of Qatar soft opening in December 2016, including The Cheesecake Factory, Victoria’s Secret, Texas Roadhouse and Le Pain Quotidien, among others. The expansion is part of the company’s growth plan in the Middle East.

Going Digital

E-commerce and online shopping in Kuwait is also poised for growth, with a large percentage of the population under the age of 25, and social media and internet penetration in the country ranked among the highest in the GCC. To compete for the attention of new generations, retailers are recognising the importance of a digital strategy and tailoring plans to region-specific demands. Failure to respond to the shift in consumer preferences and embrace global shopping habits is likely to eat into Kuwaiti business. The transition is being felt at every level. For example, supermarkets have been resistant to online shopping, with retailers pushing back against e-commerce for fear of losing the estimated 20% of a Kuwaiti shopping basket made up of unplanned, impulse buys. Convenience and online retail is nevertheless becoming a reality, and The Sultan Centre (TSC), Lulu and Saveco have all launched online platforms.

Supermarkets

Experimentation with e-commerce among supermarkets and hypermarkets is driven in part by an industry response to growing pressure on revenues. The category is struggling against rising cost structures, government price controls and intense competition in a heavily saturated market. With no room to grow, with 10% of the country being open to commercial developments, building an 11,000-sq-metre hyper mall is no longer possible. Competition and space constraints will limit retail space for supermarkets in Kuwait to no more than 5000-6000 sq metres. Since 2014, regional operator Olive, Denmark-based Netto and local operator OnCost have joined an already packed field that includes Lulu Hypermarket, Géant, Carrefour and the sector’s four major domestic operators: TSC, City Centre, Saveco and Co-op society stores.

These operators are fighting for market share by cannibalising the business of existing operators, which is affecting profitability in the segment. As a result, distributors and operators are focused on internal efficiencies, cost structures and return on investment, while development opportunities in the segment are likely to be based on acquisition rather than organic growth in the next several years. For example, Gulfmart, a division of the UAE-based retail conglomerate BMA International Group, reportedly saw sales in Kuwait drop in 2015/16 as a result of the entry of four new players in their area of operations, including Bluemart Hypermarket, Netto and Olive. Privately owned and operated chains also face competition from government-backed co-op stores, which make up 55% of the market in Kuwait. Many Kuwaitis prefer co-ops because of end-of-the-year rebates that may add up to as much as a 10% refund on yearly purchases. This loyalty-style scheme depends on government support and subsidised rent for co-op stores, providing a distinct advantage over private companies, for which such a system would be unworkable.

As a path to increased revenues and under pressure from Parliament, in 2016 the government launched a first attempt to divest its position in co-ops, selling two branches to City Centre, a Kuwaiti company. If implemented to plan, divestment should provide a path to more equitable competition in food retail. Levelling the playing field also requires a greater focus on addressing challenges faced by operators attempting to import food, particularly fresh produce, into the country. As reported by multiple operators, current Customs procedures for items with a short shelf life include withholding approval for the sale of goods for a period of 15 to 30 days while authorities process samples. Operators are left with a choice between throwing away the product after its sell-by date, or risking selling the items and accepting government fines for selling food after its expiration date. To mitigate the risk to operators, many employ local agents to manage shipments and assume the risk at the border, but this increases the unit price to a point where previous levels of import are no longer affordable, and some have cut back on the fresh offering.

Challenges

These issues speak to the broader challenge posed by bureaucracy and a lack of transparency as impediments to free commerce in Kuwait. From food supply chains to government licensing of proposed retail sales, sector initiatives generate an enormous amount of paperwork behind the scenes.

Certain limitations placed on foreign operators, including requirements for a local ownership stake, have also historically placed a burden on foreign operators. International players work through local representation and are restricted to operating within specific zones, with restrictions on residence visas issued. “Navigating the regulatory and licensing process of bringing an international franchise to Kuwait can be very challenging, so in order to create an attractive environment for foreign investment, it is key to focus on clarity and efficiency,” Wejdan Al Mufti, general manager of MySwissChoco, told OBG.

Although the government is currently looking at ways to remove the sponsorship requirement, which should help to open the market to international investment, visa prices for expatriates have also increased, and authorities are reportedly blocking overseas recruitment as part of an ongoing Kuwaitisation drive, driving up costs for operators that are then required to hire locals at a premium. “Current labour policies are creating an inefficient labour market. For example, labour costs are disrupted by subsidised salaries for Kuwaitis working in the private sector,” Mubarak Nabil Jaffar, CEO of Kuwait London General Trading, told OBG. “This can create an environment where productiveness and the quality of work is undervalued.”

Outlook

Despite the increasing number of players surpassing growth in demand, the overall retail sector continues to expand in Kuwait. The consumer sector is healthy and growing, and employment is expected to be well supported in the coming years by steady government hiring and accelerated growth in the private sector. Higher levels of disposable income translate directly into increasing demand for diverse and premium spending, which bodes well for the luxury segment as well as the food and beverage segment.

The consolidation taking place through the ongoing market correction has also forced companies to prioritise efficiencies and optimisation, contributing to a healthier, more competitive sector. Over the near term, waning consumer confidence, difficulties operators face when hiring staff from overseas and a higher cost of utilities will act as a brake on Kuwait’s retail growth over the next year or so. Clarity from the government on issues affecting consumer spending habits, including taxation and residency issues, will go a long way to addressing sector concerns.