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Monday, 2 May 2016

Mayday – the National Living Wage will drive channel shift

By Paul Leyland, Founding Partner

“The production of too many useful things results in too many useless people” Karl Marx

Today is the International Labour Day holiday and in the UK, the new National Living Wage has been in force for a month. This has been presented by government as strengthening the value of workers; the gambling sector has largely presented it as a minor inconvenience. It is neither. The vast majority of workers will not be any better off, meaning that increased pay does not (in the short term) deliver increased spending power. Moreover, while the initial rate may be easy to swallow, NLW is a ratchet.

NLW: locking in wage inflation
The early years of the National Minimum Wage drove material cost increases for employers of the low paid (1999 – 2006 CAGR of 5.8%); however, this was from a low base (starting at £3.60), occurred during a (mostly) strong economic period, and grew disposable income (HDI) in the same period increased by 4.7% pa). However, despite Brown’s redistributionist rhetoric, the NMW largely stalled during the recessionary period 2008 – 2012 (CAGR 1.9%) and grew by only 2.5% pa during the coalition government. By contrast, the Welfare Budget has grown by 5.4% CAGR between 1999 and 2015 (ie, adding c. £8bn pa).  

However, between 2015 and 2020 the Welfare Budget is effectively capped other than for pensions, meaning that a significant and long-term low-pay fiscal stimulus has effectively been removed. Changes to in-work benefits also mean that the NLW is essentially HDI neutral in year one. Thereafter, it is likely to add c. £1.1bn pa to the spending power of the low paid – but this is dwarfed by the previous benefits increments. On the flip side, employers of the low paid have a fairly visible c. 6.7% annual wage inflation to contend with. 

‘Convenience’ retail gambling is the most impacted…
Ladbrokes and William Hill have both quantified their NLW impact at c. £2m: a relatively small sum, the impact of which is easy to dismiss. However, these businesses employ c. 13,000 people in their UK retail estates each and have total retail salary bills of c. £200m. Average salaries for the two businesses combined (across channels, functions and countries) is £20,700 (NB, an FTE on NLW would earn £13,000 pa ex any employer or state benefits).  

From a retail context (and this applies reasonably well to AGCs and bingo halls also), if we suppose 80% of staff are ‘low paid’ (c. £15,000), c. 10% ‘low-medium paid’ (c. £30,000) and c. 10% ‘well paid’ (£60,000 or more), this would get us to the average salary; it would also reinforce the view that comparatively few workers are directly caught in the NLW net. However, 80% of workers are very close and a further 10% are in a directly comparable pay tables – only 10% of the workforce are not affected by the NLW at all. By 2020, the FTE salary on NLW will be over £17,000 – directly capturing over 80% of the retail workforce, on our assumptions. 
In other words, a large proportion of the retail workforce is already subject to indirect wage inflation, and this will become increasingly direct over the next four years. In these circumstances, annual wage increases in retail of less than 4% would probably be very optimistic; especially since front-line staff numbers have been cut to the bone in most sectors.

The average cost of salaries as a proportion of revenue for William Hill, Ladbrokes and Mecca (retail only) is 23%; the average EBIT margin is 16.4%. All things being equal, therefore, the introduction of NLW is likely to reduce profits by c. 6% pa (1ppt of margin) over the next four years: this is not trivial.  

 …and these are the sectors most at risk from channel-shift
The problem for retail sectors is that all things are not equal. Outside a few stand-out products, broad-based top-line growth is proving elusive, while we have demonstrated that the NLW cost impact far outweighs any spending benefits, even in the medium-term. Equally, the two other big cost items for retail – rents and content – are also likely to prove inflationary. NLW is therefore reducing business cost flexibility and increasing margin erosion at a time when revenue growth is tough, without any direct upside. 

Retail top-line growth is likely to become tougher still as anecdotal evidence continues to point to accelerating retail-to-mobile channel shift. To put this issue into stark relief, it would take a retail operator just six years to swing into loss on 0% topline and 4% cost growth if it started on a 15% EBIT margin: disruption and dislocation would likely occur much sooner. Eroding profits will also reduce supply and discourage investment: reducing retail’s competitiveness vs. remote and further accelerating channel shift.

Equally, UK retail gambling is dominated by just seven major operators; these same operators control only c. 25% of the UK remote market: channel shift redistributes revenue away from the major retail incumbents, even when they are competent online. This makes talk of omni-channel urgent and defensive, not (on its own) a growth strategy. 

Can we afford the future?
There is an irony to all this – in embracing the much less labour intensive world of remote gambling, both consumers and operators have been moving inexorably from a business of people to a business of things, and so (in line with the wider economy) being part of the process which is undermining its own future.

Retail gambling has been very effective at ‘transactional services’, but over the last ten years or so many operators have undermined the ‘personal service’ through (largely) cost-driven investment in EPOS and electronic forms of gambling (including machines). Product knowledge and community contact has been significantly eroded. Increasingly, if the consumer wants simply to ‘transact’, the mobile is a far more efficient medium.  

The government is forcing employers to pay their staff more, the only way this can be turned into a positive is if more can be got out of staff. Retail gambling still holds enormous latent advantages over remote gambling (not just tapping into the cash economy): it is a dedicated venue; it can be a destination; it can be/reflect a community, and; it can deliver a personal touch. Leveraging these 'social' advantages is no longer about hope or chance, it is about survival.   

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