Digital Retail Price Index. A comparator of online and in-store retail price inflation

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1 Digital Retail Price Index A comparator of online and in-store retail price inflation Introduction The Centre for Economics and Business Research (Cebr) was commissioned by TalkTalk to undertake a study quantifying the levels of price inflation observed in both online and in-store retail channels. The study adopts a top-down approach, using macroeconomic retail trade data from the Office for National Statistics (ONS), overseas trade data from HM Revenue & Customs (HMRC) and inflation data from the UK s main import markets. Our Findings The Digital Retail Price Index (DRPI) shows online prices falling by around 0.7% between Q and Q2 2012, meaning that DRPI inflation now stands at its lowest rate for nearly five years. The low rate of DRPI inflation seen this quarter is mainly due to UK-based internet retailers, which reported prices falling at a year-on-year rate of 0.8% in Q This contrasts with Internationally-based internet retailers, which saw prices fall by a more modest 0.1% over the same period. While DRPI inflation was in negative territory in Q2 2012, inflation on our In-Store Price Comparator Index remained firmly positive, with prices growing at a year-on-year rate of 1.6% over the same time period. That is, while online shoppers have seen a fall in prices over the past year (on the DRPI measure), those purchasing similar goods on the High Street would have seen rising prices. Over the past five years, prices have grown much less slowly on the DRPI than the In-Store Price Comparator Index, with prices growing by 3.0% compared with 6.2%.

2 Results & Analysis Figure 1 illustrates the levels of inflation based on the Digital Retail Price Index (DRPI) and In-Store Price Comparator. Figure 1 DRPI and In-Store Price Comparator Index, annual percentage change The analysis shows that the DRPI (red line) has exhibited a lower level of inflation than the In-store Price Comparator Index (blue line) for most of the time period between Q and Q There is a relatively close link between the movements of the two indices, although in recent years the gap has widened, with DRPI inflation now considerably lower than inflation on the In-Store Comparator Index. In Q2 2012, annual inflation on the DRPI measure was -0.7%, compared with +1.6% on the In-store Price Comparator Index. Over the last two years, while prices on the DRPI measure have grown by just 0.3%, on the In-store Comparator Index they have grown by 4.9%. This is indicative of inflationary pressures in the economy having a disproportionate effect on high-street businesses with fixed overheads (e.g. energy and rents) than virtual retailers. Figure 2 illustrates the price changes between the two indices over the past 2, 5 and 7 years.

3 Figure 2 Two, Five, Seven Year growth in DRPI and In-store Price Comparator Growth over: Past 2 Years Past 5 Years Past 7 Years DRPI 0.3% 3.0% 0.8% In-store Price Comparator 4.9% 6.2% 5.0% Difference -4.6 percentage points -3.2 percentage points -4.2 percentage points This shows that, over the past five years, DRPI inflation has been much lower than in-store inflation, with prices growing by 3.0% compared with 6.2%. Figure 3 illustrates price inflation trends amongst the two components of the DRPI: UK-based and Internationally-based Internet Retailers. Figure 3, Components of DRPI: UK-based internet retailers & Internationally-based internet retailers, annual percentage change 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% Q Q Q Q Q Q Q Q Q UK-based Internet Retailers International Internet Retailers DRPI

4 The analysis shows that, in Q2 2012, inflation was in negative territory for both UK-based and internationally-based internet retailers, with prices growing at an annual rate of -0.8% and -0.1% respectively. The 2.4% fall in international air freight costs between Q and Q2 2012, is the main driver of price inflation falling into negative territory among internationally-based internet retailers. For UKbased internet retailers, the weak domestic economic environment is likely to be placing downward pressure on the price of discretionary goods, pushing inflation into negative territory. Figure 4 compares DRPI inflation with the RPI measure of inflation for the UK. It shows that, for most of the past seven years, DRPI inflation has been much lower than RPI inflation, though directionally the two series have tended to follow each other 1. Cebr expects RPI inflation to fall to just 2.4% by Q2 2013, down from 3.1% in Q Given this, further declines in DRPI inflation over the coming quarters seem likely Figure 4, DRPI and RPI, annual percentage change 6% Cebr forecast 5% 4% 3% 2% 1% 0% -1% -2% -3% Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q4 2012f Q2 2013f DRPI RPI 1 The major exception to this was in 2009, when a sharp decline in interest rates pushed down mortgage interest payments. This led to a steep decline in RPI inflation. However, as DRPI excludes mortgage interest payments, this measure of inflation did not see a decline.

5 Methodology Q. How is the Digital Retail Price Index (DRPI) constructed? A. The DRPI is a composite index based on estimations of changes in retail prices observed amongst both domestic and international internet retailers respectively. The price changes affected by domestic internet retailers are calculated from Office for National Statistics (ONS) retail sales data on non-store retailing volume and value growth. The price changes affecting international internet retailers are assumed to follow macroeconomic price trends in the global marketplace. In this study, these price trends are based on the observed rate of clothes/household goods price inflation in the UK s major import markets. These price changes are adjusted for fluctuations in the sterling exchange rate and take into account changes in international air-freight costs. Q. What does the DRPI include in its calculations? A. The DRPI provides a top-down estimate of quarterly changes in the internet price of goods that are purchased online by UK consumers. These goods are typically food, household goods or clothing. The DRPI does not include services that are purchased online such as travel & accommodation, finance & insurance and utilities. Q. What is the difference between the Digital Retail Price Index (DRPI) and the CPI or RPI? A. The DRPI represents a price index for the typical basket of goods bought online, which varies from the typical basket of goods bought in-store as captured by the CPI/RPI. Figure 5 illustrates that, in the food, household goods and clothing sectors, consumers buy a different mix of products online compared to in-store. Consumers are more likely to spend money on household goods and clothes, rather than food, on the internet in general there is more competition between the three sectors online. Figure 5: How 1 is spent between the three sectors online and in-store Sector Online In-store Food 45p 66p Household goods 18p 14p Clothing 38p 20p Source: Office for National Statistics Furthermore, the CPI/RPI includes services such as energy, housing, transport and accommodation which are not included in the DRPI.

6 Q. What is the In-store Price Comparator Index? A. The In-store Price Comparator Index is a representative measure of the price changes faced by a consumer if they replicated their online purchasing habits in a store. The price index is constructed from Office for National Statistics (ONS) food, clothing and household goods volume and value growth data. Tables Price Indices, 100 = April 2005 Period ONS retail price index In-store Price Comparator index UK-based Internet Retailers Internationallybased Internet Retailers Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q DRPI

7 Q Q Q Q Q Q Q Q Q Price Indices, Annual percentage change Period ONS retail price index In-store Price Comparator index UK-based Internet Retailers Internationallybased Internet Retailers Q % -1.7% -1.6% -4.6% -2.2% Q % -2.3% -1.9% -6.1% -2.6% Q % -2.1% -1.7% -2.7% -2.0% Q % -2.1% -1.9% 1.7% -1.6% Q % -1.9% -2.1% 3.2% -1.6% Q % -1.5% -1.7% 5.5% -0.9% Q % -1.9% -2.3% 4.7% -1.4% Q % -1.9% -2.1% 4.5% -1.2% Q % -1.7% -1.9% 2.0% -1.4% Q % -0.9% -1.4% -2.1% -1.5% Q % -0.2% -1.2% -3.1% -1.5% Q % -0.1% -1.2% -3.3% -1.6% Q % 0.7% -0.7% -0.8% -0.7% Q % -0.5% -1.8% 0.7% -1.5% Q % -0.3% -1.2% 4.2% -0.5% Q % -0.4% -1.2% 11.1% 0.4% Q % 0.2% -0.8% 14.1% 1.1% Q % 1.8% -0.4% 17.0% 1.8% Q % 0.4% -2.0% 24.1% 1.9% Q % 0.2% -2.5% 24.1% 1.9% Q % -0.2% -2.3% 13.5% 0.7% Q % -1.1% -1.5% 7.6% 0.4% Q % -0.1% -0.4% 2.3% 0.0% Q % 0.9% 0.7% -2.3% -0.2% Q % 1.2% 0.8% 3.8% 0.9% DRPI

8 Q % 1.5% 0.2% 4.5% 0.6% Q % 2.7% 1.1% 2.3% 1.1% Q % 3.3% 1.2% 0.2% 0.8% Q % 3.3% 0.9% 2.3% 0.9% Q % 3.8% 0.9% 5.4% 1.5% Q % 2.9% 0.6% 4.6% 1.3% Q % 2.6% 0.1% 4.0% 0.8% Q % 1.6% -0.8% -0.1% -0.7%