Rising incomes bode well for the Philippine retail sector, while mall expansion moves outside the urban centres

With a young, rapidly growing and consumption-driven market of nearly 100m, an expanding middle class and positive consumer sentiment, the Philippines’ demographic and socio-economic status makes it one of the region’s more promising retail destinations.

Consultancy A.T. Kearney, in its 2014 Global Retail Development Index, ranked the Philippines 23rd out of 200 emerging economies evaluated, based partly on expectations of retail sales growing 10% per annum for the next three years. The report predicts another five to 10 years before the market approaches maturation, making the coming period the optimal time for new entrants seeking to gain a foothold and existing retail groups looking to expand their presence amidst more favourable trading conditions.

Adjusted for inflation, figures from the National Statistical Coordination Board show gross value added in the retail trade expanded by 6.8% in 2013. This growth is expected to continue as remittances from Filipinos overseas and the business process outsourcing (BPO) sector – the two underlying factors driving the performance of the sector – show no signs of slowing.

ADAPTING TO TRENDS: Going forward the retail landscape is expected to see greater competition and gain in sophistication. A third of the country’s population falls in the 20- to 30-year-old age bracket – the so-called retail sweet spot – and is considered more brand-conscious and prone to adapt to and demand new retailing trends. “The population is young, the workforce is growing, and if you get it right as a retailer, you will grow,” Paul A Santos, the national vice-president of the Philippine Retailers Association (PRA), told OBG.

The Philippines offers arguably the most Westernised culture and the strongest English language skills in Asia, and as a result international brands and concepts have had a high success rate. However, taking on the local retail incumbents, many of which are affiliated with large conglomerates, can prove a challenge, especially when it comes to securing retail space in the more sought-after malls and shopping districts.

GROWTH DRIVERS: Buoyed by an optimistic consumer outlook and strong consumerist culture, the World Bank forecasts private consumption to contribute more than half of GDP growth in 2015. The Philippines’ gross national income per capita totalled $3270 in 2013, which is substantially up from $2480 in 2009 and almost treble the amount recorded in 2003. A second-quarter 2014 survey released by the central bank, Bangko Sentral ng Pilipinas (BSP), reported consumer expectations for the next 12 months to be upbeat based on improved prospects for job security and more investment in the country.

At any given time, it is estimated that approximately 10% of all Filipinos are working abroad as overseas foreign workers (OFWs). The earnings they send home make up around one-tenth of the economy, and a large proportion goes towards retail spending. Cash remittances increased 6.4% in 2013 to reach record levels, and the BSP’s Department of Economic Statistics predicts 2014 remittances to expand a further 5% to reach $23bn for the year.

The BPO sector is the second-largest economic contributor after remittances. According to the IT and Business Process Association of the Philippines, the industry was responsible for $15.5bn in revenue in 2013 while employing 900,000 people – a dramatic increase from the $3.2bn of revenue and 240,000 jobs it accounted for in 2006. According to BSP figures, the average salary of a BPO worker in 2012 came out to $8849, which is nearly triple the minimum wage in Metro Manila. “Most BPO workers are in their mid-20s and early 30s, and many are living at home with high disposable incomes. Retail is really feeling the effect in a positive way,” Christopher Po, president and CEO of Century Pacific Group, told OBG.

As with OFWs and BPO workers, tourist arrivals, in both the leisure and business segments, are also on the rise, with the Department of Tourism reporting the number of foreign visitors to have grown by 9.5% in 2013. This provides an additional budding shopper base for retailers to capture, justifying the further development of retail space in both business centres and tourist hotspots.

MONETARY MATTERS: Mounting consumer demand, while supporting sales, is also driving inflation. Price increases reached a two-and-a-half-year high in May 2014, rising to 4.5% year-on-year from 4.1% in April, with bubbling consumer demand cited as one factor stoking inflationary fires. As a substantial portion of retail goods are imported, logistics costs factor heavily into merchandise pricing, and port bottlenecks and disruptions also contributing to inflationary pressure.

According to the Philippine Franchise Association (PFA), its members suffered P3bn ($67.5m) in total losses as a result of having to pay more for imported goods reaching their stores over the course of a truck ban in Metro Manila that took place between February and September 2014.

With inflation potentially creeping towards the high end of the BSP’s 3-5% target band, this could prompt a raising of key interest rates, which could, in turn, curb the appetite for spending amongst credit card holders and those with household debt. The effect would likely be limited, however. “Interest rates do not have much influence on retail sales outside of the wealthier catchments of Metro Manila as most Filipinos earn and spend in cash,” Sam Christopher Lim, the chairman for ASEAN integration at the PFA, told OBG.

Exchange rates, for the most part, have not been a major issue for retail imports over the past few years, with the value of the peso staying relatively stable against the US dollar since 2012.

DOMINANT INCUMBENTS: The Philippines’ retail landscape is dominated by four major domestic players, each of which has a diversified portfolio covering a mix of retail categories and format types.

The SM Group, whose parent company also has interests in the banking, property and hospitality sectors, is considered to be the largest of the four retail players. As of June 2014, the retail and mall giant’s ownership footprint consisted of 50 shopping malls and a total of 240 retail stores.

The Ayala Corporation, arguably the country’s largest conglomerate, owns and operates a significant mall portfolio under its Ayala Land real estate arm. To complement its mall offering, it is increasingly venturing into starting up or partnering with existing retail chains to leverage the lease space it has available in its sought-after mixed-use developments.

Robinsons, the third major competitor, develops and manages its own branded malls, supermarkets and department stores throughout the country. Rustan’s, the last of the big four, is considered the leader in the higher-end retail and fashion space, representing more than 70 foreign brands.

Considering the diversified interests of these groups and the tendency in the Philippines for mall and retail property owners to also own or partner with store franchises, penetrating the market for independents presents its challenges. “The groups are understandably prioritising their own brands and granting them more desired mall locations,” the PRA’s Santos told OBG. “While some international brands, like H&M, have been able to negotiate better slots and better rates as the landlords understand they can help drive footfall, local unaffiliated players find things challenging.”

Given the resources of the dominant sector players and the race amongst them to spread their footprint geographically and enter into new retail categories, the trend in recent years has been one of consolidation, with the larger players absorbing smaller specialist and regional retail outfits.

RETAIL SPREAD: The Philippines displays a marked contrast between urban and rural income and development levels, an attribute that is evidenced in the large concentration of malls amongst the major population centres. As of the end of 2013 real estate service firm Jones Long LaSalle (JLL) measured total shopping mall space at 13m sq metres, of which more than half (7m sq metres) was located in Metro Manila, while the bulk of the remaining space was in the secondary cities of Cebu, Davao, Cavite and Pampanga.

By 2015, JLL expects new supply of 1.4m sq metres to hit the provinces, drawing level with Metro Manila. “For the first time, wealth is being distributed outside of the capital. In the past, the regions were stagnant. Now there is an aspiration shift, and this is being seen in the pace of malls opening in the provinces,” George Royeca, a business development associate at IT company IPVG Corporation, told OBG. In addition to rising wages and disposable income levels, the attraction of the provinces for mall developers is the lack of saturation and the comparative opportunity for growth. Based on projections of per capita retail floor space, some analysts are concerned about the risk of oversaturation in the capital.

“In Metro Manila people have more choice and the mall offering is more commoditised, so one tends to go to whichever mall is closest to home or work,” said the PRA’s Santos. “In second-tier cities, however, there are not only fewer shopping malls to choose between, but less public spaces and parks. In turn, the major malls become a place of leisure to spend evenings and weekends with family and friends.”

MEGA-MALLS: While the pace of development of new malls in the provinces is expected to surpass that seen in urban centres, developers are far from packing up and shifting their focus entirely to remoter areas. The springing up of planned satellite townships in and around Manila’s outskirts and other secondary cities still provides ample scope for development.

Case in point is the town of Eastwood City in southern Quezon City. Little more than a plot of abandoned factories two decades ago, spurred by the BPO boom, Eastwood has morphed into a mixed-use node where 60,000 people work at 59 firms located in a cluster of office towers spread over 17 ha. They, along with the development’s 20,000 residents, have 500 shops to choose amongst. Similar sites that have grown off the back of the BPO sector include Bonifacio Global City and Alabang. The Bay City and Newport City precincts, in addition to housing commercial offices catering to BPO firms, have large resort and gaming components.

Another unique trait of the Philippines is that developers and shoppers alike prefer their malls big. In a 2012 ranking compiled by real estate data mining company Emporis, the country was home to three of the world’s 10 largest malls as measured by floor area. The SM Group’s Megamall, City North and Mall of Asia properties ranked third, fourth and ninth, respectively. These three malls along with Filinvest’s Festival Mall and the Ayala Group’s Greenbelt also made it onto international lifestyle website Complex.com’s 2013 list of “the world’s 50 coolest malls”.

According to third-quarter 2014 report by property firm Colliers, 56,000 sq metres of retail space came on-line in the preceding six months, bringing greater Manila’s total retail stock to 5.8m sq metres, while an additional 167,000 sq metres was expected for delivery by year-end. Demand for retail space in 2013 was strong over the course of 2013, keeping vacancy rates below 5%, according to CBRE. Average rents remained stable, however, due to a glut of supply hitting the market towards the tail end of the year.

FOREIGN BRANDS: Developers’ confidence that new malls will have uptake is also being fuelled by the arrival of international chains, which for brand positioning purposes, are quite selective in where they choose their sites. Demonstrating that expansion is taking place in multiple categories by retailers hailing from a number of regions, 2013 and 2014 saw the arrival of fashion brands from the US (American Eagle Outfitters and BH Fashion) and Sweden (H&M) as well as international jeweller Claire’s, Korean bakery Tous Les Jours, Japanese convenience store chain FamilyMart and Hong Kong supermarket Wellcome to name but a few. “Ten years ago, there was definitely a cultural predisposition towards American brands. But as Filipinos become more cosmopolitan and are exposed through the internet and media to more trends, country of origin has less relevance,” said the PRA’s Santos.

On top of an emerging consumer base, an additional appealing attribute of the Philippines is that it offers relatively affordable lease rates in comparison to more developed Asian retail centres. Acquiring a square metre of rental space in Manila costs about $390, compared to $1200 in Bangkok, $5000 in Singapore and $5370 in Shanghai.

LOCAL PARTNERSHIP: As in any emerging market, affordability is critical for the country’s retailers, whose business model requires economies of scale and a large mass-market footprint. This prevents general merchandisers from entering, and explains the prevalence of high-end fashion brands that are comfortable operating with higher-margin, lower-volume turnover. As low income levels for the majority of the population translates to food accounting for a large proportion of household expenditure, food retailers have strong prospects for growth, so long as they can adapt to meet local market particularities. “We have been dubbed a sachet economy as purchases for basics like laundry detergent and instant coffee are mostly done in small package sizes,” the PFA’s Lim told OBG.

For the PRA’s Santos, complicated and fragmented trading conditions between the urban centres and the provincial islands results in a tendency for international brands to pursue partnering with an established domestic group as a means of gaining local market knowledge. Local partnerships take on greater importance for brands looking to secure strategic store space in desired locations as it is difficult to do so without having a partnership with an entrenched conglomerate that also has a property portfolio.

Adding to the impetus for local partnerships are legislative requirements that any retailer aspiring to operate in the Philippines under full foreign ownership status must commit paid-up capital of $2.5m and make one-third of their shares available to the public within eight years of setting up. Other stipulations include terms that the retailer must have been in business for at least five years; operate at least five stores globally, or at least one store with capital of at least $25m; and invest at least $830,000 in each store in the Philippines. The law is more lenient for foreign retailers of luxury goods, which face no divestment requirement, need a net worth of $50m and must commit a minimum paid-up capital of $250,000 per store.

“The foreign ownership law does not deter the big retailers, and besides, there are tricks and ways to skirt the law,” said the PRA’s Santos.

SARI SARI: While international and local chains battle it out in for share of formal retail spend, it will take some time before the community role of traditional “mom and pop” shops (referred to colloquially as saris) is rendered obsolete. A.T. Kearney estimates informal sari saris account for around 70% of the market, and in rural areas they, along with pavement vendors and open-air markets, dominate the landscape.

Puregold Price Club, a locally listed firm specialising in hypermarkets and currently expanding into supermarkets and smaller retail formats, has grown from a single store in 1998 into the country’s largest standalone retail company. Much of its success has been built on catering to the Philippines’ informal sari sari market, which accounts for an estimated 35% of its total sales. “There are about 1m sari saris in the country, and the number is growing. They are small and challenging to reach, and so far Puregold has managed to gain around 230,000 of them as customers,” Leonardo B Dayao, president of Puregold Price Club, told OBG.

CONVENIENCE COUNTS: Urbanisation, densification, and changing work and lifestyle habits are contributing to an increase in convenience stores (c-stores), and Puregold and the other major local retail groups are looking to tap into this trend by partnering with or launching their own c-store chains.

According to 2012 figures from research firm Nielsen, the Philippines has one of the lowest penetration rates of c-stores per capita in East Asia, something that looks set to change with the proliferation of new outlets popping up throughout the country. Whereas two years ago the field consisted of just two chains, the local franchise of the US’s 7-Eleven and Mini Stop, owned by Robinsons, there are currently seven competing players in the segment. Analysts predict the number of stores will double to reach around 4000 over the next four years. “This is a very exciting segment. In the past, the market was dominated by 7-Eleven. Now others have arrived and are expanding aggressively,” said the PRA’s Santos.

Indeed, the list of new challengers battling it out with the two entrenched players represents a who’s who of leading c-store chains found throughout the region. Japanese heavyweight FamilyMart, working in partnership with an Ayala Land and Rustan’s joint venture, has announced plans to expand its base from 130 to around 500 stores by 2018.

Lawson’s, another Japanese chain that has partnered with Puregold, is expected to open its first store in early 2015, and the company has stated that it will launch 500 by 2020. The SM Group has invited Indonesia’s Alfamart as its partner brand for foraying into the segment, while Super 8 Retail acquired the US’s Circle K’s Philippine interests in March 2014. Lastly, Mercury Drug, the country’s largest pharmacy chain, is getting in on the action by converting some of its pharmacies into pure c-store outfits.

According to a study by the International Labour Organisation, 42.6% of the Philippines’ BPO sector employees work night shifts, and, as a result, most cstores in commercial areas are open 24 hours a day.

FRANCHISING MODEL: As is happening in other emerging markets, the spread of formalised retail is generating debate as to whether this is eroding the role of traditional markets, and in the Philippines’ case in particular, whether this could lead to the pushing out of family-owned sari saris. Proponents of retail modernisation argue that consumers stand to benefit from the lower prices achieved through scale as well as the greater choice and quality of stock that the larger retailers bring. For the PFA’s Lim, modern trade, when operating under a franchise model, actually allows entrepreneurs and owners of sari saris to participate in the industry’s transformation.

“For many franchisor sari sari owners are the ideal franchisee candidates as they are entrenched and trusted in the local community.” The benefits that franchisees stand to gain, according to Lim, include better access to finance as banks recognise that the franchisor would have performed their own due diligence on the applicant beforehand, as well as a higher success rate compared to a pure start-up as a franchisee is replicating a successful model.

According the PFA, the Philippines has 1400 franchise concepts representing some 125,000 franchise operations that contribute 1m jobs. Of this, 43% are food concepts, 28% retail chains and 21% services such as education centres, daycares and travel agencies. When the ASEAN Economic Community is in place at end-2015, barriers to regional franchises entering the Philippines and Philippine franchises launching in other member states will be reduced.

“ASEAN presents a potential market of around 600m people. So far our local franchises are not well represented outside of the country,” said Lim of the PFA. “One of the challenges is that we don’t even have that many truly national chains due to our being an archipelago, while another is that we are quite culturally different from the rest of ASEAN, especially when it comes to our food palate.”

ONLINE SALES GROWTH: Although growth came off a very low base, internet retailing expanded by 13% in 2013 to reach sales worth a total of P11bn ($247.5m), according to figures of Euromonitor. While the Philippines very much retains a mall-going culture in that most Filipinos enjoy shopping, online transactions are starting to become more commonplace, prompting leading Asian online retailers such as Zalora and Lazada to establish a presence in the country to cater to this nascent but growing market.

“BPO workers are interacting with computers all day and becoming quite techy. They are living at home with their parents and have high disposable income. The e-commerce retailers definitely have this segment in mind,” George Royeca, a business development associate at IT company IPVG Corporation, told OBG.

Logistically, one major barrier to e-commerce reaching critical mass is a lack of credit card penetration in the country. So far, online retailers are circumventing this challenge by accepting cash on delivery, and it should become less of an issue over time as internet payment systems, such as PayPal, become more common. Even if the transactions are not done online, given the growing ownership of inexpensive smartphones and the increasing access to the internet via 3G coverage, retailers are developing websites to showcase their products for consumers who like to browse online prior to making an in-person, brick-and-mortar purchase. A 2014 study carried out by On Device Research estimated smartphone penetration in the Philippines at around 15%, one of the lowest rates in Asia; however, growth is expected to be amongst the fastest in the region, reaching 50% by 2015.

“The biggest challenges for the development of Philippine e-commerce are the transaction payment and inadequate infrastructure, which affects the cost of delivering goods. Filipinos shop by researching online but transacting offline. However, e-commerce offers huge potential if the payment scheme is improved, especially as the current domestic credit card utilisation is low and many people still have trust issues with credit card payments done online. The huge youth demographic, which is technologically savvy, will be a significant market for retailers to tap through e-commerce,” Bernie H Liu, the chairman and CEO of fashion retailer Golden ABC, told OBG.

OUTLOOK: The Philippines’ demographic dividend, a consumerist culture and economic expansion all add up to positive signs for retailers. Although the retail sector is relatively well developed, modern trade is mostly concentrated in the province of Luzon and a few other commercial centres, presenting retail chains and franchises with the opportunity to expand their footprint to smaller towns and secondary islands.

Despite some restrictions on foreign ownership, international retailers are making the country a top expansion priority and are often looking to partner with established incumbents that can offer local insights and access to store sites. The development of malls is expected to taper off, but a thriving BPO sector and provincial growth present opportunities for retail property in new commercial and residential districts.

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The Report: The Philippines 2015

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