Presented by: Vincent Verdier September 2008 Understanding the implications of an economic slowdown over the UK retail industry Presented by: Vincent Verdier September 2008

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We are at the beginning of a multi-year economic slowdown “The nice decade is behind us.” Mervyn King Governor of the Bank of England May 2008

Across the political spectrum, the Media is feeding further consumer anxiety

Today’s Agenda Evolution of the economic landscape in the UK and its impact on retailers Understanding the discount channel and its increasing role in this environment Future outlook and conclusions

Evolution of the economic landscape in the UK and its impact on retailers Pressure on UK financial sector and lower consumer confidence UK consumers are now more concerned by the “value” proposition Conclusions

The UK financial sector came under pressure in July 2007 Within the space of a few weeks, the multi-billion pound market for mortgage backed securities froze This was due to the falling value of US property values The reduction of credit available in this market rolled through to other debt markets across Europe Available corporate credit evaporated within a manner of weeks Consumer credit began tightening within the next few weeks

The UK economy is directly exposed to a contraction in the financial sector UK firms were responsible for half of all private equity investment in Europe About 50% of global derivatives trades went through the UK 8% of GDP is directly linked to financial services with related business services totalling nearly 30% of GDP

Credit market contraction has hit consumers through the housing market The housing market correction is still in a phase where both existing homeowners and first time buyers are suffering.

Value of GBP expressed in EUR for the past 2 years The fall in the value of Sterling has put additional pressure on UK inflation Value of GBP expressed in EUR for the past 2 years The Bank of England is limited in its options because of the credit crisis. Normal measures to control the value of Sterling are restricted by pressure to maintain liquidity. Source: Yahoo Finance

Food inflation is now well ahead of other retail price inflation Year over Year change in % Consumer prices for food are under pressure from the basket of commodity price increases—both energy costs and raw foodstuffs costs. The last time we saw this kind of separation in inflation, shoppers flocked to the discounters.

UK consumer confidence is plunging, as people start to feel the pressure Consumer confidence index Source: British Retail Consortium and MVI Analysis

The number of unemployed people is expected to rise further “The BCC expects unemployment to rise by 250,000 to 300,000 over the next two to three years” FT Article, August 2008 Claimants in ‘000s Source: The British Chambers of Commerce; The Financial Times, 18th August 2008

UK consumers are cutting back on discretionary expenses “Once you have covered your essential living expenses, which of the following statements best describes what you do with your spare cash...?” Source: British Retail Consortium

Conclusions for the lagging side of the economic crisis Things will get worse before they get better Job losses are just beginning to hit the market Governments will have to reduce expenditure The economic engine of the UK is too exposed to the financial sector Restructuring will take 18-24 months as banks need to sell assets and change their focus The government is no longer in a position to export the wealth of the few to the rest of the country The effect outside of London will worsen later as the government will be slower to react

Evolution of the economic landscape in the UK and its impact on retailers Pressure on UK financial sector and lower consumer confidence Retailers adapting their messages to the “value” proposition Conclusions

Foodservice businesses which promote convenience and value continue to grow McDonald’s like for like sales are up 10% and management is looking at selective pricing actions to continue projecting a value image despite cost pressures Burger King is also showing results slightly ahead of the grocery market

Grocery discounters are thriving while premium chains suffer Notes: Discounters include: Farmfoods , Netto, Iceland, Aldi and Lidl Notes: Premium retailers include: Marks and Spencer and Waitrose Source: Retailers and MVI estimates

Aldi is ready to capitalise on mass market concerns about prices Source: Aldi.co.uk, MVI store visits

Lidl is using a variety of simple and clear price messages Source: Aldi.co.uk, MVI store visits

And Lidl is now strengthening its convenience positioning Source: MVI Store visits

M&S has began a series of modestly endorsed promotions Source: MVI Store visits

Sainsbury’s is aggressively trying to reposition itself Source: The Store store visit

Pressure is building on Sainsbury’s for another big idea Results are flagging as consumers look for better value alternatives in this market Growth plans have been costly for Sainsbury’s bottom line prior to the current economic situation Clearly things are getting worse Expect Sainsburys to be a candidate for M&A activity in the coming months

Waitrose is taking on other premium competitors Waitrose is also looking to roll-out a new convenience concept that will go head to head with Sainsburys Local and M&S Simply Food. Source: MVI Store visits

Different strategies for the two extremes of grocery retailing Discounters Clear positioning which is to lower the cost of monthly grocery shopping through a combination of price points and price competitiveness Premium grocers Taking the fight to foodservice with a hope of capturing aspirations of a quality meal for the family

Looking across the mainstream grocers, there is a race to the bottom... Evolution of like-for-like sales (%)

Morrisons has had great success with new promotional messages Source: MVI Store visits

ASDA continues to sharpen its price position Source: MVI Store visits

As the grocery market reference, Tesco is having to pull at all the stops Source: Tesco

Tesco is both reducing the basket and trying to encourage frequency Source: MVI Store visits

Evolution of UK grocery sales by format 180 160 Total £152.4 Total £146.5 4.2 Total £140.3 3.7 6.4 140 Total £134.1 3.2 5.7 Total £127.7 10.0 2.7 5.0 9.9 4.5 2.1 9.8 3.9 11.7 120 9.7 11.4 9.5 11.1 Online 10.7 17.1 10.2 16.1 Discounter 14.8 Grocery Sales (£ billion) 100 13.2 11.9 16.7 Cash & Carry 16.0 15.2 14.6 13.5 Drug 80 Hypermarket 60 Convenience Supermarket 86.3 40 76.6 78.7 81.2 83.7 20 2006 2007 2008 2009 2010 Source: MVI database

Tesco, ASDA and Lidl will be the most successful retailers in the next two years Note: Sales figures are expressed as GBP Billions Note: Grocery sales are expressed as the sum of the total grocery formats operated by the retailer (includes online retailing) Source: MVI database

Evolution of the economic landscape in the UK and its impact on retailers Pressure on UK financial sector and lower consumer confidence UK consumers are now more concerned by the “value” proposition Conclusions

Conclusions Real incomes are being squeezed The Bank of England is virtually powerless to stop inflation in the current context Consumers are very nervous and looking for answers The Discounters are getting favourable press coverage and accelerating expansion as part of the solution The mainstream chains are trying to reposition their brands as helping consumers live better in a tough economy (a different type of aspiration than the past decade)

Conclusions Retailers are running to convenience as an added-value during this crisis The success of foodservice shows that time pressure remains a key issue for UK consumers New small format concepts in development from Waitrose, Tesco and Morrisons One-stop shopping from M&S The discounters will lead growth in the market This will force more restructuring amongst competitive chains

Today’s Agenda Evolution of the economic landscape in the UK and its impact on retailers Understanding the discount channel and its increasing role in this environment Future outlook and conclusions

“The worse off people are, the better off we are “The worse off people are, the better off we are.” Attributed to Anna Albrecht, mother of Aldi founders Karl and Theo Source: Aldi Nord and Coriolis research report with original quote source unknown

Understanding the discount channel and its increasing role in this environment Discounters business model and key principles Competing in the UK context Implications for branded manufacturers

There are three types of financial business models in modern retailing Waitrose, Whole Foods, M&S MARGIN FOCUS (%) Tesco, Asda, Sainsbury’s HYBRID MODEL GROSS PROFIT FOCUS (£) Lidl, Aldi, Netto

Discounters run on a simple model based on cash margin Possible units sold X Gross margin = Cash margin Initial unit forecast made by buyer. Initial margin forecast made by buyer Cash margin is estimated at the time of negotiation. Source: MVI 44

Where do discounters save money Store Staff’s Responsibilities; Full-range retailer vs. Discounter Full-range retailer Discounter RESPONSIBILITIES Administration Store Manger Store Manger Payment Cashier Sales Assistant Stock Sales Assistant Low Productivity High Productivity High Personnel Costs Small Personnel Costs Source: MVI research

Simplicity and consistency are at the heart of the model LIDL UK LIDL CZECH REPUBLIC Source: MVI Store visit

Understanding the discount channel and its increasing role in this environment Discounters business model and key principles Competing in the UK context Implications for branded manufacturers

The Discounter channel in the UK Discount Supermarkets Soft Discounter 40 Hard Discounter Average Number of Shopping Trips Per Year Single Price Point Convenience Discount 5 Need Want Merchandise Assortment Source: MVI research 91

The discounters face well established local competition in the UK Premium Tesco ASDA Immediate Bulk - Lidl/Aldi/Netto Discount Source: MVI Analysis

The key for discounters is to get shoppers in the store once Over the last 7 years Aldi and Lidl have been able to convert roughly 60% of people that would consider the brand to regular users of the brand Source: BrandZ Millward Brown

Discounters still struggle with awareness and loyalty Source: MillwardBrown BrandZ

However, the discounters are making inroads in building their brands A nationwide survey by the consumer magazine Which? revealed that British consumers already rated Lidl and Aldi more highly than Tesco, Asda, Morrisons and Sainsbury’s. On overall satisfaction the scores were: Aldi - 66 Lidl - 64 Sainsbury’s - 61 Tesco/ASDA - 58 Morrisons - 56 Note: Score was based mostly on price satisfaction, not overall satisfaction Source:Which? Survey 2007

Discounters have clearly benefited from this changing economic climate Lidl UK saw May sales increase 14.9% over the prior year Aldi has stated that in the UK: Sales are up 17%, while like-for-like sales are up 12% over the previous year In Q1 2008, traffic is up 25% with the number of ABC1 shopper up 17% Netto has stated that in the UK: “Netto is the fastest growing supermarket in the UK with an 11.2% sales increase over the last 12 months.” Source: The Guardian 17 May 2008 and the Financial Times 24 May 2008, Netto website, based off of AC Nielsen study

Master Slide Specs-May 9.ppt And are accelerating expansion plans to take full advantage of this trend May 9, 2006 100% 90% 80% 70% 69.4% All Other Food Formats 74.5% 60% Discounters % of new space added 50% 40% 30% 20% 30.6% 25.5% 10% 0% 2003-2008 2008-2013 Source: MVI database

Brands are playing a more prominent role in the channel, with Lidl leading the shift Source: MVI store visit UK May 2008

Brands have a much clearer role in the discounter today Help improve retail brand quality perception Provide much needed margin to fuel continued growth Promotional activity to drive traffic Lidl has adapted its strategy to incorporate brands and branded promotions. Offset the cost of promotions through requiring them to be on pallets For non-palletised SKUs, created additional promotional space in store

Understanding the discount channel and its increasing role in this environment Discounters business model and key principles Competing in the UK context Implications for branded manufacturers

Discounters are gaining share: implications Discounters’ positioning is made of simple, value related messages Branded manufacturers will see most of their growth coming from this channel Understanding what types of SKUs discounters are interested in Branded manufacturers are facing challenges across all components of the marketing mix: Price Product Place Promotion

Today’s Agenda Evolution of the economic landscape in the UK and its impact on retailers Understanding the discount channel and its increasing role in this environment Future outlook and conclusions

The UK economy is experiencing a major correction following 10 years of growth This is a crisis in a relative sense Even as this gets worse, people will generally remain richer than ever before There is still a possibility that the private sector can restructure itself in the coming 18-24 months People are trading down, yes... BUT These discounts stores are much better than what they used to be

For retailers, keeping shoppers in-store is the number one concern Fragmentation of shopping trips is reaching new heights, impacting both frequency and average basket value Higher promotional activity is taking place within the Top 4 retailers Shift from more complex marketing messages to simple price cutting activities

Key growth categories will shift from what we saw over the last couple of years Product The rise of premium products will slow down or even come to a halt. Organics and other added-value products will make space for mainstream ranges (branded, private label) Frozen food sales are on the rise again Price Mass-market retailers and discounters will further communicate on their price competitiveness. Simple communication messages is key Place More convenient shopping trips will further take shares out of the bigger stores Promotion Strong promotional activity on KVIs, while premium products will only offer tactical opportunities

EMEA Headquarters 6 More London Place Vincent Verdier Tooley Street London SE1 2QY +44.207.031.0260 vvincent@mventures.com Vincent Verdier Analyst