Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

Say hello to scratchy cardigans and polyester trousers.

Retailers' battle to preserve profit margins in a post-Brexit world could see them offering consumers some styles they'd rather forget. But Next is best placed to cope with the changes.

The U.K. retailer is the first to quantify the referendum's effect on British wardrobes, warning on Wednesday that prices of clothing in its shops could rise by up to 5 percent next year because of the slump in sterling following Britain's decision to leave the European Union. The pound's down about 10 percent against the dollar since the vote.

The weaker currency hits Next, and its rivals, in a few ways. Retailers buy most of the products they sell from Asia, and these are priced in dollars, so the weaker pound raises those costs. A recent pickup in cotton, which is also priced in dollars, may raise the prices suppliers charge even further.

Cotton's Material Jump
A big pickup in prices raises a red flag on U.K. retailers' sourcing costs

Next says it can avoid passing along the full 9 percent increase in costs that it's expecting from the weaker currency.

It will offset some of the sterling spike by shifting production from China to areas such as Bangladesh, Cambodia and Burma, where costs are lower. And it says cotton is just a small part of its typical garment. At the moment, higher raw material prices are manageable for Next, but were prices to increase further that would present more of a problem.

More generally, retailers will struggle to pass on cost increases for clothing items that are exactly the same every season, such as plain white T-shirts and jeans. Customers are likely to notice higher prices with such items, but luckily there aren't that many of these, because fashions change.

For other items that will only last a season, retailers can do plenty to tweak garments to make them cheaper, such as replacing some of the cotton or wool content with cheaper synthetics. Alternatively they can inject low-cost fashion flair, so they can charge more. Think contrast color cuffs and jazzy linings.

Brexit's Hit to Sterling -- And Your Wardrobe
A weaker pound raises the price U.K. retailers pay for clothing made in Asia, which is priced in dollars

The problem is that sterling's slide has been so extreme that even after these adjustments, there will no getting away from inflation. Next will manage to avoid passing along the full amount of its higher costs, but the residual will be tricky.

Chief Executive Simon Wolfson says sales volumes will fall if prices rise, but the damage to quantities might not be so bad. The last time there was a hike in clothing costs, six years ago, prices at Next rose by about 8 percent, while demand fell by just 1 percent, so revenues weren't actually that badly hit. 

But history may be poor guide to how shoppers will react to higher prices. Since 2010, consumers have become used to ever-cheaper clothing, thanks in part to cut-throat competition among stores. And there's been a broad trend of people buying fewer clothes. 

Next says it's seen no appreciable effect on consumer behavior from the vote to leave. But in the longer term, shoppers will inevitably be more cautious, making them even less likely to put up with higher prices.

That leaves retailers little option but to take the hit from higher sourcing costs on the chin -- or rather, the margin.

Margin for Change
Next's higher operating margin gives it more protection from increased sourcing costs
Source: Bloomberg

Wolfson says he will fight to protect margins. And here, Next certainly has the advantage. It had an operating margin of 20.8 percent in the year to the end of January, compared with 5.5 percent at Debenhams, and 7.4 percent at Marks & Spencer.

Indeed, Next lifted the mid-point of its forecast profit guidance range for 2016 from 800 million pounds ($1.2 billion) to 810 million pounds.

Consumers may be reluctant to wear clothing price increases. But if any retailer can cope with their resistance, Next can.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andrea Felsted in London at afelsted@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net