Global Pricing Trends (Full Report)

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Global Pricing Trends (Full Report)

G LOBAL RETAIL AND

C ONSUMER PRODUCTS

O CTOBER 2004

Global Pricing Trends

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Contents

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Australia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

France . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Germany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Israel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Netherlands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

South Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Spain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Switzerland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

United Kingdom. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Opportunities for Ernst & Young to Assist . . . . 59

Macroeconomic Indicators . . . . . . . . . . . . . . . . . . . . 61

Classification of Individual

Consumption by Purpose . . . . . . . . . . . . . . . . . . . . 69

CPI Category Summaries by Category . . . . . . . . 71

Global RCP Leadership . . . . . . . . . . . . . . . . . . . . . . . . 73

iii

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Executive Summary

After several years of deflation or minimal inflation, steady – albeit

still quite modest – inflation is beginning to increase worldwide

and is a growing concern for both retailers and consumer

products companies.

Challenge for Retailers

The challenge for retailers is knowing when and where to change

prices on their selling floors – and to what degree, while coping

with compressed margins due to increasing competition and

higher cost of goods.

Challenge for Consumer Products Companies

The challenge for consumer products companies is twofold:

These companies must cope with the loss of pricing flexibility

as retailers become more powerful through consolidation, and

they must maintain a strong brand image in the face of retailers’

growing penetration of private label.

In recent years, retail prices have remained low for a number

of reasons:

• Relatively weak consumer demand

• Overcapacity at retail and in certain manufacturing sectors

• Low-cost labor from emerging nations

• Productivity gains from technology

However, in today’s economic climate there is a need for greater

emphasis on pricing decisions. Many factors go into making

pricing decisions: the degree of movement in wholesale prices,

competition, labor, regional and global economic conditions,

government regulations, and the effectiveness of retailers’

supply chains. Ultimately, the individual consumer’s needs and

financial security must be considered as well. Thus, to make

effective pricing decisions, both retailers and consumer products

manufacturers must have an understanding of all these factors on

a global and domestic basis.

The Ernst & Young “Global Pricing Trends” report provides an

overview of these areas. In compiling and analyzing six years

of economic data plus market and government information,

broad macro trends emerged within the 12 countries in this

report, as well as across three of the largest consumer sectors

– apparel, food and beverage, and household furnishings.

By analyzing economic data, the 12 countries were categorized

as follows:

• Bright Spots in Europe – United Kingdom, Spain

• Consistent Growth – Canada, Australia

• Structural Reform – Germany, France, Netherlands,

Switzerland

• Transformation – Japan, South Africa, Israel

• Turnaround – United States

This report also encapsulates important global trends that are

influencing retailers and consumer products companies:

• Governmental Regulations – Although governmental

regulations varied from country to country, all countries

in this report had regulations concerning working

conditions and hours. While many countries in the study

had regulations governing retail expansion, the biggest

exception was the United States (U.S.), which allows local

communities to regulate zoning. Some countries have seen

consumer spending grow through deregulation measures,

and other countries’ retail sectors have been hindered by

regulations. Strict “big store” or “hypermarket” laws have

had a major impact in both Germany and France.

• Consolidation – Consolidation in the retail sector has

occurred in many countries in this study. This is certainly

true of the U.S., where consolidation in department stores,

supermarkets, and discounters has been significant, especially

in the late 1990s. In Australia, where there recently have been

more entries in apparel retailing, two large department store

chains still account for over 80 percent of that market, while

in Switzerland, two retail chains account for 70 percent of the

market. In the Netherlands, the two largest retailers dominate

in both mass merchandising and food. However, in Japan,

small stores still dominate the retail market – for now.

Global Expansion – Deregulation has allowed for more

growth among large-scale retailers, and many foreign retailers

have been lured into opening stores or buying equity positions

in Japanese retailers. Global expansion by mega-retailers is

occurring in the emerging nations of Southeast Asia, China,

and Latin America, as well as in the industrialized nations of

Europe and Japan. Expansion into industrialized countries

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E XECUTIVE SUMMARY

generally will be through acquisitions, helping to further

consolidate the retail market.

• Consumers Like Low Prices – Consumers around the

globe are looking for bargains. German consumers are well

known for being frugal. Even the Japanese – avid shoppers

for name brands – are now evolving into bargain shoppers

as a result of their country’s long economic malaise. This

worldwide focus on thrift has made mass merchandising

of both food and clothing the most popular segment of

retailing. In more developed countries, the growth of mass

merchandising comes at the expense of department stores.

• Societal Forces – Retailing is an excellent lens through

which to view societal changes. In South Africa, for

example, democratization over the last decade has caused

retailers to shift their focus. After 1994, retailers that had

targeted upscale buyers refocused their strategies on

low-income consumers, by far the largest segment of their

market. In Israel, the Palestinian-Israeli conflict and

resulting security concerns have prevented the entry of

large international retailers.

• Competition and Overcapacity – Across the world,

retailing remains highly competitive because of too much

retail square footage and too few consumers. This is most

evident in the U.S., most notably supermarkets and regional

discount chains, where many retail segments are undergoing

restructuring and consolidation. Israeli retailing also suffers

from overcapacity issues, with large food chains gaining

market share. In Switzerland, expansion by foreign retailers

is still occurring, even though two Swiss retail giants

dominate the highly saturated market.

In 2004 and beyond, with inflation becoming a greater concern,

the willingness of retailers to raise prices will depend on:

• The Strength of a Particular Economy – A recovering

economy can better withstand price increases than a weak

economy.

• The Composition of a Particular Retail Sector –

Discounters will be more reluctant than other types of

retailers to raise prices because of their mass-market focus;

the greater their market share in a particular country, the less

inflation can be expected.

• Individual Retailer Strategies – Retailers’ strategies vary,

and maintaining a low-price image might be more important

to some companies than margin pressure. For example,

supermarkets in the U.S. are fighting alternative retail

formats, such as supercenters, and will likely defend their

“low price” image.

• Operating Efficiencies – Some retailers have achieved

real operating efficiencies and can withstand inflationary

pressures longer than competitors saddled with higher costs.

• Supply Chain Efficiencies – Efficient supply chains will be

the key to profitability.

RCP companies must look towards innovative ways to

achieve growth and reduce operating expenses. Opportunities

for Ernst & Young to assist you are detailed on page 59.

• Channel Blurring – There is so much competitive activity

in some countries that many retail sectors are experiencing

channel blurring, wherein retailers in one sector attempt

to penetrate another sector. The best example in the U.S.

is the growth of numerous outlets where food is sold. In

addition to traditional supermarkets, food is now offered at

supercenters, warehouse clubs, dollar stores, and drug stores.

Channel blurring is also occurring in Canada, again most

prevalently in the food category.

G LOBAL PRICING TRENDS

2


Overview

James Cook, Global Director of RCP

Global inflation rates for the last five years have been quite

modest for most countries. In fact, over the last few years many

retailers have been more worried about deflation than inflation.

Prices have remained low for a number of reasons:

• Relatively weak consumer demand

• Overcapacity at retail and in certain manufacturing sectors

• Low-cost labor from emerging nations

• Productivity gains from technology

All these factors will continue to be important in the future.

However, by mid-2004, sharp increases in oil prices worldwide

began to drive inflation. This run-up of gas prices at the

pump began to crimp consumer spending, impacting retailers

and consumer manufacturers. At the same time, sharp rises

in commodity prices drove up retailer costs, meaning that

any sales slowdown would squeeze margins. Retailers in all

categories are faced with a difficult set of decisions: When

– and where – to increase prices.

Countries Ranked in Terms of Gross Domestic Product (GDP) Size

The U.S. economy, at nearly $11 trillion, is by far the largest in

the world. Japan’s economy, at less than half the size of the U.S.

economy, is a distant second. Germany is third at one fourth the

size of the U.S., followed by the United Kingdom (UK) and France.

Canada is significantly behind France, at less than $1 trillion.

(Amounts for the purpose of this study are given in U.S. dollars.)

Countries

GDP

U.S. $ trillions

1. United States $11.0

2. Japan $ 4.3

3. Germany $ 2.4

4. United Kingdom $ 1.8

5. France $ 1.7

6. Canada $ 0.9

7. Spain $ 0.8

8. Netherlands $ 0.5

9. Australia $ 0.4

10. Switzerland $ 0.3

11. South Africa $ 0.2

12. Israel $ 0.1

Source: See pages 61-67

When the eight former Communist countries (Hungary,

Poland, Latvia, Lithuania, Estonia, Slovakia, Slovenia, and

the Czech Republic), as well as Malta and Cyprus, joined the

European Union (EU), the population became approximately

455 million and now has an estimated GDP of $12.5 trillion,

surpassing the U.S. economy. While the combined economies

of the EU are bigger, the U.S. still ranks number one in terms

of relative purchasing power.

Countries Retail Sales/ Retail Sales

GDP U.S. $ billions

United States 27.4% $3,011

Japan 21.8% $ 938

Germany 15.3% $ 367

United Kingdom 18.8% $ 338

France 19.2% $ 334

Canada 16.5% $ 143

Spain 13.2% $ 111

Australia 19.9% $ 81

Netherlands 11.6% $ 59

Switzerland 14.4% $ 45

South Africa 14.8% $ 24

Israel 25.8% $ 28

Source: See pages 61-67

The U.S., with 27 percent of its GDP devoted to retail and overall

retail sales in excess of $3 trillion, has by far the biggest retail

sector of the 12 countries in this report.

OVERVIEW OF THE 12 COUNTRIES’ ECONOMIES

Bright Spots in Europe: United Kingdom, Spain

GDP Growth 1999 2000 2001 2002 2003

United Kingdom 2.8% 3.8% 2.1% 1.7% 2.3%

Spain 4.2% 4.2% 2.8% 2.0% 2.4%

Source: See pages 61-67

The UK’s retail sector, driven by strong housing prices, low

unemployment, and relatively low inflation, played a central

role in the country’s economic growth over the last few years. In

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O VERVIEW

recent years, however, the economy has relied on a rapid growth

of consumer credit, leaving consumers with a heavy debt load.

And while the German and French economies have slowed,

Spain’s economy has performed well over the last five years,

slowing down only moderately in 2002 and 2003. Economic

liberalization as well as government and consumer spending

have driven Spain’s growth.

Consistent Growth – Canada, Australia

GDP Growth 1999 2000 2001 2002 2003

Canada 5.5% 5.3% 1.9% 3.3% 1.7%

Australia 5.4% 3.8% 2.0% 3.9% 2.8%

Source: See pages 61-67

Canada and Australia have experienced relatively consistent

growth, largely avoiding the recession that plagued the U.S. and

others. Both economies enjoyed a mixture of greater economic

openness, privatization, labor reform, and the removal of trade

barriers. In 2003, Canada’s GDP growth stalled over the outbreak

of “mad cow” disease and the SARS epidemic. Australia continued

to benefit from increased investment and productivity gains.

Structural Reform – Germany, France, Netherlands, Switzerland

GDP Growth 1999 2000 2001 2002 2003

Germany 2.0% 2.9% 0.8% 0.2% -0.1%

France 3.2% 4.2% 2.1% 1.2% 0.2%

Netherlands 4.0% 3.5% 1.2% 0.2% -0.8%

Switzerland 1.5% 3.2% 0.9% 0.2% -0.5%

Source: See pages 61-67

Most EU members (as well as neighboring non-members) were

hurt both by a lack of significant structural reform and the

strong euro, which made European exports less competitive. The

economies of Germany, France, and the Netherlands showed

slow to negative GDP growth rates. On the other hand, the UK

and Spain experienced relatively solid growth rates. Switzerland,

not a member of the EU, had a negative growth rate in 2003. Its

growth rate has been below the European rate overall for the last

10 years. Switzerland’s failure to effect meaningful economic

reforms and the strength of the Swiss franc have contributed to

this below-average performance.

Transformation – Japan, South Africa, Israel

GDP Growth 1999 2000 2001 2002 2003

Japan 0.1% 2.8% 0.4% -0.4% 2.7%

South Africa 2.0% 3.5% 2.7% 3.6% 1.9%

Israel 2.6% 7.5% -0.9% -0.8% 1.3%

Source: See pages 61-67

Other countries experienced profound changes for other reasons.

In South Africa, shifting the domestic political situation to

greater democracy – begun 10 years ago – had a significant

impact on retailers as whole segments of the population,

previously unserved by stores, became large new target markets.

Japan’s long recessionary climate forced a restructuring of

distribution and retail, opening up the economy to larger stores

and foreign retailers. In Israel, the economy was deeply affected

both by the Israeli-Palestinian conflict and a transformation from

reliance on manufacturing to a focus on technology.

Turnaround – United States

GDP Growth 1999 2000 2001 2002 2003

U.S. 4.5% 3.7% 0.5% 2.2% 3.1%

Source: See pages 61-67

Enormous changes in world economies over the last five years

have influenced consumer spending and retailing in the 12

countries in this report. The U.S. economy went through a brief

recession and a jobless recovery. Only in 2004 did job creation

pick up. In addition, the post-9/11 economy resulted in depressed

consumer spending and price deflation in many non-food

product categories.

GLOBAL TRENDS – 2003

Governmental Regulations

Although governmental regulations varied from country to

country, all countries in this report had regulations concerning

working conditions and hours. While many countries in the

study had regulations governing retail expansion, the biggest

exception was the U.S., which allows local communities to

regulate zoning. These communities can and do exclude certain

retail development projects based on legislatively approved

zoning codes. Some countries have seen consumer spending

G LOBAL PRICING TRENDS

4


grow through deregulation measures and other countries’ retail

sectors have been hindered by regulations. Strict “big store” or

“hypermarket” laws have had a major impact in both Germany

and France. In France, for example, there are two restrictive laws

– the Raffarin Law and the Galland Law:

• The Raffarin Law (1996) tightened commercial zoning

regulations and required government authorization of

large retail outlets. This law is so restrictive that only four

hypermarkets were created in 2003 in the whole of France.

As a result, discounters have been able to get significant

market share at the expense of hypermarkets.

• The Galland Law (1997) essentially provides a price

umbrella for discounters, who are making significant inroads

into the French hypermarkets. Many critics say the Galland

Law is a major cause of branded product inflation; calls for

its amendment are frequent. One result of the law has been

growth of private labels, which are not restricted.

In Germany, retailing has long been tightly regulated, focusing

on store trading hours. Reorganization of shopping hours in 1996

and the 2001 annulment of the German discount law, dating from

1933, were first steps in liberalizing German retailing. Extra

Saturday shopping hours were added in June 2003. Restrictive

retail laws might be one of the reasons for the lack of growth in

both the French and German economies.

Deregulation has played a role in Japan’s retail sector in the last

decade, largely due to the prolonged economic slump and the

government’s efforts to stimulate consumer spending. The much

less restrictive Large-Scale Store Location Law replaced the

Large-Scale Retail Store Law, which had protected small-, and

medium-sized retailers against big stores. This new law is less

restrictive on store size, closing times, and operating days, and

lessens the social impact of large stores by regulating noise and

traffic levels.

Security creates special concerns for the Israeli government

because of the Israeli-Palestinian conflict. Security regulations

are imposed on all public places in Israel, including retail stores,

and these structures increase operating expenses for all retailers.

Consolidation and Global Expansion

Consolidation in the retail sector has occurred in many

countries in this study. This is certainly true of the U.S.,

where consolidation in department stores, supermarkets, and

discounters has been significant, especially in the late 1990s.

Despite the narrowing of competition from five major players

to three in some retail sectors, the U.S. market is so large that

the largest retailer in the U.S. captures only 8 percent of retail

sales. Two large department store chains in Australia account

for more than 80 percent of that market, despite more entries

in apparel retailing. In Switzerland, two retail chains account

for approximately 70 percent of the market. In the Netherlands,

the two largest retailers dominate in both mass merchandising

and food. In Japan, small stores still dominate the retail market

– for now. Deregulation has allowed more growth among largescale

retailers, and many foreign retailers have been lured into

opening stores or buying equity positions in Japanese retailers.

Global expansion by mega-retailers is occurring in the emerging

nations of Southeast Asia, China, and Latin America as well as

in the industrialized nations of Europe and Japan. Expansion into

industrialized countries generally will be through acquisitions,

helping to consolidate the retail market further.

Consumers Like Low Prices

Consumers around the globe are looking for bargains. German

consumers are well known for being frugal; even the Japanese,

avid shoppers for name brands, are now evolving into bargain

shoppers as a result of their country’s long economic malaise.

This worldwide focus on thrift has made mass merchandising

of both food and clothing the most popular segment of retailing.

In more developed countries, the growth of mass merchandising

comes at the expense of department stores.

Societal Forces

Retailing is an excellent lens through which to view societal

changes. In South Africa, for example, democratization over the

last decade shows how retailers have shifted their target market

focus. After 1994, retailers that had targeted upscale buyers

refocused their strategies on low-income consumers, by far the

largest segment of their market. In Israel, the Palestinian-Israeli

conflict and resulting security concerns have prevented the entry

of large international retailers.

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O VERVIEW

Competition and Overcapacity

Across the world, retailing remains highly competitive because

of too much retail square footage and too few consumers. This is

evident in the U.S., where many retail segments are undergoing

restructuring and consolidation, most notably supermarkets

and regional discount chains. The expansion of big mass

merchandisers led to the disappearance in the U.S. of many

regional discounters and supermarkets through liquidation or

mergers. Israeli retailing also suffers from overcapacity issues,

with large food chains gaining market share. In Switzerland,

expansion by foreign retailers is still occurring, even though two

Swiss retail giants dominate the highly saturated market.

Channel Blurring

Some countries are seeing so much competitive activity that

many retail sectors are experiencing channel blurring, wherein

retailers in one sector attempt to penetrate another sector. The

best example in the U.S. is the growth of numerous outlets where

food is sold. In addition to traditional supermarkets, food is now

offered at supercenters, warehouse clubs, dollar stores, and drug

stores. Channel blurring is also occurring in Canada, again most

prevalently in the food category.

TRENDS IN GLOBAL PRICES

Apparel

Apparel price deflation occurred over the last 5 years in 11 of the

12 countries in this study. Most striking is the fact that apparel

deflation did not depend on changes in a country’s GDP. For

example, in the U.S., despite a buoyant economic climate in

the late 1990s, apparel deflation began to appear – entirely as a

result of productivity gains.

Reasons for Apparel Deflation:

• The growth of low-cost labor markets among

emerging nations.

• Improved manufacturing productivity due to

technological advances.

• Overcapacity at retail.

• Growth of low-price, private-label merchandise.

• Elimination of apparel quotas.

G LOBAL PRICING TRENDS

6

Low-Cost Labor Markets

Many emerging nations view apparel as an industry that does not

require high investment or skill on the part of employees; in turn,

apparel manufacturers look for cheap labor markets that would

welcome such an industry. Over time, the number of places

where apparel is manufactured has expanded throughout the

globe, including all parts of Asia, Africa, the Caribbean, Eastern

Europe, and Latin America. Apparel manufacturing jobs have

largely left the U.S., although Western Europe still manufactures

high-end couture apparel and footwear. The end result has been

an overcapacity of apparel manufacturing, causing prices to drop.

Improved Productivity

Improved productivity has also contributed to apparel price

deflation, the result of successful application of technology that

drives down operating expenses and inventory levels. Better

coordination between manufacturers and retailers in the ordering

process has also helped.

Retail Overcapacity and Private Label

Overcapacity at retail became apparent as many countries’ retail

space grew considerably. Retailing around the globe became

more promotional, and in all countries the growth of massmerchandisers

led the way in store gains. In many countries,

channel blurring occurred, leading to aggressive pricing

promotions, as new entrants into retail or product categories used

lower prices to attract customers. In poor economic climates –

most notably Japan – weak consumer demand led to further

apparel deflation. At the same time, the introduction of privatelabel

apparel gave many retailers greater margins by eliminating

the middleman while simultaneously offering consumers lower

prices than national brands, driving further price deflation.

Elimination of Apparel Quotas

When the global apparel quota system ends in January 2005,

there will likely be a profound transformation in apparel prices

worldwide. China is already the largest supplier of apparel in

the world, and its manufacturing efficiencies and low labor costs

may drive out smaller country competitors. What will occur at

the retail level Much will depend on how well retailers have

managed their operating and inventory costs. The strength

of individual economies will also be a driving factor. In a

buoyant economy, consumers will spend more on attractive


and fashionable merchandise, and retailers will not have to

pass along much of their cost savings. But in a poor economy,

the reverse will be true: Retailers will be forced to surrender

any cost savings to their customers. The accompanying charts

illustrate the varying levels of price inflation and deflation

experienced by countries in the study. Only one country,

Spain, has seen no apparel price deflation in recent years

due to structural and regulatory inefficiencies in the Spanish

distribution network.

Exhibit 2

Annual Percentage Change

12%

10%

8%

6%

4%

2%

0%

-2%

-4%

Apparel: Low Deflation

Canada

Germany

Japan

United States

Exhibit 1

-6%

-8%

-10%

Annual Percentage Change

12%

10%

8%

6%

4%

2%

0%

-2%

-4%

-6%

-8%

-10%

-12%

Australia

France

Spain

Apparel: Inflation

1998 1999 2000 2001 2002 2003

Years (Quarters)

Sources: Australian Bureau of Statistics, France National Institute for

Statistics and Economic Studies (INSEE), National Statistics Institute

of Spain

Countries with Some Apparel Inflation

• Spain is the only country in the study with no deflation from

1998 to 2003.

• Australia has experienced alternating bouts of inflation and

deflation; the recent trend has been deflationary because of

highly competitive conditions in the retail segment.

• France’s apparel inflation rate has ranged between nearly

0 percent to slightly deflationary during the last five years

thanks to discounters and a trend toward outsourcing of

manufacturing to low-wage countries.

-12%

1998 1999 2000 2001 2002 2003

Years (Quarters)

Sources: Statistics Canada, German Federal Statistical Offi ce, Statistics

Bureau of Japan, U.S. Bureau of Labor Statistics

Countries with Low Apparel Deflation

• Japan had the most consistent rate of apparel deflation due to

its poor economic performance and weak consumer demand;

at the same time, a restructuring of the retail market that

emphasized elimination of distribution bottlenecks coincided

with growing acceptance of discounting. Traditionally frugal

consumers who became even more focused on prices due

to a weak economic environment drove Germany’s apparel

deflation, and overcapacity was also a factor.

• U.S. and Canadian apparel prices were impacted by

overcapacity, outsourcing to low-wage countries, the growth

of private label, and productivity gains in supply chains and

manufacturing.

• In Canada, new entrants into the market increased

competition at retail, while channel blurring and the rise of

discounters put pressure on apparel prices.

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Exhibit 3

Annual Percentage Change

Apparel: High Deflation

12%

10%

8%

6%

4%

2%

0%

-2%

-4%

-6%

-8%

-10%

-12%

1998 1999 2000 2001 2002 2003

Israel

Netherlands

South Africa

Switzerland

United Kingdom

products. Supply chain fears in the form of disease (e.g., “mad

cow”) can impact pricing; one instance of “mad cow” disease

in Canada closed the Canadian beef market and sent the price

of beef soaring. Low levels of consumer demand can also

cause prolonged bouts of deflation, as happened in Japan. In

the UK, food and beverage prices fluctuated, but there were

also bouts of deflation due in part to the buying power of large

supermarket chains. This factor has decreased the price of not

only food, but clothing (supermarket chains sell clothing) and

certain household items (e.g., electrical goods). In Australia,

the two largest retailers increasingly used promotions to attract

customers and grow market share.

Years (Quarters)

Exhibit 4

Sources: Israel Central Bureau of Statistics, Statistics Netherlands

(STATLINE), Statistics South Africa, Swiss Statistics, UK National

Statistics

Countries with High Apparel Deflation

• Israel’s deflationary trend stems from its weak economy, the

Israeli-Palestinian conflict, the highly competitive nature of

Israeli retailing, and a decrease in customs duties.

• South Africa’s apparel deflation was caused by the retail

market’s focus on discounting in an effort to increase market

share among low-income consumers. In addition, high food

prices caused retailers to reduce clothing prices in order to

move product and maintain market share.

• Deflation has been particularly severe in the UK apparel

segment because of channel blurring, as big supermarket

chains penetrated the clothing segment and attracted valueconscious

consumers.

• The Netherlands and Switzerland also experienced

steep drops in apparel prices due to overcapacity in the

retail segment, a focus on discounting, poor economic

performance, and weak consumer demand.

Food and Beverage

The food and beverage sector for practically all countries

has been mostly inflationary, for a variety of reasons. Food

prices are highly volatile, especially meats, poultry, and dairy

Annual Percentage Change

20%

16%

12%

8%

4%

0%

-4%

Food & Beverage: High Inflation

1998 1999 2000 2001 2002 2003

Years (Quarters)

Sources: Australian Bureau of Statistics, Israel Central Bureau of

Statistics, Statistics South Africa

Australia

Israel

South Africa

Countries with High Food Inflation

• Compared with other countries in this study, Israel, Australia,

and South Africa experienced relatively high food inflation.

• South Africa had the highest food price inflation – close to 20

percent in 2003 – but inflation began to subside because of

the stronger rand, the deregulation of the agricultural sector,

and a rapid rollout of new retailing space.

• Food price inflation has dropped in Israel in recent years

because of the growing market share among grocery chains

that deliver quality at low prices.

G LOBAL PRICING TRENDS

8


Exhibit 5

Annual Percentage Change

20%

16%

12%

8%

4%

0%

-4%

Food & Beverage: Low Inflation

1998 1999 2000 2001 2002 2003

Years (Quarters)

Canada

France

Spain

Switzerland

United States

Sources: Statistics Canada, France National Institute for Statistics and

Economic Studies (INSEE), National Statistics Institute of Spain, Swiss

Statistics, U.S. Bureau of Labor Statistics

Countries with Low Food Inflation

• Canada, France, Switzerland, and the U.S. all experienced low

levels of food price inflation because of intense competition

in the food retail segment, overcapacity at retail, the growth of

low-price private-label products, and channel blurring.

• In Spain, the high cost of distribution and other structural

issues meant that food price inflation was consistently the

highest in this group.

Countries with Food Deflation

• In the UK, food prices have experienced several bouts with

deflation in the last five years due to the competitive nature

of food retailing.

• Japan has experienced food deflation due to a poor

economy, weak consumer demand, and restructuring in

retail distribution.

• Early in the second half of 2003, the Netherlands’ food retail

sector was deflationary due to an early-autumn price war

between supermarket chains.

• In Germany, food prices dropped from the end of 1998 until

2002, but then rose sharply because of the introduction of

the euro. Between 2002 and 2003, food prices were volatile,

dropping and then rising in the summer of 2003 because of

unusually hot weather.

Household Furnishings

This merchandise category has been the most diverse in terms of

price changes, although most countries in this study experienced

inflation. Certain countries experienced deflation brought on by

declining demand (Japan) or other circumstances. In Israel, weak

consumer demand resulted from security concerns, a struggling

world economy that depressed Israel’s high-tech sector, and high

levels of unemployment.

Exhibit 7

Exhibit 6

12%

Netherlands

Household Furnishings: High Inflation

Annual Percentage Change

20%

16%

12%

8%

4%

Food & Beverage: Deflation

Germany

Japan

Netherlands

United Kingdom

Annual Percentage Change

10%

8%

6%

4%

2%

0%

-2%

-4%

-6%

South Africa

United States

-8%

0%

1998 1999 2000 2001 2002 2003

Years (Quarters)

-4%

1998 1999 2000 2001 2002 2003

Years (Quarters)

Sources: Statistics Netherlands (STATLINE), Statistics South Africa,

U.S. Bureau of Labor Statistics

Sources: German Federal Statistical Office, Statistics Bureau of Japan,

Statistics Netherlands (STATLINE), UK National Statistics

9

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O VERVIEW

Countries with High Household Furnishings Inflation

• In the Netherlands, South Africa, and the U.S., household

furnishings price inflation was high compared with other

countries in this study, although 2002–03 prices declined

because of increased overseas sourcing.

• In the U.S., the consistent strength of the housing market

pushed up demand for household furnishings

Exhibit 8

Annual Percentage Change

12%

10%

8%

6%

4%

2%

0%

-2%

-4%

-6%

-8%

Household Furnishings: Low Inflation

1998 1999 2000 2001 2002 2003

Years (Quarters)

Countries with Low Household Furnishings Inflation

• There was minimal inflation for household furnishings in

Canada, France, Germany, Spain and Switzerland.

• Spain had the highest consistent level of inflation because of

structural inefficiencies.

Canada

France

Germany

Spain

Switzerland

Sources: Statistics Canada, France National Institute for Statistics and

Economic Studies (INSEE), German Federal Statistical Offi ce, National

Statistics Institute of Spain, Swiss Statistics

Exhibit 9

Annual Percentage Change

12%

10%

8%

6%

4%

2%

0%

-2%

Household Furnishings: Deflation

Australia

Israel

Japan

United Kingdom

Countries with Household Furnishings Deflation

• Israel experienced tremendous volatility in the household

furnishings sector from 1998 to 2003, due to low consumer

demand and a troubled domestic economy.

• Japan’s long economic recession was the main reason for

deflation in this sector; the weak economy resulted in poor

consumer demand.

• In the UK, aggressive promotional activity in furniture and

furnishings kept prices mostly deflationary.

2004 and Beyond

In 2004, an improving global economy began to drive

commodity inflation, which will, in turn, begin to drive higher

retail prices. Higher gasoline prices worldwide will also drive

inflation, perhaps enough to crimp economic growth. The

willingness of retailers to raise prices will depend on a number

of variables:

• The strength of a particular economy: A recovering economy

can better sustain price increases than a weak economy.

• The composition of a particular retail sector: Discounters

will be more reluctant than other types of retailers to raise

prices at retail because of their mass-market focus; the

greater their market share in a particular country, the less

inflation can be expected.

• Individual retailer strategies: Retailers’ strategies vary, and

maintaining a low-price image might be more important

than margin pressure to some companies. For example,

supermarkets in the U.S. are fighting alternative retail

formats such as supercenters and will likely defend their

“low price” image.

• Operating efficiencies: Some retailers have achieved real

operating efficiencies and can withstand inflationary

pressures longer than competitors saddled with higher costs.

• Supply chain efficiencies: Efficient supply chains will be

the key to profitability for both the retailer and consumer

products manufacturer.

-4%

-6%

-8%

1998 1999 2000 2001 2002 2003

Years (Quarters)

Sources: Australian Bureau of Statistics, Israel Central Bureau of

Statistics, Statistics Bureau of Japan, UK National Statistics

G LOBAL PRICING TRENDS

10


Australia

Christopher George, RCP Leader, Australia

Overview

The retail industry in Australia consists of a diverse mixture

of outlets and players, including large shopping complexes,

small strip-shopping centers, major retailing chains, and

small, stand-alone businesses. Retailing is Australia’s largest

employer, representing 17 percent of the total workforce, ahead

of both manufacturing and property and business services.

Employment is concentrated in the supermarket/grocery, food

retailing, and department store sectors, which together comprise

approximately 63 percent of the retail workforce. Increased

household spending in 2003 was underpinned by improvement

in the labor market, evidenced by a relatively low unemployment

rate of approximately 6 percent, real wage increases, and

housing-related wealth gains. These factors have encouraged

customers to borrow against the equity in their homes and to use

personal credit to spend. Large direct importers have benefited

from the rise of the Australian dollar, as it has appreciated by

over 20 percent against the U.S. dollar since early 2003. Strong

competition in the retail market caused most of these exchange

rate gains to be passed on to customers in the form of lower

prices, causing price deflation in the general merchandise

market. In particular, price deflation has affected technology and

electrical products.

Australian Government and Retail

At the Commonwealth level, the 1974 Trade Practices Act is

the primary legislation that addresses anti-competitive or unfair

market practices, regulating the retail sector. The Australian

Competition and Consumer Commission (ACCC) administers

the Trade Practices Act, which covers exclusive dealing, price

discrimination, resale price maintenance, and the abuse of

market power by firms with a substantial market share. The retail

sector also is regulated by the Prices Surveillance Act, which was

implemented by the government in 1983. Since 1995, the ACCC

has administered the act, and has the power to:

• Veto proposed price increases by businesses under price

surveillance

• Inquire into pricing practices

• Monitor prices, costs, and profits of businesses

Government regulations on business licenses – including store

trading hours and hours of operation, permits, tenancies, and

leasing – vary from state to state, but there is a movement toward

uniform retail tenancy legislation.

Retail Structure

A two-decade trend of retailers moving away from suburban

shopping strips and toward large shopping malls – which also

incorporate a range of entertainment venues such as cinemas

and game arcades – is beginning to wane. There are too many

large suburban shopping malls in many areas, and the market has

largely reached saturation. As consumers begin to seek unique

retail experiences, the trend of retailers moving back to suburban

shopping strips has gathered momentum.

In Australia, the department store sector is relatively

consolidated, with two dominant players accounting for

82 percent of the market. Overall, the department store

segment is losing market share, but store restructuring and

refurbishments, heavy discounting, the launch of new and

exclusive brands, and positive consumer sentiment have

helped to stem market share losses.

The recent emergence of “bulky goods centers” (that offer a

comprehensive range of homewares/household merchandise) and

factory outlet centers are the sector’s latest response to shoppers’

changing requirements.

Growth in food sales increased at a slower pace in 2003 and

into 2004. Inflation and intense competition have caused

a slowdown in grocery retail growth. However, analysts

anticipate an increase in food sales, and Australia’s major food

retailers are moving ahead with plans to open more than 80

supermarkets in the next 12 months despite fears the new stores

will damage sales at existing locations. Overall, the food sales

sector is facing a period of prolonged margin contraction and

deteriorating returns.

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A USTRALIA

The apparel sector is becoming increasingly competitive,

with strong growth at both smaller chains and independents.

These small operators prefer to operate outside large suburban

shopping malls. The larger clothing chains, franchised retail

outlets, and innovative specialty retail formats are expanding

more rapidly than stand-alone operations.

Reasons Behind the Economic Climate

“The Australian dollar’s appreciation relative to the U.S. dollar

throughout 2003 has made U.S. imports cheaper, and allowed

most retailers to enjoy improved margins through lower costs

and increased consumer demand” says Christopher George,

Australia’s Retail and Consumer Products Leader. However,

intense competition has forced many retailers to pass on all

or most of these savings, especially for audio/visual products.

Computer, audio/visual goods, and motor vehicle prices have

been declining since mid-2001, contributing to deflation.

Apparel sales have been moderate to strong into 2004 due to

robust competition among department stores and other fashion

outlets. Cheaper imports and discounting have kept prices down.

Clothing retailers, highly dependent on imports (almost

55 percent of total apparel sales), have benefited from the strong

Australian dollar.

Household goods retailing has grown at a steady pace because

of vigorous housing construction and renovations, although the

growth rate has been slowing since June 2003.

2004 and Beyond

Of some concern is the poor state of household savings

and the heavy reliance on borrowing to fund any additional

consumption. Currently, household debt levels represent almost

150 percent of total income. Households are likely to ease their

spending in the light of a steady accumulation of debt and the

possibility of further rate rises later in 2004. More restrained

house price increases and slower employment growth are also

likely to moderate the pace of retail trade in 2004. The projected

soft landing for the property market suggests that household

spending is not expected to experience a severe downturn.

Positive employment forecasts are also expected to soften the

slowdown in household consumption.

Demand for household goods and spending in the café and

restaurant areas are not likely to be as buoyant as in the past few

years, but sales should improve for supermarkets/grocery stores

and other food retailing stores. Sales in household goods in

particular, are likely to come under pressure due to a slowdown

in the housing/property market. With customers driven by value,

competition from bulky goods stores and specialty fashion stores

is expected to be strong and department stores will continue

to face price pressures and tight margins. The outlook for

department stores in later 2004 is for slower growth, reflecting

a moderation in private demand. However, competition for

the consumer dollar will remain intense with domestic travel,

recreational goods and car purchase sales expected to grow

in later 2004, albeit more moderately than last year. Overall,

underlying growth remains positive for the Australian retail sector.

Dealing with the Economic Climate

The Australian retail industry is highly competitive, compelling

retailers to minimize costs, in particular labor costs, which

account for 12.4 percent of revenue. Increases in mandatory

superannuation contributions (employer mandated retirement

funds) as a share of labor costs added to the increase in wages.

Retail industry efficiency will continue to be affected by

information technology, particularly in the area of inventory

control, via technologies such as electronic data exchange

and scanning. Major players have implemented e-commerce

strategies for both the supply and demand sides of their

businesses to improve efficiency and cut costs. Several players

have refurbished stores, altered product offerings, and improved

layouts to meet changing consumer demands. Major retailers, led

by the department stores, have engaged in higher-than-normal

levels of discounting in response to lower-than-expected FY03

results. This trend is likely to continue as major retailers deploy

aggressive tactics in a push for greater market share.

Declining inflation in the food retailing sector has spurred the

major supermarkets to seek growth through liquor retailing

and discount fuel strategies, enabling them to attract additional

customers, enhance customer loyalty, dominate the liquor

retailing sector, and capture significant market share in the petrol

retailing sector. Through alliances with key petroleum suppliers,

G LOBAL PRICING TRENDS

12


these players have ventured into combined convenience store

and fuel operations. Retailers have reported positive consumer

response to fuel discounts (e.g., spend $30 or more in one

transaction and receive four cents off per liter of fuel). There

have been market share changes in the supermarket sector as a

result of the timing of the rollout of the petrol offer by the major

supermarket chains, but the long-term effects are uncertain. The

next sector under consideration by supermarkets is pharmacy;

however, legislative hurdles will need to be overcome to allow

their entry into this lucrative market.

Deflation in the specialty electrical retailing sector, a key

growth area in recent years, has resulted from the strength of the

Australian dollar, which reduced prices of technology. Continued

advances in technology, aggressive marketing, and Australians’

tendency to be early adopters of new technology have helped to

counter the impact of deflation.

The Australian retail market has traditionally been one of the

most concentrated in the world. However, specialty chains and

franchise operators that are swift to understand and meet rapidly

changing consumer demand have increased overall competition

in the retail sector. At the same time, consumer demand has

shifted in favor of specialty outlets with an emphasis on service.

Department stores will continue to add specialty stores to their

existing chains to improve profit margins and increase sales.

Smaller operators will increasingly merge with each other to

increase their economies of scale and remain viable.

Exhibit 10

14%

12%

Australia

Percentage Change in CPI Relative to Previous Year

All Groups

Food and Non-Alcoholic Beverages

Alcohol and Tobacco

Apparel

Household Furnishings

Annual Percentage Change

10%

8%

6%

4%

2%

0%

1998 1999 2000 2001 2002 2003

-2%

-4%

Years (Quarters)

Source: Australian Bureau of Statistics

Discussion of Graph

Exhibit 10 illustrates inflation and deflation trends from 1998 to 2003 for all groups, food and non-alcoholic beverages, alcohol and tobacco, apparel, and household furnishings.

All groups began at -0.2 percent, peaked in 2001 at 6 percent, but dipped to 2.4 percent in 2003. The price of most goods rose from 1 July 2000, after the introduction

of the Goods and Services tax. Food and non-alcoholic beverages experienced inflation steadily throughout the 5 years, and remained at 3.4 percent at the end of 2003.

In mid-2000 to mid-2001, alcohol and tobacco experienced a significant peak in inflation, but came down to 1998 levels by 2003. Apparel and household furnishings also

experienced peaks in mid-2000 to mid-2001.

13

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Canada

Jacques Dostie, RCP Leader, Canada

Canadian Economy and Retail

Canada’s economy has experienced strong growth over

the last four years. However, in 2003 growth slowed to 1.7

percent, down from 3.3 percent in 2002. Why The value of

the Canadian dollar rose 22 percent relative to the U.S. dollar,

which resulted in fewer exports. Other factors with adverse

impacts on Canada’s economy in 2003 include the SARS

outbreak, the electrical blackout that affected Ontario and much

of the northeastern U.S., and fears about “mad cow” disease,

which led to restrictions on Canadian beef exports. Overall,

Canada’s economy remains strong despite its slower growth.

As the value of the U.S. dollar has fallen in relation to the

Canadian dollar, Canadian retailers who pay for imports in U.S.

currency have benefited. The falling U.S. dollar has lowered

import prices, and, when these savings were not passed on to

consumers, improved gross profit margins.

Retail sales account for approximately 17 percent of Canada’s

GDP. Canada’s diverse economy relies less on consumer

spending (compared with the U.S., for instance) because of its

strong natural resources and manufacturing base.

Canadian Government and Retail

Canadian provincial governments regulate store hours and

shopping periods (e.g., Sunday and holiday store openings). The

federal and provincial governments also impose retail taxes on

consumers. Most provincial governments impose retail sales

taxes (at varying rates), and the federal government imposes

the 7 percent Goods and Services Tax (GST). The federal

Competition Act regulates competitive practices in the Canadian

market, especially regarding mergers; the Privacy Act sets out

how retailers and other businesses may collect, use, and disclose

consumers’ personal information.

Retail Structure

Canadian retailing comprises general merchandise stores (e.g.,

department stores, mass merchandisers) and specialty stores

in a variety of segments. There are many local and regional

players, as well as leading foreign-owned retailers. The

competitive landscape of Canada’s retail industry has changed

significantly over the last decade, with the entrance of large

U.S.-based chains into Canada. The success of discounters, club

stores, and mass merchandisers resulted in a round of intense

consolidation. In some sectors only a couple of large players

remain. The consolidated powerhouses and strong remaining

players are able to achieve economies of scale, supply chain

efficiencies, and increased purchasing power. This results in

improved profitability and increased geographic reach as new

formats, such as discounters and club stores, grow, and mass

merchandisers enter the market and begin to threaten the leading

position of department stores. To compete in this environment,

retailers are reducing their operating costs, streamlining their

supply chains, and investing in information technology.

Lines across channels are increasingly blurring. A prominent

grocery store chain led the charge in offering general

merchandise – clothes, small appliances – as well as services

such as pharmacies, photo finishing, and drycleaning in some

of its formats. This tactic of diversification is also seen in the

drugstore sector, which has, in some cases, branched out into

offering groceries. The concept of channel blurring is also

being implemented by retailers who are forging alliances with

other retailers in order to increase foot traffic. For instance,

a card and gift retailer has a venture with a chocolate and ice

cream retailer where both concepts are being offered in one

store format.

Reasons for Deflation in Canadian Apparel Sector

The factors driving deflation in the Canadian apparel sector are

similar to those in the U.S.:

• New entrants into the market and the increase in the number

of stores in this sector have heightened competition, forcing

many retailers to use price promotions to attract customers.

As is the case in the U.S., Canadian customers have become

used to promotional prices and often defer purchases until

goods are on sale.

• The rise of discount merchandisers has put further downward

pressure on prices. In some cases, discounters offer designer

and brand-name merchandise at discount prices; in other

instances, they offer lower quality goods at bargain prices.

The result is that consumers can now choose from a variety of

15

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C ANADA

price points. Foreign discount and warehouse club retailers,

with global scale and lean supply chains, have increased

pricing pressures. The first signs of deflation in Canada began

soon after the discounters and “category killers” (a product,

service, brand, or company that has such a distinct sustainable

competitive advantage that competing firms find it impossible

to operate profitably in that industry), entered the market in

the early to mid-1990s.

• To counter the competitive threats posed by these new

entrants, Canadian retailers have streamlined their supply

chains, improving operational efficiency and reducing

costs. These savings are then passed on to the consumer (by

department stores and specialty retailers) or added to the

bottom line (by private-label retailers).

• Ironically, a strategy used to increase retailer margins –

private-label merchandise – has added to the deflationary

pressures in clothing and footwear. Private-label merchandise

is usually targeted at price points below nationally branded

merchandise. As a result, consumers purchase the same

quantity of clothing, but pay less for it.

• Channel blurring has also had an impact on prices. Today,

grocery stores sell clothing and general merchandise, while

general merchandisers sell food. Retailers often will use these

non-traditional items as loss leaders to attract customers,

capitalizing on their scale and purchasing power. Grocery

stores, for example, may sell children’s clothing at very low

prices. Food retailers, accustomed to lower margins than

traditional non-food retailers, are increasingly using this tactic.

• To shore up margins and take advantage of lower labor

costs, retailers increasingly turned to offshore sourcing of

goods. These sourcing efforts allowed retailers to maintain or

increase profit margins while lowering prices. The sharp fall

of the U.S. dollar contributed to lower prices in 2003, notes

Daniel Baer, Ernst & Young Canadian Retail Sector Leader.

“A great deal of apparel is sourced many months in advance

from Asia, then paid for later, often in U.S. dollars,” he says.

“Last year, the U.S. dollar declined considerably, resulting in

costs actually falling in the time between placing the order

and paying for the goods.”

2004 and Beyond

The economic slowdown in 2003 resulted in the Bank of Canada

cutting its key overnight interest rate four times from July 2003

to April 2004. The Bank of Canada is expecting core inflation

to average 1.5 percent for 2004 and to reach its 2 percent target

by the end of 2005. The improving U.S. and global economies

will improve Canada’s export market prospects, but a stronger

Canadian dollar may dampen exports and boost competitively

priced imports. Over the long term, this could negatively affect

employment and result in lower consumer confidence.

Low inflation or deflation will likely continue for the medium

term in the clothing and footwear segment. As mass merchandise

retailers continue to use their pricing power with suppliers and

other specialty retailers enter the market with “cheap and chic”

clothing – offering the latest trends at cheap prices – consumers

will continue to demand low prices.

The lifting of World Trade Organization apparel quotas by

January 2005 will also affect Canadian retailers. The removal

of quotas on imported clothing will result in even more imports

of cheaper garments from low-cost producers. These cheaper

goods may allow retailers to increase their margins, notes Baer.

“However, given retailers’ reliance on price promotions, it may

result in further price cuts, negating the impact on gross margin.”

Dealing with the Economic Climate

The high level of competition has made it difficult for retailers

to raise prices. However, retailers can mitigate the effects of

deflation by building private or exclusive brands, which promote

exclusivity in consumers’ minds and allow for higher margins.

Further, to avoid fighting a difficult and losing battle based

on price alone, retailers can improve customers’ shopping

experiences by focusing on issues such as customer service,

customer convenience, and innovative product offerings.

Retailers can also implement and improve customer relationship

management initiatives in order to identify and target their key

customers and discover effective ways to lure them into stores.

Finally, retailers can continue their cost-cutting inventory

reduction efforts.

Big-box retailers, a fast-growing segment of the market, have

historically not been included in Statistics Canada sales figures.

Until mid-2004, they have been classified as wholesalers. The

change in classification is expected to add billions of dollars to

annual retail sales data figures.

G LOBAL PRICING TRENDS

16


Exhibit 11

6%

5%

Canada

Percentage Change in CPI Relative to Previous Year

All Groups

Food and Non-Alcoholic Beverages

Apparel

Household Furnishings

Annual Percentage Change

4%

3%

2%

1%

0%

-1%

1998 1999 2000 2001 2002 2003

-2%

-3%

-4%

Years (Quarters)

Source: Statistics Canada

Discussion of Graph

Exhibit 11 illustrates inflation and deflation trends from 1998 to 2003 for all groups, food and non-alcoholic beverages, apparel, and household furnishings. All groups rose from a low of 0.7

percent at the end of 2001 and peaked in 2003 at 4.3 percent. Inflation then declined steadily during the year, finally resting at 2 percent by the end of 2003. In 2000, apparel remained

minimally inflationary, ending the year at 1.7 percent; in 2001, prices began to decline further, and apparel retailers began to grapple with a deflationary environment. This downward

pressure continued throughout 2002. In 2003, deflation continued for much of the year, but inflation rose to a two-year high of 0.2 percent by the end of the year in this segment. The food

and non-alcoholic beverages segment was inflationary for the entire period from 1998 to 2003. However, inflation rates have declined after peaking at a rate of 5 percent in 2001. Inflation in

this sector has declined steadily since then, ending 2003 at 1.8 percent. Household furnishings have remained at a relatively steady inflationary rate throughout these years.

17

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France

Olivier Macard, RCP Leader, France

Two relatively new laws, the Raffarin and the Galland, have had a

major impact on retailing in France. The Galland Law is seen as

the main cause of several issues:

• Recurring inflation in branded product goods.

• Development of private-label goods.

• Strong growth of the hard discount.

The French government has announced that the Galland Law

will be reshaped.

Overview

The French food retailing market is one of the most highly

concentrated in Europe. The five leading food retailers

have a combined market share of approximately 86 percent.

Hypermarkets and supermarkets dominate the food retailing

scene, representing 66 percent of total food sales. There were

1,264 hypermarkets and 5,616 supermarkets in France in 2003.

The non-food sectors are much more fragmented. Small

independent outlets still dominate some sectors (e.g., books,

jewelers, optical, furniture, and leisure), but they face increasing

competition from large specialty chain stores.

Moreover, food retailers, mainly hypermarkets, are becoming

involved in a wide sphere of product areas, including books/

music, apparel, small electrical appliances, and cosmetics.

In apparel retailing, independent stores and retail chains (with

an average size less than 400 square meters) are the two main

distribution models in France, each accounting for approximately

25 percent of the market. The top 10 apparel retailers represent a

market share of 33 percent.

Highly Regulated Industry

The Raffarin Law (1996) limits the opening of new stores

larger than 300 square meters. It had the effect of freezing the

physical expansion of supermarkets and hypermarkets in France.

In 2003, only four hypermarkets were created.

The Galland Law (1997) prohibits below-cost selling and has

gradually leveled prices of branded products by prohibiting the

sale of articles below the cost price defined in the supplier’s terms

of sale. Additionally, terms of sale are now public information

in France. This law has shifted the focus of retailer and supplier

negotiations toward services (called “commercial cooperation”)

rather than price since price agreements are now transparent.

Since retailers cannot open new hypermarkets (Raffarin Law) or

adopt an aggressive sales strategy by selling at a loss (Galland

Law), market shares vary only slightly.

Recently, a new agreement has been signed between retailers,

manufacturers, and the French Government to make prices

decrease by 3 percent in France by the end of year 2005. The

final agreement (17 June 2004) states that prices should decrease

by 2 percent on national and international branded products until

September 2004, and then by 1 percent in 2005. Retailers and

manufacturers will equally share the cost of the first phase of the

price decrease. Only retailers will finance the second phase.

Price Changes

Most agree the Galland Law has been a cause of inflation for

branded products. Price increases by suppliers can no longer be

offset on the shelves with revenues for services (which cannot be

included in determining the cost of sales). The adoption of the

euro was also considered an opportunity to increase prices.

The number of private-label products on store shelves has

increased dramatically. Retailers have bet on those products to

improve their price image. The market shares of these products

now represent between 20 percent and 30 percent of many

retailers’ sales. Retailers who focused their efforts on limiting

the prices of these products were more successful, as privatelabel

goods are characterized by deflation.

A first attempt to reshape the Galland Law took place with the

“Circulaire Dutreil” in 2003, which suggested that retailers

and suppliers gradually shift revenues from services to rebates.

However, nothing happened, as suppliers were not keen to take

risks in their negotiations with retailers.

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FRANCE

The non-food sector is characterized by deflation, mainly

because of the increasing share that global sourcing is taking in

retailers’ purchases.

In the clothing market, there are two main sources of sustained

price pressure and occasional deflation:

• Intense competition between clothing retailers puts pressure

on prices in all segments of the market. Thanks to improved

technology, competitive pricing, and differentiated offers,

category killers rapidly captured market share in France. This

increased competition resulted in lower prices for consumers.

Price reductions, both in the form of prolonged sales periods

and intra-season sales, are key to clothing retailers’ strategies

for gaining market share and driving sales.

• Productivity gains in textile and clothing manufacturing,

combined with increased sourcing from lower-cost regions

such as Southeast Asia, North Africa, Eastern Europe, and

Turkey, have enabled retailers to reduce costs.

Nonetheless, French consumers seem to sense that prices are

increasing, even if statistics show that inflation is low. There are

several reasons for this:

• Retail offerings have changed, as innovative products with

new prices replace old products.

• New types of consumer spending (e.g., communications,

leisure) have developed.

• Introduction of the euro has been a major contributor

in raising consumer awareness of price, revenue, and

spending, resulting in a search for cheaper alternatives.

• Prices of some sensitive products (e.g., tobacco,

vegetables) have increased.

• Difficult economic conditions led consumers to pay more

attention to their spending.

Reasons Behind the Economic Climate

Difficult economic conditions

• Domestic inflationary pressures are weak because there is

significant excess capacity in product and labor markets after

three years of below-trend growth. In addition, consumer

spending is faltering due primarily to weakened consumer

confidence and rising unemployment.

Consumer value sentiment is on the rise

• The emergence of a more value-oriented consumer profile

across most income categories drives pricing pressures. In

France, hard-discounters have swiftly gained market share in

food and non-food categories, at the expense of traditional

hypermarket and supermarket formats. Hard-discounters

represent 12 percent of food retailing sales.

Discount stores also benefit from French regulations,

which make it more difficult for hypermarket chains to

open stores and prohibit loss-making sales. Hypermarket

operators are now responding to the threat by introducing

discount lines of their own.

2004 and Beyond

In 2004, inflation should be held down by slow improvements in

economic activity, wage moderation, and the strong euro. Intense

competition will also continue to limit the possibility of retailers’

raising prices. In addition, the removal of quotas on Chinese

exports in 2005 promises additional low-price imports into

Europe, especially within the clothing market.

Should the below-cost price floor be changed, expect the

following:

• A shift between services revenues and rebates would mean

lower net results for retailers.

• A refocus by retailers on volume strategy may lead to

reductions in the number of products offered and the

de-listing of suppliers.

• A shifting balance between retail formats as supermarkets

lose ground to hypermarkets.

• Further cost-cutting and organizational reshaping by retailers.

• A probable attempt by retailers to shift part of these burdens

onto suppliers through changes in the supply chain and the

development of short-inventory management.

Nevertheless, any restructuring of the Galland Law will likely

not occur quickly because of the law’s far-reaching effects.

G LOBAL PRICING TRENDS

20


Exhibit 12

Annual Percentage Change

20%

18%

16%

14%

12%

10%

8%

6%

4%

France

Percentage Change in CPI Relative to Previous Year

All Groups

Food and Non-Alcoholic Beverages

Alcohol and Tobacco

Apparel

Household Furnishings

2%

0%

-2%

1998 1999 2000 2001 2002 2003

Years (Quarters)

Source: France National Institute for Statistics and Economic Studies (INSEE)

Discussion of Graph

Exhibit 12 shows inflation trends from 1998 through the end of 2003 for all groups, food and non-alcoholic beverages, alcohol and tobacco, apparel, and household furnishings. All groups were

relatively stable through the period; by the end of 2003, inflation reached 2.2 percent. Food and non-alcoholic beverages peaked in 2001, and then dropped sharply in 2002 to 1.4 percent

before rising to 2.4 percent in late 2003. Apparel experienced deflationary trends with negative price changes in 2000 and 2003.

21

©2004 EYGM LIMITED


Germany

Thomas Harms, RCP Leader, Germany

Overview

The German retail market, the most important in Europe and

the third largest in the world, is home to some of the largest

retail groups in Europe. Germany gave birth to the discount

format, which has had a strong influence on German buying

habits ever since. Paradoxically, the German retail sector has

faced a negative sales trend in recent years even as retail space

increased. Inflation-adjusted sales in 2003 were lower than in

1995; total retail sales of 320 billion euro in 2003 represented a

decrease of 0.8 percent in real terms versus 2002. The problems

within the retail sector are not just related to the weak economy

in Germany, but have structural causes as well, including:

• The modest recession, high unemployment rate, and

political reforms led to low consumer confidence and

increased consumer focus on price. Discussions about

price increases related to the introduction of the euro have

exacerbated this trend.

• The share of retail spending as part of private consumption

shrank from 42 percent to below 30 percent since the

beginning of the 1990s. Even additional disposable income

would have had limited benefit for retail.

• Competition in the German retail sector is mainly based

on price. The retail slogan seems to be: “Thriftiness is

cool!” Pressure on margins is growing, and the discounters’

market share is rising.

• Retail space per inhabitant in Germany exceeds that

of comparable countries, affecting retail shelf space

productivity, yet the expansion of retail space is continuing.

German Government and Retail

Traditionally, the German retail sector has been highly regulated

and strongly influenced by trade unions. The reorganization of

shopping hours in 1996 and the 2001 annulment of German

discount laws (dating from 1933) were first steps toward a

more dynamic and competitive retail environment. Extending

Saturday shopping hours until 8 p.m., starting in June 2003,

led to sales increases at inner-city shops and department stores.

The German government is discussing further liberalization of

shopping hours, but there are still many restrictions for retailers,

including labor laws, land-use and environmental protection

regulations, and the law against unfair trading. Advocates of

further deregulation have difficulty gaining ground because of

political issues such as high non-wage labor costs and employee

dismissal protection. Political reforms in 2004 are unlikely to

lead to immediate benefit to retailers.

Retail Structure

Germany’s retail structure continues to experience dramatic

changes and problems. Ten companies control more than onefourth

of German retailing, a relatively low concentration in

comparison to other European countries. Overall, the number

of retail companies declined approximately 15 percent between

1995 and 2000. The winners in this changing and saturated

competitive environment have been and will continue to be the

discounters, specialty retailers, and chain stores. The largest

losers are traditional small- and medium-sized specialty dealers,

whose 1980 market share of 55.4 percent is expected to plummet

to just 25 percent by 2010.

The German retail industry is plagued by structural problems.

A glut of retail space, the undifferentiated profile of many retail

outlets, retailers’ low equity ratios, inefficiencies in back-office

processes, and growth in the breadth and depth of product ranges

are just a few of these issues. Recent price wars have added

to these problems by turning consumers into bargain hunters

without offering retailers any long-term solutions. Discounters

have profited from this situation, gaining a market share of

40 percent in food retailing.

Despite lingering problems, an Ernst & Young survey, “Retailers

at the Crossroads: Risks and Rewards on the Road to Recovery,”

April 2004, indicated the German retail sector is looking to the

future with optimism. Study participants expected a wave of

consolidation and predicted, in contrast to prior years, that some

large-market participants (retailers with a significant market

share) will make their exit in the coming years.

Reasons for Price Development

The German Federal Statistical Office has observed a

long-term trend toward declining inflation since the mid-1970s.

Globalization and access to international markets are the main

reasons for this development during the last decade; production

costs dropped significantly due to flexibility in the selection

23

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G ERMANY

of production sites. The consumer is now able to select from a

range of international products, limiting retailer-pricing power.

Retailers have passed along savings to consumers in the form

of lower prices to boost their top lines and gain market share.

These developments coincided with an economic downturn in

Germany, as high unemployment rates and political reforms led

to declining consumer confidence and demand, resulting in an

even more intense focus on price.

In the apparel sector, discounters made significant inroads and

vertical retailers were selling fashion at low prices. Food retailers

faced a similar situation, with discounters holding a 40 percent

market share. Discussion about price increases in food following

the introduction of the euro caused even stronger consumer

sensitivities to price.

2004 and Beyond

Analysts forecast consumer price inflation to fall to 0.9 percent

in 2004 after averaging 1.0 percent in 2003. Overall deflation is

not likely to occur, although it cannot be ruled out, particularly

if the euro becomes stronger over the coming months. The weak

economy, the strong euro, lower oil prices, and wage temperance

will keep inflation at a low level; the current forecast is 1.5

percent for 2005.

Consumers are expected to save significant proportions of their

income due to continuing job insecurity and worries about their

financial situations. At the same time, higher contributions to

welfare will likely limit any increase in disposable incomes.

The consumers’ willingness to buy is still at a historically low

level, according to the opinion research center GfK (Market

Research Institute – Gesellschaft für Konsumforschung). In

addition, competitive pressures will remain intense, meaning that

price increases at retail will come slowly if at all. Only alcohol

and tobacco are projected to be inflationary in 2004 due to tax

increases of 1.2 cents per cigarette in March and December.

“We expect that apparel will follow the deflationary trend in

the U.S.,” says Thomas Harms, Ernst & Young Industry Leader,

Retail and Consumer Products, Germany. “The sector could

experience even more vigorous price reductions beginning in

2005. The elimination of apparel quotas on January 1, 2005,

could mean price reductions of 15 percent over time. China

may emerge as a dominant source for apparel but will not be

able to monopolize the apparel trade because of retailers’ and

manufacturers’ needs to have multiple sources. Those retailers

that have efficient supply chains will be most able to survive

apparel-pricing pressures.”

Consumer preferences for low-priced casualwear and activewear

have put additional pressures on retailers. “Because apparel

sourcing is based on the U.S. dollar,” says Harms, “a further

weakening of the U.S. dollar in comparison to the euro would

ease profit margin pressures in Germany, but the opposite

development would force consolidation in the market.”

In food retailing, the elimination of farm subsidies will likely

drive lower prices for agricultural products, as the EU gave

the German government until mid-2004 to decide how direct

payments to agriculture would be stopped. As a result, significant

structural changes are expected in the meat and dairy industries.

Dealing with the Economic Climate

The inability to raise prices has caused retailers to focus on

other business processes. Reduction of personnel expenses and

premises costs are still high priorities in the industry. However,

optimization of internal processes and financial controls also

are becoming important. Maintaining an efficient supply chain

that guarantees a constant flow of new merchandise is essential

in driving traffic and boosting margins. There is a trend toward

vertical diversification in apparel.

Retailers have learned that allowances and vendor rebates are

not profit drivers. In fact, their use makes the supply chain

increasingly unmanageable due to significant peaks and

valleys in inventories. These inventory swings not only impact

distribution center stocking levels and in-store presentations, but

also create significant cash-management challenges, including:

• Managing working capital investments.

• Inventory sell-through and markdown strategies around

volume and/or off-season buys.

• Shelf-space productivity.

• Incremental resets of displays.

Aggressive management of allowances and vendor rebates is

essential in decreasing these burdens.

G LOBAL PRICING TRENDS

24


Retailers also will need new technologies to improve margins,

including:

• Inventory management systems to reorder out-of-stock

merchandise.

• Price optimization programs to manage promotions and

markdown activities.

• Customer relationship management (CRM) programs to

target loyal customers with more effective promotions and

loyalty programs.

Professional real estate management is yet another way to

improve margins. Portfolio analyses, lease contract controlling,

and divestiture of unprofitable locations are just a few of the

options available to creative retailers.

In addition, retailers will have to distance themselves from

discount prices, positioning themselves instead as retail brands.

This will require them to extend their share of the value-added

chain by offering services along with goods. According to

“Retailers at the Crossroads,” approximately 70 percent of

companies expect services in connection with products to

increase in importance.

Investment, often substantial, is needed to realize the full

potential of cost cutting as well as to attain a position as a retail

brand. However, financing new investments is a problem for

medium-sized retailers in Germany, given their traditionally low

equity ratios. Bank loans to retailers are becoming increasingly

restrictive, and while alternative means of financing exist, few

retailers are in a position to make use of them.

Exhibit 13

Annual Percentage Change

7%

6%

5%

4%

3%

2%

1%

0%

-1%

Germany

Percentage Change in CPI Relative to Previous Year

1998 1999 2000 2001 2002 2003

All Groups

Food and Non-Alcoholic Beverages

Alcohol and Tobacco

Apparel

Household Furnishings

-2%

-3%

Years (Quarters)

Source: German Federal Statistical Offi ce

Discussion of Graph

Exhibit 13 shows the inflation and deflation trends from 1998 through the end of 2003 for all groups, food and non-alcoholic beverages, alcohol and tobacco, apparel, and household

furnishings. The Consumer Price Index (CPI) turned up slightly from 2000 until the beginning of 2002, but did not cross 2.5 percent since 2002 inflation stayed between 1.0

and 1.2 percent. Apparel reflected the deflationary trends in that segment; minimal inflation since 1998 turned into deflation at the end of 2002, measuring -0.5 percent in 2003.

Alcohol and tobacco showed significant inflation due to tax increases in tobacco; the introduction of the euro pushed inflation to a peak of 5.6 percent at the beginning of 2003.

Food and non-alcoholic beverage was deflationary from the end of 1998 until mid-2000 but went steeply up to a positive 6.1 percent prior to the euro introduction in 2001. After

2002, food and non-alcoholic beverage inflation dropped back to -1.3 percent before rising to 1.4 percent in late 2003 due to the impact of a hot, dry summer in Europe. Finally,

household furnishings maintained a slightly inflationary trend through 2002, dropping to 0.1 percent at the end of 2003.

25

©2004 EYGM LIMITED


Israel

Doron Sharabany, RCP Leader, Israel

Overview

The structural changes of the past decade have transformed the

Israeli economy from one based on traditional manufacturing

to one focused on the high-tech sector, driven by exports. Israel

enjoys a diversified and sophisticated economy compared with

those of its neighbors, with GDP per capita at $16,000, almost

twice that of Saudi Arabia and more than 10 times that of

Jordan or Egypt.

However, Israeli economic indicators have regressed in the

last few years due to the ongoing Israeli-Palestinian conflict,

a struggling world economy (especially in the high-tech

sector), instability in Iraq, Israeli budgetary difficulties, and

rising unemployment.

“Having a relatively small, saturated market, retailers in Israel

are trying to shift from gaining market share through aggressive

price competition to gaining market share through segregation

built on private labels, strong brands, and high customer-service

awareness,” says Doron Sharabany, RCP Leader, Israel. Israel’s

retail industry is highly competitive, with too much square

footage visited by too few consumers. The recent recession has

exacerbated a trend toward aggressive pricing, with severe price

reductions in 2003.

Israeli Government and Retail

The Israeli government regulates retail businesses in terms of:

• Store hours: Regulations regarding Sabbath and holidays

account for 70 days a year during which retailers cannot

trade. Note: These regulations are not fully imposed in all

locations in Israel.

• Security: Security regulations are imposed on all public

places in Israel, including retail stores. Security expenses

impact the income statements of many retailers, adding up

to as much as 0.5 percent of a retailer’s sales.

• Price labels: All retailers have to indicate prices on all

products, causing additional expense.

• Antitrust Authority: This institution regulates aspects of

mergers and acquisitions of businesses and retail stores; it

also regulates business relations with suppliers.

• Basic-products pricing: The Israeli government controls

prices of basic products, limiting their profitability in

particular and competitiveness among retailers in general.

Retail Structure

Israeli retailing is divided into five main categories: food,

DIY (Do It Yourself), pharmaceutical, apparel, and electricity

products. All five categories can be found in supercenters, big

retailing chains, malls, and small stores. Recent retail trends

have local businesses moving to powercenters and malls, led by

the big food chains (the biggest and most influential retailers in

Israel). Mass merchandisers are not abundant in Israel, and there

are no international big retailers, but franchisees of international

brands exist.

Small food chains have opened in recent years despite restrictive

regulations and massive competition. However, there is a greater

trend toward big supercenters and hard-discount retail stores in

the food category, as consumers favor retailers able to deliver

low prices with reasonable quality. All retailers have been

compelled to reduce operating expenses and lower inventory

levels by streamlining their supply chains. Many retailers that

have experienced downturns in profitability are now closing

unprofitable stores and curtailing new store openings.

Reasons Behind the Economic Climate

Deflation in 2003 occurred because of:

• Security concerns that include the ongoing Israeli-

Palestinian conflict, terror attacks, and instability in Iraq.

• A struggling world economy, especially in the high-tech

sector, that led to high levels of unemployment in Israel and

lower private consumption.

• Increasing focus on consumer prices as a result of Israel’s

highly competitive retail markets.

Because of the ongoing recession, weak consumer demand, and

high competition, retailers began decreasing prices. At the same

time, consumers’ preference for hard-discount chains and less

expensive products heightened competition among retailers. In the

apparel market, declining customs duties contributed to deflation.

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I SRAEL

To boost margins, retailers began differentiating themselves by

creating private labels, generally at lower price points than national

brands. Finally, overexpansion in retailing square footage in the

mid- to late-1990s intensified both competition and deflation.

2004 and Beyond

Deflation is expected to be moderate in 2004 in most categories

because of sustained improvement in the Israeli economy. After

two years of deviations, inflation is expected to converge to

the low target range (1–3 percent) in 2004 and beyond. These

assessments assume no substantial change in Israel’s security

situation and a relatively moderate growth rate in 2004 and

beyond. In this scenario, retail prices for a wide range of

commodities would pick up. However, a rise in prices might

come slowly due to the downturn in job creation.

More optimistic assessments assume a relatively high growth

rate and inflation for all categories in 2004 and beyond. In this

scenario, retailers’ commodity prices will rise substantially.

There are also other, more pessimistic scenarios in which

the retail industry would suffer from low consumer demand

and high competition. These scenarios might also include a

complete breakdown of the peace process, leading to escalating

Israeli-Palestinian violence; occurrence of or further terrorist

attacks; persistent global economic weakness; or failure of the

government to correct its fiscal imbalances in coming years.

Dealing with the Economic Climate

The inability to raise prices, caused by low consumer demand

and a high level of competition, has put most retailers in a

bind. The immediate solution for many is to close unprofitable

stores and to renew their cost-cutting efforts in the supply chain,

inventory management, and human resources. Longer-term

strategies include:

• Maintaining an efficient supply chain, giving retailers a

constant flow of new merchandise that will boost margins.

• Utilization of technology for:

– Inventory management systems that quickly detect outof-stock

merchandise and reorder rapidly.

– Price optimization programs that manage promotions

and markdown activities.

– Customer relationship management (CRM) software

that analyzes consumer databases for the benefit of

retailers.

• Creation of private-label products in an attempt to improve

profitability and create segregation that will strengthen

positions in a price-oriented market.

G LOBAL PRICING TRENDS

28


Exhibit 14

30%

25%

Israel

Percentage Change in CPI Relative to Previous Year

All Groups

Food and All Beverages

Tobacco

Apparel

Household Furnishings

Annual Percentage Change

20%

15%

10%

5%

0%

1998 1999 2000 2001 2002 2003

-5%

-10%

Years (Quarters)

Source: Israel Central Bureau of Statistics

Discussion of Graph

Exhibit 14 shows inflation and deflation trends from 1998 through the end of 2003 for all groups, food and all beverages, tobacco, apparel, and household furnishings. All groups peaked in

1998 at 8.6 percent and then declined to zero in 2000. By the end of 2003, deflation was 1.8 percent. Beginning in 1999, deflationary trends took hold and inflation rates dropped steadily until

early 2002 when the NIS (the New Israeli Sheckel currency) depreciation resulted in higher prices. The deflationary trend continued in 2003 due to both Israel’s security situation and weakness

in the global and domestic economies. Tobacco was highly inflationary in 2002 due to an increase in customs duties. Starting in mid-1999, apparel was deflationary mainly because of a

decrease in customs duties and increased manufacturing productivity. Household furnishings experienced a reduction in prices between the end of 1999 and the beginning of 2002.

29

©2004 EYGM LIMITED


Japan

Takaaki Nimura, RCP Leader, Japan

Overview

Japan has the world’s second largest economy. And while

consumer demand makes up about 57 percent of GDP, it has

been flat for years for a variety of reasons. Japan’s economy has

experienced a roller-coaster ride of highs and lows over the last

three decades, moving rapidly from boom to recession in the late

1980s as consumer and corporate spending plummeted.

Since 1998, Japan has been operating in a deflationary

environment. During that period retail sales have declined to

approximately 128.4 trillion yen in 2003, down more than

7 percent from 2000. Japanese consumers have cut back on

spending over the last few years for numerous reasons, including:

• Corporate restructuring: As companies began to shed

workers and unemployment rates rose, consumers

curtailed spending.

• Demographics: Japan has one of the world’s most rapidly

aging populations. According to the Economist Intelligence

Unit, during the last 30 years, the percentage of Japan’s

population aged 65 and over more than doubled, from 7.1

percent in 1970 to 19 percent in 2003. One result has been

that younger people are now finding it more difficult to

find full-time employment. These factors have resulted in

reduced spending as aging consumers save for retirement,

and younger consumers no longer have the same disposable

income. Real disposable income has decreased since 2000,

and savings rates in turn also have decreased.

• Deflation: As consumers watch prices decrease, they begin

to wait until prices fall even lower.

The Japanese retail market is highly fragmented, with a majority

of stores run by small business owners. These smaller stores,

however, are under increasing pressure from larger stores,

mass merchandisers, discounters, department stores, and

convenience stores, which offer a wider variety of merchandise

as well as lower prices, based on cost efficiencies due to scale.

This fragmented market presents significant opportunities to

retailers. For example, convenience stores have proven to be

popular and successful in Japan, especially in large metropolitan

areas. Younger consumers prefer them to larger, less-convenient

supermarkets because of proximity and accessibility.

At the same time, the Japanese retail sector has significant

problems with over-storing retail locations to sustain profitability

and growth. As the economy picks up, observers fear that

successful retailers will begin to expand and open new locations,

even though the market cannot sustain them.

Deregulation in Japan’s retail sector over the last decade has

dramatically changed the face of Japanese retailing. Deregulation

allowed for the growth of large-scale retailers and permitted an

influx of foreign retailers into the market. In this competitive

market, consumers have gravitated toward discount stores and

mass merchandisers, to the detriment of department-store sales.

Department stores have laid off full-time staff to save costs

(hiring part-time workers instead), but the resulting decline in

customer service has further eroded their market positions.

Japanese Government and Retail

Japan has undergone deregulation in its retail environment over

the last decade. The Large-Scale Retail Store Law had been

implemented to protect small and medium-sized retailers against

big stores. This law was replaced in 2002 by the Large-Scale

Retail Location Law, which is less restrictive in terms of store

size, closing times, and operating days. The new law is aimed

primarily at protecting the social environment by focusing on

noise levels, traffic jams, etc., rather than the economic impact

of large stores versus small and mid-sized retailers.

Deregulation has allowed for the growth of major chains and

entrance by foreign retailers into the market. The increased

competition in the market has resulted in a decrease in

the number of small stores, as consumers migrate to the

larger stores, with their variety of goods and more efficient

infrastructures. These large retailers also have embraced

technological advances such as point-of-sale systems and

electronic data interchange, which have driven further structural

changes in the retail sector. Where wholesalers and middlemen

once played a large role in the distribution segment, these

roles have now been diminished, as retailers reduce costs by

interacting directly with manufacturers.

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J APAN

Reasons for the Economic Climate

The reasons for Japan’s deflation are complex. After booming

from the 1950s to the 1970s, Japan’s economic growth slowed

down in the mid-1980s, but recovered by the late-1980s, creating

the so-called “bubble era.” A period of steep asset-price inflation

began, creating a wealth effect from sharply rising land and stock

values; consumers and companies spent and invested heavily. In

1989, however, the Bank of Japan raised interest rates sharply to

halt what it considered excessive speculation, lifting the official

discount rate (ODR) five times between 1989 and 1990. These

actions, including a government move to limit the amount of

money financial institutions could lend to clients for real estate

purchases, resulted in plummeting stock and land prices. The

bursting bubble resulted in an economic decline that lasted

more than a decade, driving asset price deflation and rising

unemployment that throttled consumer spending. Companies that

invested heavily in the 1980s remain burdened with overcapacity

and are reluctant to undertake new capital expenditures. Banks,

weighed down by extraordinarily high rates of non-performing

loans, also have been unwilling to lend money for these ventures.

The overall weakness of the economy, in conjunction with

low commodity prices, lessened inflationary pressures, and

in 1999–2002, average consumer prices fell year upon year.

Prices fell again in 2003 as well, but at a lower rate than

previously experienced.

2004 and Beyond

The Bank of Japan has forecasted that consumer prices will

continue to decline in 2004. The core CPI, excluding perishable

food, is expected to move to -0.2 percent. This projected decline

has led financial markets to believe that the Bank of Japan will

continue its current monetary policy until at least March 2005.

However, corporate spending is increasing, and consumers

appear to be opening their wallets as well. These improvements

illustrate the potential for broader economic recovery, as core

consumer prices remained flat in early 2004 versus a year

earlier, indicating a halt in the deflationary slide. However, while

consumer spending is improving and downward pressure on

prices is lessening, economists believe the CPI will start rising

continuously only after 2005.

Dealing with the Economic Climate

Retailers are expected to continue to downsize and consolidate.

Falling prices will continue to erode revenues, and retailers’

profits will continue to be squeezed. However, this may take

many years, as Japan’s near-zero-interest-rate policy allows

companies to be highly leveraged and extends the pace at which

companies restructure.

As Takaaki Nimura, leader of Japan’s Ernst & Young retail

practice, notes, “Retailers should continue to focus on

operating low-cost facilities to mitigate the effects of deflation.

Overcapacity should be curtailed so that prices are not driven

down further by competition.”

In recent years, successful retailers have forged global sourcing

relationships to cut costs, but they will not be able to rely

solely on cost-cutting measures. Successful retailers have been

restructuring and focusing on specialty goods to differentiate

themselves from their competitors.

Recovery Will Hinge on Domestic Consumption Improving

The Japanese economy is showing signs of recovery, but much

of this improvement is based on a growing export market.

Economists are noting that export growth to China is responsible

for much of this rise, and that if the Chinese economy

“overheats,” Japanese export demand will diminish, curtailing

Japan’s recent growth trend.

G LOBAL PRICING TRENDS

32


Exhibit 15

4%

3%

Japan

Percentage Change in CPI Relative to Previous Year

All Groups

Food and All Beverages

Apparel

Household Furnishings

Annual Percentage Change

2%

1%

0%

-1%

-2%

1998 1999 2000 2001 2002 2003

-3%

-4%

-5%

Years (Quarters)

Source: Statistics Bureau of Japan

Discussion of Graph

Exhibit 15 shows inflation and deflation trends from 1998 to 2003 for all groups, food and all beverages, apparel and household furnishings. All groups experienced decreasing inflation rates

in 1998, which became deflationary in the third quarter. All groups have experienced deflation since then, which ended 2003 at –0.4 percent, after experiencing a low of –1.2 percent in 2001.

While still deflationary, the rate has been lower since the latter part of 2002. Food and all beverages deflation occurred in 1999, reaching -2.5 percent in 2000; inflation peaked in 2002 at

1.2 percent. Deflationary trends persisted, however, resulting in a dip again in 2003, bottoming out at -0.8 percent. Apparel has been deflationary since 1998 and has experienced deeper levels

compared to food and all beverages. Deflation rates dropped to their lowest (2.7 percent) in 2001. Rates have steadily been improving since then, ending 2003 at –1.3 percent. Household

furnishings prices peaked at the end of 2002, but rounded off the five years with deflation at 3 percent.

33

©2004 EYGM LIMITED


Netherlands

Hans Beeftink, RCP Leader, Netherlands

Overview

The Netherlands has been experiencing a changing consumer

market, with 50 percent of GDP coming from consumer

spending. These changes have been driven largely by the

introduction of the euro, which led to inflation (during a time

in which reduced inflation was expected). This environment

presented opportunities for price-fighters and ultimately mass

merchandisers to reduce their prices. For example, since 2003

supermarkets and supermarket-related stores (drug stores,

etc.) have engaged in a price war as a result of the economic

recession. The decrease in inflation in consumer products

began in 2002, gradually spreading to other categories, with

food, non-alcoholic beverages, and alcohol and tobacco (mostly

alcohol), giving back much of the huge price increases gained

from the introduction of the euro. With customers now focused

on price, the price-fighters have won market share at the cost of

lower-margin retailers.

Consumer demand is low as a result of pessimism about the

current economic situation. Many consumers are postponing

major expenses and increasing their savings. However, a

Netherlands economic recovery is expected to take place in 2005

at the earliest.

The Netherlands Government and Retail

The federal government has a modest role in regulating retail

store and personnel hours, as well as working conditions

(e.g., smoking in public areas is forbidden except in bars and

cafes). The NMa (the Dutch competition authority) regulates

competition in the Dutch market by approving important

acquisitions. Local governments approve new store construction

through zoning commissions. Tax reductions in former years

have increased private consumption, especially in comparison

to government consumption.

Retail Structure

There are two main retail food concepts in the Netherlands: high

quality supermarkets and stores as well as discount supermarkets

and outlet stores. However, a third concept, supermarkets that try

to offer quality at the best price, is currently being developed.

Mass merchandisers have been by far the most influential in this

sector. Food stores and pubs experienced significant problems as

consumers held them responsible for a greater part of inflation

(the euro effect) than other sectors.

Recession caused mass merchandisers to lower their prices in

many sectors. Price-fighters (including outlet stores for clothing)

have driven prices lower, and price promotions made consumers

more aware of the price differences. Even so, Dutch consumers

still value trademarks and fashion.

Big retailers have taken drastic actions to improve their results

and cash flow. Most are pursuing a variety of reorganization

options, including:

• Using purchasing power to drive supply chain efficiencies.

• Sourcing from Asia or Eastern Europe.

• Postponing new formula openings and price promotions.

• Lowering overhead costs.

As always, however, loyalty of Dutch consumers is closely

linked with convenience, as they tend to choose the retail venue

closest to home.

Reasons for the Economic Climate

In 2002, inflation began decreasing in the Netherlands as a result

of the recession, the price-conscious consumer, and the post-euro

effect. Inflation continued to decrease as a result of the growing

market share of discount stores and outlet stores (clothing) and

later, the price war.

The success of the price-fighters has influenced mass

merchandisers on their pricing policies. In turn, their pricing

will likely drive many local supermarkets, unable to compete

with the purchasing power of the mass merchandisers, into

bankruptcy. Decreasing inflation also has a significant effect on

retail clothing margins.

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N ETHERLANDS

The recession and slow-growing economy have severely limited

consumer confidence. Consumers are waiting for the economy

to grow before spending freely. However, much of the savings of

Dutch consumers is in security for mortgaged housing.

The decline in inflation also has been influenced by the dollar

effect. The dollar effect caused changes in gas and oil prices,

but also in prices of other goods on the world market, such

as powdered milk and other agricultural consumer products.

Low interest rates played a role in non-food reduced inflation

(categories such as apparel), as many consumers shifted their

buying to big-ticket items and housing.

Private label is yet another factor in declining inflation; retailers

are steadily increasing the percentage of private label in their

merchandise assortments. While this allows retailers better

margins and product differentiation, lower priced private-label

goods also fuel the decrease in inflation.

2004 and Beyond

The decline in inflation is expected to moderate in 2004, and the

Netherlands is looking forward to an economic turnaround in early

2005. What is uncertain at this moment is the amount government

spending will decrease as a result of the federal deficit.

Prices will likely inflate more slowly than in the U.S. This

assumption is based on widespread expectations of a further rise

of the euro in relation to the U.S. dollar.

Food and non-alcoholic beverage prices will likely remain

flat as the price war continues in 2004, although alcohol

and tobacco prices will rise in 2004 as a result of customs

duty increases. Clothing and footwear-specific trademarks

will promote their shops or products to compete with outlet

stores or each other. Prices in these sectors are still declining

because of mass merchandiser purchasing power and improved

manufacturing productivity.

Retailers will continue to focus on improving store traffic with

price promotions on selected products. In addition, retailers

will attempt to decrease shrinkage, increase bonuses, and boost

working capital. As decreases in inflation spread from retailers

to suppliers, pricing pressures will affect the furnishing and

operations, transportation, and communications sectors. Costs of

housing and energy are also likely to rise.

Dealing with the Economic Climate

The inability to raise prices at retail has put most retailers in

a bind. Operating costs continue to rise, especially medical

expenses, pension benefits, and insurance costs. Retailers have

and will continue to cut costs and reduce inventory levels.

A constant flow of new merchandise is essential to drive

traffic and boost markups. Private label will be another major

strategy, especially if retailers can evolve their private labels

into private brands.

Technology also plays a role in boosting sales through price

optimization programs that help to control promotions and

markdown activities. Customer relationship management (CRM)

is also an option; these programs use customer databases to

target loyal customers with more effective promotional and

loyalty programs.

Retailers need to focus on shrinkage, both measured (perishable

food thrown away) and unmeasured (either theft or differences

in cash and pricing). They will also need to cooperate to create

purchasing power.

Smart retailers will:

• Emphasize quality, “green products,” and customer-friendly

environments

• Be alert to demographic developments, especially those

related to one-parent families, singles, and the elderly

• Take full advantage of pricing, promotion, stock reduction,

and purchasing power

• Aggressively seek cost reductions, especially overhead

G LOBAL PRICING TRENDS

36


Exhibit 16

10%

8%

Netherlands

Percentage Change in CPI Relative to Previous Year

All Groups

Food and Non-Alcoholic Beverages

Alcohol and Tobacco

Apparel

Household Furnishings

Annual Percentage Change

6%

4%

2%

0%

-2%

1998 1999 2000 2001 2002 2003

-4%

-6%

Years (Quarters)

Source: Statistics Netherlands (STATLINE)

Discussion of Graph

Exhibit 16 shows the inflation and deflation trends from 1998 through the end of 2003 for all groups, food and non-alcoholic beverages, alcohol and tobacco, apparel, and household furnishings.

All groups peaked in 2001, caused by the introduction of the euro, and then declined in 2002. By the end of 2003, inflation was approximately 2 percent. Apparel reflected deflationary trends

beginning in 2003, dropping steadily to -5 percent in 2003 before leveling at -2 percent in the same year. Food and non-alcoholic beverages were deflationary beginning in late 2003 as a result

of the price war between supermarkets, which started in the early autumn. Pub prices (beer/ale) increased the last two years against trend lines, resulting in more beer consumption at home than

out of home.

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South Africa

Ian Catt, RCP Leader, South Africa

Economy and Retail

South Africa is currently celebrating 10 years of democracy that

brought about significant changes. However, social structures take

longer than a decade to evolve, and the South African economy is

still characterized by both first- and third-world economies.

Historically, retail networks in South Africa have been positioned

to service primarily major rural centers and urban areas. A

mixture of both formal and informal traders had serviced the

rural third-world market. That situation is changing as retailers

recognize the enormous importance and opportunities that exist

in meeting the needs of the lower end of the mass market.

The South African economy has been battered in recent years

by wild fluctuations in the rand/dollar exchange rate. This has

had far-reaching implications for the retail market because of its

impact on inflation and interest rates. A rapid weakening of the

rand against the dollar in 2001 pushed inflation to its highest level

in 10 years. Conversely, an equally rapid strengthening of the rand

in 2003 drove inflation to its lowest level in more than 30 years.

Other issues affecting the South African economy and retail

market include drought conditions, stagnation in the global

economy, unemployment, and HIV/AIDS.

Government and Retail

In February 2000, South Africa officially adopted inflation

targeting. At the time, the 2002 target for CPIX inflation (this

is defined as inflation excluding the interest cost of mortgage

bonds) was between 3 percent and 6 percent. Recently, however,

the South African Reserve Bank’s ability to manage inflation

through adjustments in the interest rate has been diminished,

as movements in prices have been mainly supply driven (i.e.,

shifts in the exchange rate). In this instance, while changes in the

interest rate have an impact on the market’s ability to spend, it

has no significant impact on prices.

The government passed new legislation in 2003 that deregulated

the pharmacy sector and allowed retailers to take direct

ownership of pharmacies for the first time. Pending legislation

to limit profit mark-ups on prescription-based pharmaceutical

products will exert downward pressure on prices.

Retail Structure

The South African retail market is categorized into durable,

semi-durable, and non-durable retailing. The largest retailers

are in the non-durable sector, which is highly concentrated – the

sector’s top four retailers account for 95 percent of sales. Durable

and semi-durable retail sectors are less concentrated, with

50 percent and 60 percent combined market shares for the top

five retailers in each, respectively.

A pressing issue for the retail sector is the rapid growth of

trading space. With respect to first-world consumers, the market

is relatively mature, with an increase in the convenience-retailing

format being the key focus. At the other end, or third-world

consumer side of the market, the race for space is more frenzied,

with large numbers of new store openings expected this year.

Due to the highly concentrated market, retailers are restricted

from entering into major acquisitions that may be detrimental to

competition in the industry. As a result, retailers are expanding

outside their core markets into either new retail segments or

new lines of business. Another effort to increase growth in this

increasingly constrained market is expansion outside of South

Africa. The most common expansion markets are Australia and

across the African continent.

Reasons for the Economic Climate

While South Africa has not experienced widespread deflation,

there have been pockets of declining inflation in key industry

sectors, specifically apparel, textiles, unprocessed foods,

and appliances.

The core factor driving the decline in inflation in these markets

has been the recent strengthening of the rand against the dollar.

At the end of 2003, import deflation in the manufacturing sector

was at 8.2 percent. High import sectors, such as footwear and

audio/visual equipment, have benefited from a fall in import

costs. Unprocessed food prices also have benefited from a

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S OUTH AFRICA

stronger rand. With the deregulation of the agricultural sector

in the mid-1990s, crops are now priced on the open market

in dollars.

The apparel sector experienced average deflation in 2001 and

2002 of 0.50 percent and 1.24 percent, respectively, while the

CPI went as high as 13 percent during this period. In this case,

higher food prices forced many apparel retailers to cut their

prices in an effort to capture sales. In order to protect market

share, the rest of the sector followed, and prices tumbled.

The rapid rollout of new stores is putting additional downward

pressure on prices. Retailing space is growing faster than both

the population and disposable incomes. Competition in the grocery

market has been further heightened with the announcement by a

leading retailer that it plans to reduce gross margins in order to

push volumes and grow market share.

2004 and Beyond

In early 2004, goods inflation (excluding mortgage rates)

was at a healthy 2.2 percent. However, services inflation

(mainly government administered prices), was approximately

8 percent. Service providers have increased prices to meet social

commitments (targets for the provision of services to previously

disadvantaged communities as agreed to with the government)

and to overcome capacity constraints.

Inflation in the South African economy is currently rising.

The main causes are an unfavorable “base effect” (due to

the volatility in the strength of the rand which ultimately

affected inflation in the previous year), increasing business

expenses (wage costs), drought conditions, and higher

household operating costs. “The market’s view is that inflation

will continue to rise during 2004, before slowing again in 2005,”

according to Ian Catt, Ernst & Young’s South Africa Retail

and Consumer Products Leader. “Recent increased pressures

on oil prices do not bode well for inflation levels should these

higher oil prices be sustained or even increase further. Since our

economy is so dependent on extensive use of oil, its price must

have consequential adverse impacts on other prices.”

There is concern that the CPIX inflation rate will breach the

ceiling target of 6 percent later this year. The Reserve Bank

may increase interest rates to reduce inflationary pressures and

prevent this from happening.

Such a move may encourage a firmer rand for longer periods of

time and lay the groundwork for a cut in spending toward the end

of 2005. This action, combined with new wage negotiations from

a lower base in 2004 and lower regulated tariff adjustments in

the services sector, may once again encourage dangerously low

inflation in 2005.

Linkages with major trading partners also affect South Africa,

which is an open economy with a large percentage of its GDP

made up of imports and exports. Over time, the country’s

inflation rates will begin to converge with those of major trading

partners, which have remained low.

Dealing with the Economic Climate

South Africa is a highly brand-conscious market with a number

of very well known and highly regarded brands, especially in the

food and drink market. This situation provides manufacturers

with pricing power against less expensive competition and a

defense against significant price cuts.

Deflation has made retailers more cost-conscious. This has

resulted in an increased investment in technology to reduce costs

and increase efficiencies, mainly at the “receiving dock doors”

and through the supply chain, thus reducing overstocking and

increasing stock turns.

Store cards and loyalty programs now have a significant

presence in the retail sector. Promotions and price cuts are often

limited to members and drive lower prices while building store

loyalty and monitoring buyer behavior.

Other strategies to supplement lower prices in certain product

lines include expansion outside of South Africa. Africa is an

increasingly popular destination, which often offers more

opportunities and higher margins on investments.

G LOBAL PRICING TRENDS

40


S OUTH AFRICA

Exhibit 17

35%

30%

South Africa

Percentage Change in CPI Relative to Previous Year

All Groups

Food

Alcohol

Tobacco

Apparel

Household Furnishings

Annual Percentage Change

25%

20%

15%

10%

5%

0%

1998 1999 2000 2001 2002 2003

-5%

-10%

Years (Quarters)

Source: Statistics South Africa

Discussion of Graph

Exhibit 17 shows the inflation and deflation trends from 1998 through the end of 2003 for all groups, food, alcohol, tobacco, apparel, and household furnishings. The impact of the rand is

clearly seen in the erratic price movements since 2001. Food experienced a significant peak in mid 2002 at 19.1 percent before settling to a near low of 2.6 percent at the end of 2003. Apparel

is the only sector to experience significant deflation over the past five years due to a lack of pricing power. This is a symptom of a fragmented market, low barriers to entry, and increasing

competition for discretionary spending.

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Spain

Jose Antonio Martin de los Santos, RCP Leader, Spain

Overview: The Spanish Economy

Spain remains among the most dynamic economies in the euro

area. The Spanish economy has proven extraordinarily resilient

to an unfavorable external environment. Although the economy

has slowed to some extent, Spain has been able to negotiate

the cyclical downturn with positive real GDP growth rates of

approximately 2 percent to 2.5 percent. The continuing buoyancy

of household and general government expenditures, as well as

investments in construction, has underpinned this growth – with

private consumption accounting for some 60 percent of GDP.

The Spanish economy is expected to expand more robustly in

2004–05 as the international economy recovers. Household

consumption is expected to remain the primary engine of

growth. Other components of domestic demand, particularly

government spending and housing investment, are also forecasted

to grow strongly.

The Spanish economy, driven by a prolonged expansion of

domestic demand combined with persistent structural rigidities,

has experienced greater inflation than other countries within the

euro area. These underlying price pressures are expected to cool

off in the short run, although improving conditions in the euro

area and elsewhere might cause prices to accelerate again.

Retail Structure

Spanish retailing is divided into four main categories: specialty

stores (with many subsets), mass merchandisers, department

stores, and other traditional shops. Mass merchandisers

have captured substantial market power after a period of

consolidation, with the largest transactions occurring in:

• Wholesale and retail distribution of consumer goods

• Retail distribution of everyday consumer goods

• Retail distribution of DIY (Do It Yourself) and

household goods

Although the Spanish retail distribution sector is experiencing

an ongoing structural transformation, obstacles to competition

remain. Of particular concern are legal provisions that tend to

close off markets by erecting entry barriers to some activities,

resulting in market fragmentation. These barriers eliminate

potential competition and encourage retailers to grow via

acquisition rather than service extension, leading to sector

concentration and, ultimately, higher prices.

Price Pressures

Since the adoption of the euro, Spain has consistently experienced

inflation differentials near 1 percent within the euro area,

with inflation ranging from 2.5 percent to 4 percent. The euro

introduction coincided with price adjustments and the “rounding-prices

effect,” as retailers concentrated their price increases

at the time of the denomination change. This inflation was

aggravated by the prolonged expansion of domestic demand, the

persistence of structural rigidities, a dependence on imported

energy, and ongoing progress in liberalizing and deregulating

internal markets. In the retail industry, inflation resulted from

the transfer of cost increases from producers and retailers to consumers.

Among the sub-sectors that have pushed inflation higher

are food and non-alcoholic beverages and clothing and footwear.

Food prices have increased at annual rates of 4 percent to 6 percent,

due to excessive inventory levels and inefficiencies in the

transmission of lower prices to consumers.

Inflationary tensions are similar in the apparel sector,

although other retail sectors have shown inflation rates in line

with the euro area. Despite recent trends, inflation remains an

acute concern in Spain, and the inflation differentials, though

narrowing, remain.

2004 and Beyond

In coming years, deregulation measures are expected to

introduce more effective competition in certain retail sectors,

reducing price pressures in the short run. Some sectors, such as

apparel or food and beverages, may face increased competition

from Eastern European countries that will soon join the

European Union, which could result in further deflationary

pressures. “The ongoing structural transformations compel firms

in the retail distribution and consumer products industries to face

great challenges in dealing with these rapidly changing pricing

trends,” says Jose Antonio Martin de los Santos, Retail and

Consumer Products Leader in Spain.

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S PAIN

Exhibit 18

14%

12%

Spain

Percentage Change in CPI Relative to Previous Year

All Groups

Food and Non-Alcoholic Beverages

Alcohol and Tobacco

Apparel

Household Furnishings

Annual Percentage Change

10%

8%

6%

4%

2%

0%

1998 1999 2000 2001 2002 2003

Years (Quarters)

Source: National Statistics Institute of Spain

Discussion of Graph

Exhibit 18 shows the inflation and deflation trends from 1998 through the end of 2003 for all groups, food and non-alcoholic beverages, alcohol and tobacco, apparel, and household furnishings.

All groups peaked in late 2000 (at 4 percent), mid-2001 (4.2 percent) and late-2002 (4.5 percent), reflecting inflationary trends in food and non-alcoholic beverages, alcohol and tobacco

apparel, and household furnishings. Food and non-alcoholic beverages reflected the inflationary trends in that segment. Since 2001, inflation rates in this sector have been continuous, with

growth rates of 4 percent to 6.8 percent. Apparel shows a fairly erratic trend since 2002, with peaks of 8.7 percent and 11.6 percent in the second half of the year. Household furnishings were

fairly steady with a slight decrease ending the six-year trend.

G LOBAL PRICING TRENDS

44


Switzerland

Bruno Chiomento, RCP Leader, Switzerland

Overview

Swiss real GDP growth over the past two decades has been

among the lowest in the OECD (Organization for Economic

Co-operation and Development, which includes 30 member

countries), averaging a mere 1.5 percent from 1980–2000. This

is due in part to high productivity levels and relatively low

population growth, but the biggest component of Swiss GDP

is private consumption. In the second half of the 1990s, Swiss

consumer spending rose impressively, but since 2001 there has

been a marked slowdown. Private consumption is expected to

grow by 1.7 percent in 2004.

In 2003, the retail trade suffered from a flagging economy

and muted consumer sentiment. But a March 2004 survey, by

financial services company UBS, revealed positive indicators

for wholesalers for this year. Sales were still muted in the first

quarter, but responses indicating anticipated higher sales were

in the majority. For example, after a decade during which the

proportion of Swiss households’ consumption spent on food and

beverage fell from 18 percent to 15 percent, food and beverages

finally drove growth again. In February, retail sales increased

by a real 3.7 percent year-over-year, and for 2004, positive

expectations dominate all categories.

Swiss manufacturers are trying to expand their businesses

abroad, but are hampered by prices for food and beverages,

some of which are 36 percent higher than the EU average.

This differential makes Swiss manufacturers uncompetitive

in standardized bulk goods, forcing them to rely on exports of

premium-quality products and Swiss specialties.

Swiss Government and Retail

Retailers face numerous barriers to receiving authorization to

expand. Local governments (cantons) enforce strict laws for

construction of new sales space, as well as for store hours. The

permit process for new buildings is lengthy, without guarantee of

success. Different communities of interests (lobbies), such as the

Swiss Association for Transport and Environment, also take part

in the negotiations and influence the approval process.

The Swiss government regulates working conditions, food

legislation, and competition in the market. The Federal

Competition Commission acts directly if it observes that

competition has been hindered in an unlawful way through

concerted practice, abuse of dominant position, or merger.

Retail Structure

Primary retail categories include mass merchandisers,

department stores, specialized trade, direct mail selling, kiosks,

and vending machines. The Swiss market is highly concentrated,

with two major retailers holding a combined 70 percent market

share. Although the market is saturated, it is expected to

experience increased competition as foreign companies come

into Switzerland.

Overall economic conditions are looking favorable for 2004.

Retailers are optimistic that sales and earnings in almost all areas

of trade will be better than in the previous year, and the number

of sales outlets will likely increase in many segments, including

electronic appliances, textiles, and clothing and footwear. At the

same time, smaller food shops, drugstores, and jewelry stores

will continue to close.

According to Bruno Chiomento, Ernst & Young Switzerland’s

Retail and Consumer Products Industry Leader, “Swiss retail

and consumer products companies face increased international

competition despite the positive outlook for 2004. They need to

continue to streamline processes and costs to keep margins at the

current level.”

Inflation Remains Low

Inflation in Switzerland is still not a threat. In December 2003,

the inflation rate was 0.6 percent; analysts expect an annual

inflation of just under 0.5 percent in 2004. Except for the end of

2002, when oil prices rose, inflation levels have been consistently

low for years. Despite the weakness of the Swiss franc, imported

goods are becoming cheaper and cheaper. Prices of imported

goods included in the Swiss CPI were 1.7 percent less expensive

in February 2004 than a year earlier.

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S WITZERLAND

INSERT FLAG HERE

2004 and Beyond

Despite the positive outlook for 2004, the Swiss retail trade

is facing many challenges. Fragile consumer confidence,

diminishing wholesaler pricing power, and intense competition

in a saturated market keeps prices and margins under pressure.

The expansion of foreign retailers into Switzerland will only

increase competition.

In the apparel industry, sales declined sharply in 2003, even

as exports rose by 27 percent in the first 10 months; consumer

prices for apparel declined by 2 percent. In addition to

overcapacity, the apparel sector is also under mounting pressure

from foreign competition. Swiss manufacturers are now being

forced to outsource labor-intensive production processes to

low-wage countries. Only key functions, including design,

marketing, or finishing, are now completed in Switzerland.

High-quality, designer sector, and specialist niches represent

the best opportunities for Swiss manufacturers as low-priced

competition continues.

Low Deflation Risk

As of 2004, low inflation rates were not expected to change

much, with annual inflation of 0.4 percent expected in 2004,

rising to 0.9 percent in 2005.

The risk of deflation remains minimal, due largely to

Switzerland’s independent and proactive Swiss National Bank

(SNB). The SNB remains ready to react to deflation and to

restore stability if necessary.

Exhibit 19

6%

4%

Switzerland

Percentage Change in CPI Relative to Previous Year

All Groups

Food and Non-Alcoholic Beverages

Apparel

Household Furnishings

Annual Percentage Change

2%

0%

-2%

-4%

-6%

1998 1999 2000 2001 2002 2003

-8%

-10%

-12%

Years (Quarters)

Source: Swiss Statistics

Discussion of Graph

Exhibit 19 shows the inflation and deflation trends from 1998 through the end of 2003 for all groups, food and non-alcoholic beverages, apparel, and household furnishings. All groups have had

very low inflation over the whole period. The average inflation rate has been stable since the third quarter of 2002 at around 0.5 percent. In December 2003, the inflation rate was 0.6 percent.

Food and non-alcoholic beverages declined in the first half of 1999 to -0.9 percent, but improved gradually and rose to 2 percent in September 2000. In 2002, food and non-alcoholic beverages

peaked at 3.9 percent before declining to 1.3 percent in mid-2002 and bottoming out at 0.7 percent. Since 2002, food and non-alcoholic beverages has been inflationary and ended in

December 2003 at 2.3 percent. From 1998 to the beginning of 2000, apparel was stable with an inflation rate between 0.4 percent and 0.9 percent. Then in the first quarter of 2001, the sector

declined to -5 percent. The most significant drop – to –11 percent – occurred in September 2001. In December 2001, deflation improved and ended at -4.0 percent. Apparel reached a peak at

3.6 percent at the end of 2002 before dropping to -2.3 percent in December 2003. Household furnishings remained at a minimal inflationary rate over this period.

G LOBAL PRICING TRENDS

48


United Kingdom

Howard Martin, RCP Leader, UK

The UK retail sector has entered a period of low growth with

continued pressure on already thin margins. Specifically,

deflation in apparel and low-price inflation in other categories

is an established trend driven by structural changes, an

increasingly value-conscious consumer, and productivity gains.

Unfortunately, this extreme pricing pressure will persist for the

foreseeable future. To offset price concerns, retailers will have

to leverage scale, exert unwavering control over operating costs,

and exploit further supply chain gains. “While overall retail

price inflation will trend at around 1 percent to 2 percent in

2004, price deflation persists in some categories, with apparel

clearly the most affected. The conundrum for retailers is to grow

volumes without sacrificing margin, not only during a period of

intense pricing pressure, but also at a time when the cost burden

continues to mount,” says Howard Martin, Retail and Consumer

Products Leader for the UK.

Overview: UK Economy and Retail

The retail sector accounts for 19 percent of GDP. Retailers

have enjoyed three years of strong growth. Price growth, low

unemployment, and low inflation drove consumer spending.

However, the UK consumer is now beginning to show signs of

nervousness. Rising interest rates, record levels of household

debt, and other pressures, such as increased National Insurance

contributions and rising utility costs, are starting to take their toll.

Sectors Most Affected by Deflation

According to Online National Statistics (ONS) data, inflation

is just over 1 percent per year. However, this is clearly not a

uniform trend across the retail sector. Deflation has been a

significant theme in certain product categories:

• Apparel has been most affected; since 1987, the price of

women’s apparel has fallen by one-fourth. In early 2004,

apparel deflation was approximately 4 percent.

• Prices of white goods have declined by 14 percent

since 1987.

Deflation is less prevalent in other sectors:

• Prices for furniture and furnishings have been constant,

albeit just below the level of inflation, for the last five years

despite aggressive promotional activity.

• Food prices have fluctuated considerably, but on average

have been close to overall inflation rates. The arrival of the

hard discounters in the UK failed to exert a material impact

on pricing as expansion plans have been slower

than expected.

Combined with incessant cost pressures, such as upward-only

rent reviews and increases in the national minimum wage,

deflation has led to a narrowing of margins in recent years.

Reasons Behind the Economic Climate

The inexorable march of supermarket groups into non-food

segments has undoubtedly contributed to sector deflation.

Apparel retailers in particular are suffering.

The supermarket giants are leading the charge toward

rock-bottom prices. For example, one apparel brand at a leading

supermarket retailer generates annual sales of some £1billion,

making the supermarket the number 2 volume-apparel retailer in

the UK, according to Fashiontrak. Recent figures from another

major supermarket retailer show that sales of its apparel increased

34 percent – six times the market rate. In fact, this retailer sells

30,000 pairs of one brand of jeans per week at prices as low as

£4.00 (U.S.$7). These aggressive tactics have driven industry-wide

price cuts and promotional activities. At one well-known High

Street apparel retailer, average sales prices fell by 5 percent in

2003; the spring 2004 edition of its mail-order directory included

price reductions of between 5 percent and 23 percent.

The supermarket pricing impact is not confined to the apparel

sector. While penetration of electrical goods is not yet as high,

sales in supermarkets of toasters, kettles, and irons for under £8

(U.S.$14) and microwaves for under £35 (U.S.$62) are clearly

contributing to declining prices.

In addition to the buying power of the supermarkets, other

structural changes are also driving deflation, notably the

emergence of a number of low-cost models across the consumer

products sector: no-frills cheap flights, discounted branded

clothing, and low-cost, large-scale, online-only retailers.

Furthermore, the primary response thus far from incumbents is

to lower prices or match those of the emerging threats, thereby

perpetuating downward pricing pressure.

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U NITED KINGDOM

Over the last few years, UK consumers have become less loyal,

more used to bargain hunting, and more insistent upon value.

As a result, retailers are increasingly vying with other forms of

leisure for consumer expenditures. It’s a battle that retailers are

slowly losing – retail share of consumer expenditure has declined

steadily from more than 38 percent in 1993 to just under

35 percent in 2003.

Important as external pressure on prices has been, it’s imperative

to note that retailers themselves have also made deflation

possible. Productivity gains, through ever cheaper sourcing

and increased supply chain efficiencies, have resulted in lower

prices as retailers seek to grow revenues and market shares.

And in some instances, retailers’ own inaccurate forecasting and

planning have compounded the problem. For example, in the

apparel sector in 2003 there were higher levels of stock than in

previous years during the crucial Christmas selling season. This

forced retailers into deeper and earlier discounting, maintaining

sales volume at the expense of margins.

2004 and Beyond

Overall retail price inflation is likely to stay at around 1 percent

to 2 percent for the foreseeable future. As consumer spending

comes under pressure from interest rate increases – and as

high levels of consumer debt take their toll – retailers will face

continued pricing difficulties.

Lifting textile and apparel quotas between China and the UK

in 2005, which comes on top of China’s entry into the World

Trade Organization (WTO) in 2001, likely will result in even

cheaper imported manufactured goods. This could trigger

further deflationary pressure. Estimates suggest that Chinese

apparel imports to the UK will increase from £1.7 billion

in 2003 to £2.8 billion in 2005, equivalent to one in five

garments. Given the sector’s already highly competitive

environment, any margin gains from cheaper sourcing will

likely be transferred to consumers.

Since 2001, the entertainment sector (CDs, DVDs) has tracked

with overall inflation. However, as low-price Internet retailers

increase their market share and supermarkets continue their

incursions into non-food areas, this segment is unlikely to

escape price-cutting.

Pricing is also likely to become more competitive in the food

sector. Increased private-label penetration will be a contributing

factor, but more importantly, there is a real prospect of renewed

price wars due to recent consolidation in the sector.

Dealing with the Economic Climate

“It [deflation] is not a problem as long as we are not giving

up margin.”

– CEO, UK High Street clothing retailer,

2004 Annual Report statement

Maintaining Margin

The margin outlook will continue to be challenging as retail prices

go down and operating costs go up. Although the beneficial effect

of a weak dollar on input prices offers some respite, retailers still

will have to pursue strategies to drive volumes (to compensate for

lower average selling prices) and protect margin.

The need to focus on retail fundamentals may be obvious, but

product range, brand identity, service, value, and speed to market

will be more critical than ever.

Property Management

Space expansion and the maximization of scale remain key

to retailers, despite upward-only rental reviews becoming

an established trend and out-of-town space at a premium. In

view of the highly leveraged nature of the sector – fixed costs

account for up to 70 percent of total operating costs – any

increase in sales has a disproportionate effect on profitability.

For example, a FTSE 100 index (a share index of the largest

100 companies in the U.K. as quoted on the London Stock

Exchange) apparel retailer is investing £64 million in store

refurbishment and expansion (75 percent of total capital

expenditure), with the majority allocated to the addition of

400,000 square feet of new space.

A proposed relaxation of restrictions on large-format stores in

edge-of-town locations (the PPS6 legislation) is “unlikely to lead

to a surge in retail park development,” according to an analysis

from CB Richard Ellis. Finding viable sites and obtaining

planning permission will remain extremely difficult, making the

effective investment, management, and utilization of real estate

assets more important than ever.

G LOBAL PRICING TRENDS

52


Controlling Costs

Retailers will need to continue to make tough decisions in order

to control operating costs. A number of retailers have recently

announced moves to cut central costs, principally headcount.

Supply Chain Gains

To offset the need for price investment, retailers are looking to

their supply chains to help drive down costs and drive up sales.

Strategies include:

• Exploiting opportunities to collaborate with their

suppliers to improve availability and reduce costs through

initiatives such as collaborative planning, forecasting and

replenishment (CPFR), and factory gate pricing.

• Sourcing products from overseas to reduce costs and become

innovative, creating longer and more global supply chains.

• Getting products on the shelf more quickly and refreshing them

more frequently, requiring greater velocity in the supply chain.

• Introducing new store formats (including mezzanine floors),

more in-town stores, and alternative shopping channels (e.g.,

the Internet).

• Providing value-added services, such as home delivery or

product installation.

• Rationalizing or outsourcing back-office processes.

These strategies require the orchestration of multiple third

parties, technology and security standards, information security,

attention to privacy concerns, and effective data management.

The result of these strategies is an increase in supply chain

complexity. Business restructuring projects are designed to

manage this complexity, reduce costs, and improve service.

Technology investment as part of this complexity is significant,

particularly in new technologies such as CPFR and Radio

Frequency Identification (RFID).

The mixed results of early adopters of these strategies have

demonstrated the importance of making the right decisions.

Organizations that apply a deflation “lens” to a portfolio of

change projects will be those better equipped to maintain

competitive advantages in an increasingly difficult market.

Exhibit 20

Annual Percentage Change

8%

6%

4%

2%

0%

-2%

-4%

United Kingdom

Percentage Change in CPI Relative to Previous Year

1998 1999 2000 2001 2002 2003

All Groups

Food and Non-Alcoholic Beverages

Alcohol and Tobacco

Apparel

Household Furnishings

Transportation

-6%

-8%

-10%

Years (Quarters)

Source: UK National Statistics

Discussion of Graph

Exhibit 20 shows the inflation and deflation trends from 1998 through the end of 2003 for all groups, food and non-alcoholic beverages, alcohol and tobacco, apparel, household furnishings,

and transportation. All groups had a relatively small inflationary trend for this period. However, this was offset by significant deflation in apparel, which began to turn around in 2003, and

decreasing inflation in alcohol and tobacco.

53

©2004 EYGM LIMITED


United States

Jay McIntosh, RCP Leader, U.S.

Overview

The ability to increase or decrease prices because of competitive

and economic pressures is of primary importance to the U.S.

retail industry in 2004 and beyond. Recent government reports

suggest that inflation is growing somewhat, although it is still

not worrisome. Nevertheless, retailers and suppliers, already

affected by higher energy and raw materials costs, are finding

it increasingly necessary to pass along these increases to

consumers. On the other hand, consumers, still nervous about the

economy, are looking for value, and as a result retailers may have

to be more promotional than they would like.

U.S. retailing has always been highly competitive, and, as a

result, price promotions are prevalent. The recent recession in the

early 2000s exacerbated this strategy for practically all retailers.

Large mass merchandisers also helped to lower prices at retail

because of their enormous global buying power. As a result,

while declines in apparel prices began in the mid-1990s due to

productivity gains, in the early 21st century, deflation spread to

practically all non-food consumer categories. Deflation was most

severe in 2002 for these categories but since then has moderated

because of the pickup in the U.S. economy, improving demand,

and an attempt by many retailers to be less promotional.

U.S. Government and Retail

Unlike some other countries, the federal government does not

regulate retailers in terms of new store openings and store

hours. Local governments are responsible for approving new

store construction through zoning commissions. In recent years,

local community resistance to big supercenters has prevented

these stores from expanding in certain localities. The federal

government does, however, regulate working conditions and

acquisitions for all businesses. For example, the U.S. Department

of Labor recently released an update on federal white-collar

overtime regulations.

Retail Structure

U.S. retailing is divided into three main categories: department

stores, mass merchandisers, and specialty stores (with many

subsets). The biggest and most influential group is mass

merchandisers, several of which have enormous global buying

power. Mass merchandisers cater to an increasingly valueconscious

consumer. Those retailers able to deliver low prices

along with reasonable quality are favored. This has had a

negative impact – primarily severe apparel deflation – on

department stores and certain specialty retailers. All retailers

have been compelled to reduce operating expenses and lower

inventory levels by streamlining their supply chains. Many

retailers that experienced downturns in profitability are now

curtailing new store openings and closing unprofitable stores;

these efforts should improve cash flows and lower funding

requirements. Balance sheets are improving, allowing many of

these retailers to fix their problems.

Reasons Behind the Economic Climate

Deflation began to occur in the mid-1990s because of increasing

productivity gains and changes in where goods were produced.

Most apparel and many household items are now manufactured

in Asia, primarily in China. Retailers passed along these savings

to consumers in the form of lower prices to boost their revenues

and market shares. But the recession in 2000–01 changed the

nature of the deflation. While productivity gains were still

driving deflation, weak consumer demand also made an impact.

In addition, over-expansion in square footage during the buoyant

economy of the mid- to late 1990s hurt top-line growth as well.

Lifestyle changes also played a role; a trend toward casual dress

in the workplace during the 1990s meant that consumers could

buy clothing that was much less expensive than traditional

business apparel. As consumers took advantage of low interest

rates to buy houses and big-ticket appliances, apparel purchases

declined. Retailers also contributed to deflation by increasing the

percentage of private label in their merchandise assortments; this

merchandise is generally lower priced than national brands.

55

©2004 EYGM LIMITED


U NITED STATES

According to Jay McIntosh, Americas Director of Retail and

Consumer Products, “The major reasons for deflation in apparel

are the changes in sourcing and consumers’ buying habits. A

significant percentage of those goods are now manufactured in

China at a lower cost, and those savings have been passed on to

consumers. Also, consumers are doing more of their shopping

at discounters and off-price specialty retailers, and they are not

paying full price for many items. Consumers are very focused on

price, and it will be difficult for retailers to change their behavior.”

2004 and Beyond

Deflation began to moderate in 2003 and should improve

further in 2004 in most categories because of sustained

improvement in the U.S. economy and the growth of consumer

demand. In addition, retailers curtailed inventory growth, and

for the important holiday season of 2003 were not only less

promotional but also offered creative promotions that did

not affect margins. Mega-retailers in the U.S. appear to be

stabilizing prices to gain margin and improve profitability. This

trend will likely ripple through the rest of the retail industry.

At the same time, commodity prices for a wide range of raw

materials – cotton, oil, and steel – are rising substantially.

These increases will likely be passed along to consumers,

eventually. And while the U.S. economy has been slow to create

new jobs, recent government reports suggest that job creation

may be gaining momentum. If that trend is sustained, price

increases at retail should pick up. But any downturn in job

creation will cause consumers to become more frugal, forcing

retailers to moderate any price increases.

Apparel could experience severe price reductions beginning in

2005. Apparel quotas will be eliminated as of January 1, 2005,

which could mean price reductions of as much as 15 percent

over time. Not all apparel will be affected; for example, couture

apparel from Europe will experience as much as 20 percent

increases in late 2004 because of the weak dollar. Quota

elimination will affect manufacturers and retailers, especially in

the U.S. China could emerge as a dominant source for apparel

but will not be able to monopolize the apparel trade because of

retailers’ and manufacturers’ need to have multiple sources. In

addition, some countries, because of their proximity to the U.S.,

will be able to offer rush orders of popular styles and fashions.

Retailers with a significant part of their merchandise assortment

in apparel will be affected most, although most are counting on

offering the consumer better quality at current prices, thereby

avoiding big price cuts. In addition, those retailers with efficient

supply chains will be most able to survive apparel-pricing

pressures. If the U.S. economy continues to strengthen, retailers

might be able to keep some of the savings for themselves instead

of passing along those savings to consumers. But if the economy

turns sour, retailers will likely be forced to pass along cost

savings to consumers.

In the short term, apparel prices might actually rise. In 2004,

for example, prices were expected to rise because there was not

sufficient 2004 quota to complete fourth-quarter shipments,

and manufacturers will not be able to borrow against next year’s

quota, as it will no longer exist. This could mean there will be

higher production costs and late deliveries, with prices rising

(temporarily) at retail.

Dealing with the Economic Climate

The inability to raise prices has put most retailers in a bind.

Operating costs are rising, especially medical expenses and

pension benefits. Retailers are in a continual cost-cutting mode.

Having an efficient supply chain is key in order for them to get

a constant flow of new merchandise to drive traffic and boost

margins. Private label – a price deflator – can evolve from

label to brand, allowing higher markup; many specialty apparel

chains are well known for their eponymous brands. Once a

brand becomes established with consumers, they are willing to

pay higher prices for it. One factor that might help stabilize or

improve apparel pricing is the popularity of updated and more

expensive career dressing.

The utilization of technology will be essential. Retailers must

invest in:

• Inventory management systems that will quickly detect outof-stock

merchandise and reorder rapidly.

• Price optimization programs that manage promotions and

markdown activities.

• Customer relationship management (CRM) software that

analyzes customer databases to target loyal customers with

effective promotions.

G LOBAL PRICING TRENDS

56


Exhibit 21

5%

4%

United States

Percentage Change in CPI Relative to Previous Year

All Groups

Food and All Beverages

Apparel

Household Furnishings

Annual Percentage Change

3%

2%

1%

0%

-1%

1998 1999 2000 2001 2002 2003

-2%

-3%

-4%

Years (Quarters)

Source: U.S. Bureau of Labor Statistics

Discussion of Graph

Exhibit 21 shows the inflation and deflation trends from 1998 through the end of 2003 for all groups, food and all beverages, apparel and household furnishings. All groups peaked in 2000 at

3.8 percent and then declined to 1.1 percent in 2002, by the end of 2003, inflation was 1.9 percent. Apparel reflected the deflationary trends in that segment. In 1998 inflation was minimal at

0.3 percent, but beginning in 1999, deflationary trends took hold and rates dropped steadily from -1.2 percent in 1999 to -3.2 percent in 2001 before falling to -3.6 percent in 2002. Deflation

improved somewhat and ended 2003 at -2.1 percent. Food and all beverages was inflationary for the entire period – running about 2 percent in the early years before rising to 3.3 percent in

mid-2001. By mid-2002, food and all beverages inflation dropped to 1.3 percent before surging to 3.5 percent in late 2003 due to the increase in meat prices. Household furnishings was also

inflationary through the end of 2003.

57

©2004 EYGM LIMITED


Opportunities for

Ernst & Young to Assist

Ernst & Young provides quality assurance, tax, and transaction

advisory services through in-depth knowledge of the RCP

industry. We also offer a vast range of services to assist RCP

companies looking for growth as well as reduction in operating

expenses. Among the many services that may be available in

your country of operation are:

Cash Management Review

Ernst & Young’s Cash Management team reviews cash

management processes and bank relationships and identifies and

helps to implement opportunities to improve cash flow, reduce

non-earning assets, and reduce related expenses.

Corporate Real Estate Services

Ernst & Young’s Corporate Real Estate Services can help

retailers transform their real estate into a strategic and

competitive advantage. By making comprehensive real estate

decisions, retailers will be able to choose optimal store locations

and better utilization of square footage. Ernst & Young supports

clients in finding the appropriate store locations, including

location planning and searching, analysis of investment

decisions, and leasing and purchase support.

Marketing and Advertising Risk Services

Marketing and Advertising Risk Services helps retailers

review their advertising and marketing service contracts

and alliances to identify opportunities for cost savings and

recoveries, verify “proof of performance,” and identify areas

to streamline processes.

Supply Chain Management

Supply Chain Management services can provide a framework

for the improvement of systems and processes through strategic

sourcing, e-procurement, stock control, lean manufacturing,

operational-losses management, and industry-specific

operational improvements.

Supply Chain Risk Review

The Supply Chain Risk Review considers the whole supply chain

investment cycle and focuses on implementation and control.

Cross-Border (Canada)

Ernst & Young’s Canadian Retail and Consumer Products

professionals have extensive experience in dealing with

cross-border issues. Based in locations across Canada, our team

provides assurance and internal audit, U.S. federal and state tax,

international tax, human capital, and transaction support services.

Financial Modeling (South Africa)

Ernst & Young’s financial modeling experience empowers teams

to evaluate the financial and commercial implications of a

range of environments. The business modeling team can create

innovative modeling solutions, analyzing the associated risks

of each situation, to enable clients to make more informed and

effective business decisions. The group develops and reviews

complex financial, operational, and process models in support of

corporate visions and performance improvement.

Mystery/Test Shopping (Germany)

Do you want to know if your retail employees are as competent

and friendly as you expect Would you like to check if

your merchandise management system works accurately

Ernst & Young can help find the answers to those questions.

Trained test shoppers examine arrangements between producers

and retailers, analyze consumer behavior, and check customer

service and quality at the point of sale.

Rebates and Conditions (Germany)

Transparency of agreed-to rebates and conditions is an important

requirement to ensure that supplier bills payable reflect

accurate deliveries, sales, and returns as well as the appropriate

conditions. Ernst & Young can provide comprehensive support

in this field, ranging from the allocation of relevant information

for contract negotiations to helping to address completeness, and

security within the settlement of benefits.

Tax Effective Supply Chain Management (Canada)

Tax Effective Supply Chain Management (TESCM) is

the process of integrating tax planning into supply chain

management. TESCM considers the global tax impact of current

and prospective changes in business processes, product flows,

and assets to address the profitability and capital efficiency of

supply chains. Our tax professionals offer integrated services

around transfer pricing, customs, duties, VAT, local compliance,

and human capital.

59

©2004 EYGM LIMITED


Macroeconomic Indicators

General

Real GDP

(Local

Currency)

GDP (Local

Currency)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change

Over

Previous

Year

Retail Sales

U.S. $

(Billions)

Retail

Sales as

Percentage

of GDP

Unemployment

Rate*

National

Currency

per U.S. $

Euro per

U.S. $

Source for

pages 62– 67,

except for

national

accounts and

unemployment

data for South

Africa and

Israel (See

below)

Part I, Tables

2b of National

Accounts

of OECD

Countries

– Vol. 1

Part I, Tables

2a of National

Accounts

of OECD

Countries

– Vol. 1

From OECD

Statistics,

Annual

National

Accounts

for OECD

Member

Countries,

Tables A1 to

A14

From OECD

Economic

Outlook,

Annex

Table 1

Euromonitor

from trade

sources,

national

statistics

Calculated

from Retail

Sales U.S. $

and GDP in

U.S. $

From OECD

Economic

Outlook, Annex

Table 14.

Data based on

the National

Survey of Urban

Employment;

see OECD

Economic

Outlook Sources

and Methods.

From OECD

Statistics,

Annual

National

Accounts

for OECD

Member

Countries,

Tables C1

to C3

Comments

Output

approach,

constant 1995

prices. Gross

domestic

product at

market prices

is the sum

of the gross

values added

of all resident

producers at

market prices,

plus taxes, less

subsidies on

imports.

Output

approach,

current

prices. Gross

domestic

product at

market prices

is the sum

of the gross

values added

of all resident

producers at

market prices,

plus taxes, less

subsidies on

imports.

At current

prices and

current

exchange rates

% change,

year over

year

Exchange

rate –

national

currency per

U.S. $

Exchange

rate, Euro

went into

circulation

Jan. 1, 2002

National accounts estimates are compiled according to the 1993 SNA (“System of National Accounts 1993,” Commission of the European Communities-Eurostat,

International Monetary Fund, Organisation for Economic Co-operation and Development, United Nations and World Bank, 1993). The adoption of new national

account systems, SNA93 or ESA95, has been proceeding at an uneven pace among OECD member countries, both with respect to variables and the time period covered.

As a consequence, there are breaks in many national series. Moreover, some countries are using chain-weighted price indices to calculate real GDP and expenditures

components. The source of unemployment data for South Africa and Israel is the Labor Force Survey and Israel’s Central Bureau of Statistics, respectively

* Commonly used definition. Labor market data are subject to differences in definitions across countries and to many series breaks, though the latter are often of a

minor nature.

61

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M ACROECONOMIC INDICATORS

Australia

Year

Real GDP

(Billions of

Australian $)

GDP (Billions of

Australian $)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change Over

Previous Year

Retail Sales

U.S. $ (Billions)

Retail Sales as

Percentage of

GDP

Unemployment

Rate*

Australian $

per U.S. $

1998–99 574 592 372 5.4% 64 17.3% 7.8% 1.59

1999–00 595 626 404 3.8% 68 16.9% 7.0% 1.55

2000–01 608 671 389 2.0% 72 18.5% 6.3% 1.72

2001–02 631 714 369 3.9% 76 20.5% 6.8% 1.93

2002–03 649 753 409 2.8% 81 19.9% 6.3% 1.84

Source: See page 61

All the data refer to fiscal years beginning on 1 July of the year indicated.

* Data for unemployment taken from the Household Labor Force Survey. Though the survey covers persons aged 15 and over, the OECD extracts and publishes data

based on persons aged 16 to 64, in order to provide for comparability with other countries. Persons laid off for less than four weeks (because of bad weather or plant

breakdown) are included among the employed; all other layoffs are considered as unemployed or out of the labor force. The national labor force is calculated with

reference to the civilian labor force.

Canada

Real GDP

Percentage

Change

Over

Previous

Year

Retail

Sales

U.S. $

(Billions)

Year

Real GDP

(Billions of

Canadian $)

GDP (Billions of

Canadian $)

GDP in U.S.

$ (Billions)

Retail Sales as

Percentage of

GDP

Unemployment

Rate*

Canadian $

per U.S. $

1998 880 915 617 4.1% 116 18.8% 8.3% 1.48

1999 929 982 661 5.5% 122 18.5% 7.6% 1.49

2000 979 1,076 724 5.3% 126 17.3% 6.8% 1.49

2001 997 1,107 715 1.9% 129 18.1% 7.2% 1.55

2002 1,030 1,155 736 3.3% 135 18.4% 7.7% 1.57

2003 1,047 1,215 867 1.7% 143 16.5% 7.6% 1.40

Source: See page 61

* Unemployment data are from the Current Population Survey of persons aged 16 and over. The data are seasonally adjusted by the Bureau

of Labor Statistics.

G LOBAL PRICING TRENDS

62


France

Year

Real GDP

(Billions of

Euros)

GDP

(Billions of

Euros)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change Over

Previous Year

Retail Sales

U.S. $

(Billions)

Retail Sales

as Percentage

of GDP

Unemployment

Rate*

French Franc

per U.S. $

Euro per

U.S. $

1998 1,259 1,306 1,452 3.6% 274 18.8% 11.5% 5.90

1999 1,300 1,355 1,444 3.2% 284 19.7% 10.7% 6.16 0.94

2000 1,349 1,420 1,308 4.2% 295 22.5% 9.4% 1.09

2001 1,377 1,476 1,320 2.1% 303 23.0% 8.7% 1.12

2002 1,394 1,521 1,431 1.2% 318 22.2% 9.0% 1.06

2003 1,396 1,552 1,744 0.2% 334 19.2% 9.6% 0.89

Source: See page 61

* INSEE provides the OECD with quarterly series on civilian employment. They are seasonally adjusted by the OECD, and figures for the armed forces are added

in order to arrive at total employment. Monthly seasonally adjusted unemployment data corresponding to the Eurostat harmonized unemployment rates are also

provided by INSEE.

On January 1, 1999, the euro became the currency, and the franc became a non-decimal, sub-unit of the euro.

Germany

Year

Real GDP

(Billions of

Euros)

GDP

(Billions of

Euros)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change Over

Previous Year

Retail Sales

U.S. $

(Billions)

Retail Sales

as Percentage

of GDP

Unemployment

Rate*

Deutschemark

per U.S. $

Euro per

U.S. $

1998 1,876 1,929 2,144 2.0% 354 16.5% 8.7% 1.76

1999 1,915 1,979 2,108 2.0% 353 16.7% 8.0% 1.84 0.94

2000 1,970 2,030 1,870 2.9% 357 19.1% 7.3% 1.09

2001 1,986 2,074 1,856 0.8% 357 19.2% 7.4% 1.12

2002 1,990 2,110 1,986 0.2% 362 18.2% 8.1% 1.06

2003 1988 2,129 2,403 -0.1% 367 15.3% 8.9% .89

Source: See page 61

On January 1, 1999, the euro became the currency, and the deutschemark became a non-decimal, sub-unit of the euro.

63

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M ACROECONOMIC INDICATORS

Israel

Real GDP

Percentage

Change Over

Previous Year

Retail Sales as

Percentage of

GDP

Year

Real GDP

(Billions of NIS)

GDP (Billions of

NIS)

GDP in U.S. $

(Billions)

Retail Sales

U.S. $ (Billions)

Unemployment

Rate NIS per U.S. $

1998 424 393 103 3.3% 20 18.9% 8.5% 3.8

1999 435 430 104 2.6% 21 20.4% 8.9% 4.1

2000 468 468 115 7.5% 23 19.6% 8.8% 4.1

2001 464 474 113 -0.9% 24 21.1% 9.4% 4.2

2002 460 491 104 -0.8% 27 25.7% 10.3% 4.7

2003 466 496 109 1.3% 28 25.8% 10.7% 4.6

Source: See page 61

Unemployment data from Labor Force survey of civilian population aged 15 and over.

Japan

Real GDP

Percentage

Change Over

Previous Year

Retail Sales as

Percentage of

GDP

Year

Real GDP

(Billions of Yen)

GDP (Billions of

Yen)

GDP in U.S. $

(Billions)

Retail Sales

U.S. $ (Billions)

Unemployment

Rate

Yen

per U.S. $

1998 517,526 514,595 3,931 -1.1% 975 24.8% 4.1% 130.91

1999 517,822 507,224 4,453 0.1% 968 21.7% 4.7% 113.91

2000 532,553 511,462 4,746 2.8% 962 20.3% 4.7% 107.77

2001 534,863 505,847 4,162 0.4% 951 22.8% 5.0% 121.53

2002 532,973 498,102 3,972 -0.4% 942 23.7% 5.4% 125.39

2003 547,144 498,614 4,301 2.7% 938 21.8% 5.3% 115.93

Source: See page 61

Unemployment data are from the monthly Labor Force Survey of persons aged 15 and over. The data are seasonally adjusted by the OECD.

G LOBAL PRICING TRENDS

64


Netherlands

Year

Real GDP

(Billions of

Euros)

GDP

(Billions of

Euros)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change Over

Previous Year

Retail Sales

U.S. $

(Billions)

Retail Sales

as Percentage

of GDP

Unemployment

Rate*

Guilder per

U.S. $

Euro per

U.S. $

1998 337 354 393 4.3% 51 12.9% 4.2% 1.98

1999 351 374 399 4.0% 52 13.1% 3.2% 2.07 0.94

2000 363 402 371 3.5% 54 14.5% 2.6% 1.09

2001 367 429 384 1.2% 55 14.3% 2.0% 1.12

2002 368 445 418 0.2% 57 13.7% 2.3% 1.06

2003 366 453 513 -0.8% 59 11.6% 3.7% 0.89

Source: See page 61

* Unemployment refers to persons registered at employment offices who do not work at all or who work fewer than 12 hours per week, and who are available for

paid work for at least 12 hours per week. The series is based on the monthly survey undertaken by Statistics Netherlands.

On January 1, 1999, the euro became the currency, and the guilder became a non-decimal, sub-unit of the euro.

South Africa

Year

Real GDP

(Billions of

Rand)

GDP (Billions of

Rand)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change Over

Previous Year

Retail Sales

U.S. $ (Billions)

Retail Sales as

Percentage of

GDP

Unemployment

Rate* Rand per U.S. $

1998 591 739 134 0.8% 16 12.0% 25.2% 5.5

1999 603 801 131 2.0% 17 13.2% 23.3% 6.1

2000 624 888 128 3.5% 19 14.6% 26.2% 6.9

2001 641 983 114 2.7% 19 16.8% 27.9% 8.6

2002 664 1,121 106 3.6% 22 20.4% 30.0% 10.5

2003 676 1,209 160 1.9% 24 14.8% 29.7% 7.6

Source: See page 61

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M ACROECONOMIC INDICATORS

Spain

Year

Real GDP

(Billions of

Euros)

GDP

(Billions of

Euros)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change Over

Previous Year

Retail Sales

U.S. $

(Billions)

Retail Sales

as Percentage

of GDP

Unemployment

Rate*

Peseta per

U.S. $

Euro per

U.S. $

1998 487 528 588 4.3% 89 15.2% 15.0% 149.38

1999 507 565 602 4.2% 92 15.3% 12.8% 156.16 0.94

2000 529 610 562 4.2% 96 17.1% 11.0% 1.09

2001 544 653 585 2.8% 99 16.9% 10.5% 1.12

2002 555 696 655 2.0% 105 16.0% 11.4% 1.06

2003 568 743 839 2.4% 111 13.2% 11.4% 0.89

Source: See page 61

* Unemployment data are from the quarterly Labor Force Survey of persons aged 16 and over living in households (excluding, for instance, residents at institutions

like religious establishments). A partial change in the sample of census areas took place in the first quarter of 2000, and some methodological changes in the way

data were collected were introduced at the beginning of 1999.

On January 1, 1999, the euro became the currency, and the peseta became a non-decimal, sub-unit of the euro.

Switzerland

Year

Real GDP

(Billions of

Swiss Francs)

GDP (Billions of

Swiss Francs)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change Over

Previous Year

Retail Sales

U.S. $ (Billions)

Retail Sales as

Percentage of

GDP

Unemployment

Rate*

Swiss Francs

per U.S. $

1998 330 380 269 2.4% 42 15.4% 3.4% 1.45

1999 335 389 265 1.5% 43 16.1% 2.9% 1.50

2000 346 406 246 3.2% 44 17.7% 2.5% 1.69

2001 349 414 251 0.9% 44 17.6% 2.5% 1.69

2002 350 417 274 0.2% 45 16.3% 3.1% 1.56

2003 348 417 316 -0.5% 45 14.4% 3.9% 1.35

Source: See page 61

* Unemployment data are from the quarterly Labor Force Survey; data are seasonally adjusted by the OECD.

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66


United Kingdom

Year

Real GDP

(Billions of

Pounds)

GDP (Billions of

Pounds)

GDP in U.S. $

(Billions)

Real GDP

Percentage

Change Over

Previous Year

Retail Sales

U.S. $ (Billions)

Retail Sales as

Percentage of

GDP

Unemployment

Rate*

Pound per

U.S. $

1998 787 859 1,423 3.1% 267 18.7% 6.2% 0.60

1999 809 904 1,462 2.8% 276 18.9% 6.0% 0.62

2000 839 951 1,439 3.8% 285 19.8% 5.5% 0.66

2001 857 994 1,431 2.1% 300 20.9% 5.1% 0.69

2002 872 1,043 1,563 1.7% 315 20.2% 5.2% 0.67

2003 892 1,100 1,795 2.3% 338 18.8% 5.0% 0.61

Source: See page 61

* Unemployment data are from the quarterly Labor Force Survey. The OECD Economic Outlook statistics differ slightly from those published in the LFS due to

realignment of data to a different calendar period and seasonal adjustment methods.

United States

Real GDP

Percentage

Change Over

Previous Year

Retail

Sales as

Percentage

of GDP

Year

Real GDP

in U.S. $

(Billions)

GDP in U.S. $

(Billions)

Retail Sales

U.S. $

(Billions)

Unemployment

Rate*

U.S. $ per Euro

1998 9,067 8,747 4.2% 2,042 23.3% 4.5%

1999 9,470 9,268 4.5% 2,206 23.8% 4.2% 1.07

2000 9,817 9,817 3.7% 2,376 24.2% 4.0% 0.92

2001 9,867 10,101 0.5% 2,527 25.0% 4.7% 0.89

2002 10,083 10,481 2.2% 2,744 26.2% 5.8% 0.94

2003 10,398 10,988 3.1% 3,011 27.4% 6.0% 1.13

Source: See page 61

* Unemployment data are from the Current Population Survey of persons aged 16 and over. The data are seasonally adjusted by

the Bureau of Labor Statistics.

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Classification of Individual

Consumption by Purpose

INDIVIDUAL CONSUMPTION EXPENDITURE

BY HOUSEHOLDS:

01. FOOD AND NON-ALCOHOLIC BEVERAGES

01.1 Food

01.1.1 Bread and cereals

01.1.2 Meat

01.1.3 Fish

01.1.4 Milk, cheese, and eggs

01.1.5 Oils and fats

01.1.6 Fruit

01.1.7 Vegetables, including potatoes and other tuber

vegetables

01.1.8 Sugar, jam, honey, syrups, chocolate, and confectionery

01.1.9 Food products n.e.c.

01.2 Non-alcoholic beverages

01.2.1 Coffee, tea, and cocoa

01.2.2 Mineral waters, soft drinks, and juices

02. ALCOHOLIC BEVERAGES, TOBACCO, AND NARCOTICS

02.1 Alcoholic beverages

02.1.1 Spirits

02.1.2 Wine

02.1.3 Beer

02.2 Tobacco

02.2.1 Tobacco

02.3 Narcotics

02.3.1 Narcotics

03. CLOTHING AND FOOTWEAR

03.1 Clothing

03.1.1 Clothing materials

03.1.2 Garments

03.1.3 Other articles of clothing and clothing accessories

03.1.4 Repair and hire of clothing

03.2 Footwear

03.2.1 Shoes and other footwear

03.2.2 Repair and hire of footwear

05. FURNISHINGS, HOUSEHOLD EQUIPMENT, AND ROUTINE

MAINTENANCE OF THE HOUSE

05.1 Furniture, furnishings and decorations, carpets and

other floor coverings, and repairs

05.1.1 Furniture and furnishings

05.1.2 Carpets and other floor coverings

05.1.3 Repair of furniture, furnishings, and floor coverings

05.2 Household textiles

05.2.1 Household textiles

05.3 Heating and cooking appliances, refrigerators, washing

machines, and similar major household appliances,

including fittings and repairs

05.3.1 Major household appliances whether electric or not

05.3.2 Small electric household appliances

05.3.3 Repair of household appliances

05.4 Glassware, tableware, and household utensils

05.4.1 Glassware, tableware, and household utensils

05.5 Tools and equipment for house and garden

05.5.1 Major tools and equipment

05.5.2 Small tools and miscellaneous accessories

05.6 Goods and services for routine household maintenance

05.6.1 Non-durable household goods

05.6.2 Domestic services and home-care services

07. TRANSPORT

07.1 Purchase of vehicles

07.1.1 Motor cars

07.1.2 Motorcycles

07.1.3 Bicycles

07.2 Operation of personal transport equipment

07.2.1 Spare parts and accessories

07.2.2 Fuels and lubricants

07.2.3 Maintenance and repair

07.2.4 Other services in respect to personal transport

equipment

07.3 Transport services

07.3.1 Passenger transport by railway

07.3.2 Passenger transport by road

07.3.3 Passenger transport by air

07.3.4 Passenger transport by sea and inland waterway

07.3.5 Other purchased transport services

Countries using this classification: France, Germany, Netherlands, Spain,

Switzerland, and United Kingdom.

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CPI Category Summaries

by Category

Classification of Individual Consumption by Purpose, COICOP

Countries All Group Food and Non-Alcoholic Beverages Alcohol and Tobacco Apparel and Footwear Household Furnishings and Operations Transportation

1 Australia ! Includes

restaurant and take-out meals

2 Canada ! Includes

restaurant and take-out meals

* Follows the Classification of Individual Consumption by Purpose (COICOP).

! Includes jewelry; watches

not specified

! Includes jewelry

and watches

! Excludes bicycles

Combined with Communication;

includes child care, pet food and supplies,

and financial services

Excludes bicycles

3 France* ! ! ! ! ! !

4 Germany* ! ! ! ! ! !

5 Israel ! Combined with Alcohol; includes

restaurant and take-out meals

6 Japan ! Combined with Alcohol; includes

restaurant and take-out meals

Tobacco Only Includes diapers Two series, one for Furnishings and

the other for Operations. Operations

includes Energy and taxes

! Excludes Operations

but includes domestic service

7 Netherlands* ! ! ! ! ! !

8 South Africa ! Food and Non-Alcoholic

Beverages are separated out

into two categories

Alcohol and Tobacco are

separated out into two

categories

! Furnishings and Operations are

separated out into two categories

Excludes bicycles

Combined with

Communication

9 Spain* ! ! ! ! ! !

10 Switzerland* ! ! ! ! ! !

11 United Kingdom* ! ! ! ! ! !

12 United States ! Combined with Alcohol; includes

restaurant and take-out meals

Includes jewelry

and watches

Combined with Furnishings and

Operations; includes clocks and

indoor plants and flowers

!

Includes motor vehicle

insurance; excludes bicycles

71

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Global RCP Leadership

Canada

Jacques Dostie

1-514-879-2606

jacques.dostie@ca.ey.com

United Kingdom

Howard Martin**

44-20-7951-4072

hmartin@uk.ey.com

Netherlands

Hans Beeftink**

31-592-399-735

hans.beeftink@nl.ey.com

Germany

Thomas Harms**

49-211-9352-18502

thomas.harms@de.ey.com

Russia & the CIS

Marcus Rhodes

7-095-755-9739

marcus.j.rhodes@ru.ey.com

United States

James Cook*

1-312-879-3170

jim.cook@ey.com

Jay McIntosh**

1-312-879-3385

jay.mcintosh@ey.com

France

Olivier Macard**

33-1-55-61-06-16

olivier.macard@fr.ey.com

Spain

Jose Antonio Martin

de los Santos

34-91-572-75-65

joseantonio.martinsantos@es.ey.com

Switzerland

Bruno Chiomento**

41-58-286-8320

bruno.chiomento@ch.ey.com

Belgium

Daniel Van Cutsem

32-2-774-9445

daniel.van.cutsem@be.ey.com

Italy

Marco Bosca

39-011-516-5236

marco.bosca@it.ey.com

Israel

Doron Sharabany

972-3-623-2518

doron.sharabany@il.ey.com

Thailand

Ralph Tye**

66-2-264-0777

Ralph.R.Tye@th.ey.com

Japan

Takaaki Nimura**

81-3-3503-1275

nimura-tkk@shinnihon.or.jp

Hong Kong

John Nicolai

852-2629-3831

john.nicolai@ey.com

* Global Leader

** Area Leader

Brazil

Sergio Romani

55-11-3523-5455

sergio.r.romani@br.ey.com

South Africa

Ian Catt

27-11-772-3031

ian.catt@za.ey.com

Australia

Christopher George**

61-2-8295-6051

christopher.george@au.ey.com

About Ernst &Young

The members of the Ernst & Young global organization help companies in businesses across all industries—from emerging growth

companies to global powerhouses—deal with a broad range of business issues. Our 100,000 people in more than 140 countries

around the globe pursue the highest levels of integrity, quality and professionalism to provide clients with a broad array of services

relating to audit and risk-related services, tax, and transactions.

73

©2004 EYGM LIMITED


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Notes

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Notes

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Notes

INSERT FLAG HERE

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All Rights Reserved.

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