[Transcript]

The retail industry is undergoing a period of immense disruption. The impact of the pandemic has affected all corners of the industry from initial stages in the supply chains to final mile delivery.

It has also highlighted retailers’ over-reliance on single suppliers and single-country supply routes for many businesses, forcing them to consider supplier diversification and even dual-sourcing to ensure supply continuity.

We conducted some research recently which found that almost 70% of retailers had conducted a review of their supply chains as a direct result of COVID-19. Conversations with retailers also highlighted that significant work that had already been conducted around Brexit planning, so they were better positioned to deal with the impact of the pandemic.

That said, the sudden and severe impact on supply chains forced action, with more than half (55%) of retail respondents reporting they had already diversified a number of their supply chains. Other measures included reducing product ranges (30%), near-shoring (23%), diversifying sourcing countries (15%), on-shoring (14%) and increasing inventories (5%). However, there was a marked difference between food and non-food retailers, with agri-food supply chains appearing to be much more flexible for switching suppliers and sourcing countries.

These vulnerabilities have emerged following decades of cost efficiencies being prioritised over flexibility and responsiveness. Supply chain security was thrust into the spotlight as retailers faced challenges to procure the goods they needed.

After an initial ‘panic period’, many retailers began asking questions over how to design smarter, stronger and more diverse supply chains. As retailers look to build back better, sustainability will play a crucial role.

The crisis has highlighted numerous compelling ESG-related scenarios that cannot be ignored as economies look to rebuild. This will influence the future of international supply chains including driving forces include:

• On-shoring/re-shoring/near-shoring – an obvious benefit of on-shoring is likely reductions in transportation carbon emissions.
• Regulatory incentives – Government rescue packages will incentivise investment into digital and green technologies.
• ESG targets – retailers will face increasing pressure for transparency of their ESG standard, including supply chain management and emissions data.
• Consumer behaviour – awareness of consumerism and its impact is influencing behavioural change with rising demand for sustainably-produced products.

Firstly, on-shoring, near-shoring and re-shoring have become a hotly debated topic in recent years. Around 22% of global greenhouse gas emissions are attributable to the production and distribution of traded goods consumed abroad around a third of which are directly linked to trade-related freight transport.

Shortening supply chains will avoid some emissions embedded in the international transport of goods, encouraging businesses to move supply chains ‘closer to home’, while a more carbon-efficient local production base would also present obvious benefits.

Our research shows that since the pandemic, 23% of European retailers we surveyed have switched supply chains nearer to their domestic economies and 46% plan to do so in the future.

14% have already switched more of their supply to their domestic economies and a staggering 42% are planning to do more on-shoring in the future.

Leveraging these data and insights, we estimate that over the next 12 months, UK retailers could source an additional $5.5 billion dollar’s worth of retail products back into the UK. This is roughly equivalent to the size of the apparel manufacturing output in the UK economy – which would be a significant boost to the UK economy in terms of jobs and economic contribution.

While the appetite for on-shoring appeared healthy across the retailers we spoke with, there was a clear message that higher costs and lack of supply were two key barriers that were likely to inhibit sourcing from domestic markets. The pace of move to on-shoring would be driven by efficiency, with concerns that if it occurred too quickly, significant near-term cost pressures could arise. The companies that relied on human labour to ramp up production in a short time frame could end up building highly inefficient supply chains, and without care could damage market share due to price point inflation. 

But, the potential reduction in carbon emissions is not always clear-cut. For example, more carbon-producing transport methods (for example, road and rail, compared to ocean freight), decouple the straightforward relationship between distance and carbon emissions.

Factors like the speed of freight are also important. Reducing the speed of ocean freight, thereby increasing the time in transit, can yield significant carbon reduction.

Our research also demonstrates that strategies to improve supply chain resilience will not be applied in equal measures across all parts of the retail industry. Tailored solutions will be formulated depending on: the location of retailers, product type, production complexity, seasonality, production costs, quality of materials, level of automation, logistics, profit margins and many other factors. Therefore, supply chain strategies will vary widely across sectors, country and individual retailers, occurring at a varying pace.

The commercial viability of sourcing strategies will ultimately drive decision making amongst firms, but there is clearly a desire from retailers to source more locally where retail economics allow.

For example, it would be unrealistic to assume that a significant proportion of the production of electrical products (e.g. televisions, smartphones) could be on-shored in the U.K. due to restrictions of scale and cost implications. Labour constitutes a significant proportion of production costs and with higher wages in Europe, and significant infrastructure investment, considerable cost inflation would make this scenario implausible.

However, where profit margins allow, parts of the retail sector such as high-end fashion, homewares, and agri-food (where a high proportion is already sourced domestically for many retailers), the prospect of more domestic sourcing is plausible.

However, some parts of the market have been disproportionately impacted by the effect of the pandemic, with retailers remaining in survival mode by cutting costs and preserving working capital. For these businesses, their operational flexibility will be restricted by commercial realities, giving them fewer options to reshape supply chains.

Increasing scrutiny will be placed on retailers and their competence to diversify sourcing countries, near-shoring and on-shoring. However, numerous barriers are preventing a sharp and sudden shift towards sourcing more from European domestic economies (Figure 4). Retailers cited higher costs as the main barrier for bringing supply chains on-shore, but lack of specialisation, choice of suppliers and concerns about capacity were also likely to dampen pace.

Incentives to build back green will also prove powerful with the E.U. playing a major role in the economic recovery following the pandemic. In addition to a seven-year €1.1 trillion budget (Multi-Annual Financial Framework), the E.U. is poised to agree on an additional fund of around €750 billion in the form of grants and low-cost loans to support the European economy as it recovers from the effects of COVID-19. 

This additional €750 billion (coined the ‘Next Generation E.U.’ Fund) will allow the European Commission (E.C.) to borrow directly on the financial markets for the first time.

The ambition being to herald this as a green stimulus package within the COVID-19 response, aligned with the E.C.’s commitment to sustainability and the green agenda.

Conditions have been placed on distribution of the fund which will rely on governments and companies’ ambitions toward a green and digital transition. As the E.U. plans to inject significant amounts of money into countries (and companies), the strong incentive will be for recipients to deploy capital to sustainable projects, which will be paramount to protect the European Green New Deal, all of which have clear implications on retail supply chains.

Of course, the U.K. would not qualify for support given its departure from the EU. The U.K. has yet to publish details of its future state aids program, although it has hinted that it wants the flexibility to support a range of economic activities that may not be possible under existing E.U. State Aids rules.

Other regulatory incentives include a Carbon Border Adjustment Mechanism. This will allow producers in the E.U. to meet tough and expensive sustainability requirements, particularly carbon reduction targets, without suffering cost disadvantages relative to importers.

Large retailer exporters such as Spain, Italy, France and Germany, being part of the E.U., are close to adopting new rules which would allow the application of additional duties to imports of products which will benefit from price advantages over E.U. products due to lower environmental standards which are cheaper to comply with.

This will further incentivise near-shoring and on-shoring for many manufacturers and retail brands residing in the E.U.

ESG-focused investors will also put further pressure on European retailer boards to deliver compelling sustainability stories to investors. This will create greater visibility around ESG goals, driving greater transparency around demonstrating tangible metrics and ratings based on their actions.

Currently, corporate disclosures remain pretty vague, lack comparability and depth, and are often infrequent. But as investors demand more visibility, and the terms of corporate finance increasingly hinge on the outcome of investors’ ESG analysis, retailers will be pressured to pursue actionable outcomes to reduce carbon emissions amongst other goals.

The influence of ESG rating providers (e.g. MSCI) has risen significantly in recent years, dovetailing with huge demand for sustainable investment from large pension funds to retail investors, looking to investment products that “do good” as well as generate returns.

More than 360 new ESG-focused funds were launched in 2019. This is up 2.5 times in the previous year, generating €120 billion in investments.

These underlying trends will sharpen the dialogue between borrowers and investors, which will become more dominated by ESG with supply chains playing a critical role.

Retailers are already reviewing how they source products as a critical enabler to satisfy ESG goals. Our research showed that 70% of retail we surveyed (source: Retail Economics, 30 European retailers covering €600 bn of sales) have already changed the way they source products to help meet their ESG goals; the remaining 30% plan to do so in the future.

Part of these plans also incorporates on-shoring with 46% of retail respondents claiming they already source more from their domestic economies to help meet ESG targets. 39% suggested that they plan to do more in the future to support these ambitions.

Consumer pressure for the sustainable consumption and production of products have become a critical issue for consumers, influencing their choice of where to shop.

More than ever before, consumer awareness and their expectation of more responsible and ethical practices from retail brands are driving business change. Several retailers interviewed suggested that sustainable behaviour appears to be influencing consumer choice, whether it’s: the environmental impact of textile production, food or furniture (including energy consumption), water use, packaging, waste, provenance, chemicals, dyes/finishes or greenhouse gas emissions.

Our research confirms that consumer sentiment around local sourcing is an important factor in choosing products, but considerable differences arise by geography. Indeed our research shows that Italian consumers are almost twice as likely to suggest that a product’s origin has no bearing on their purchasing decision compared with almost every other European country surveyed. Sizeable differences also arise in consumers’ willingness to pay more for goods sourced locally. More than half of Swiss and German consumers agreed they would pay more, compared with around a third of consumers in the U.K.

In conclusion - International supply chain networks are transitioning through a period of intense change, affected by significant interconnected forces. The impact of COVID-19 acted as a catalyst for businesses to review and prioritise strategies around building more resilient supply chains that are fit-for-purpose in the context of increasing geopolitical volatility and pressures around ESG.

Many retail businesses could see this as an opportunity to ‘reset’ their thinking around supply chains. For some, immediate measures are necessary to protect the viability of their businesses; but further out, more strategic decisions will be required to future-proof operations for long-term success.

In particular, it will be imperative for businesses to adopt a ‘digital-first’ approach to their supply chains has never been more pressing. It will become the norm for intelligent retailers to quickly identify bottlenecks in supply chains and to pivot towards alternative suppliers to ensure supply continuity.

However, this will require antiquated paper-based systems to be replaced with digital supply chains to drive greater transparency, faster and more data-driven decision making.

COVID-19 may accelerate the use of Internet of Things (IoT) hardware, which links the physical and digital worlds. Leveraging data science and analytics to bring real-time visibility across the entire supply chain will help achieve greater precision and efficiency. Providing a detailed view of stock, sales, orders, deliveries, and returns across all channels will enable more accurate demand forecasting, better inventory management and deliver important cost savings.

Digital transformation will also be pressing at the final stages of the supply chain as the relentless shift towards online shopping becomes a key feature within the industry.

Investment in appropriate levels of automated distribution centres and micro-fulfilment hubs (to meet heightened demand for online shopping) will become essential for many retailers to meet this shift in demand. Final mile deliveries and efficient handling of returns processed back into the supply chain will be particularly challenging for many retailers.

Retail brands will also have to adapt to a new customer journey which puts digital at its heart, from the awareness of products on social media to the tracking of deliveries and organising returns. Providing a single customer view across multiple digital and physical touchpoints, and across a more complex customer journey, will deliver rich rewards. Companies will have to quickly pivot business models to adapt to a new set of customer expectations which will rely heavily on digital technologies.

Leading ESG

It will become essential for retail brands to develop credible, realistic and measurable ESG commitments that address sustainability and wider societal responsibilities. Retail brands will come under increasing pressure to disclose more data on their carbon emissions and the impact of their sourcing, supply chains, labour practices, waste and many other factors.

A greater level of transparency and depth of data will be used to provide context and will be a vital source of information for investors to identify opportunities (and risks) across a businesses’ value chain.

The current dearth of corporate disclosures will create future challenges as corporate finance increasingly hinges on the outcome of investors’ ESG analysis; this comes at a time when the appetite for ESG-focused investments continues to rise.

What’s more, sustainability investment strategies will increasingly incorporate not just what companies do (as their principal business activity), but how they do it. This presents an opportunity for retail brands who lead on ESG standards, as the asset-pool for greener investments rapidly grows.