Emerging Market Spotlight ______Retail in South Africa: Making an Impression July 2011

South Africa has forever had the Fast Facts reputation of being the world’s treasure cache of mineral  The South African economy is the strongest on the African resources. From the discovery of continent, accounting for 17% of Africa’s gross domestic diamonds on the banks of the output (GDP). Orange River in 1867 to a series  South Africa’s currency, the Rand, is the most actively traded of gold rushes and subsequent emerging market currency. The country’s stock exchange, development of gold fields, the JSE Securities Exchange, was ranked 18th in the world in mining as an industry has been terms of market capitalization as of March 2009. crucial to the economic  The South African Retail sector is the largest on the African development of this sub-Saharan continent and was ranked 24th on A.T. Kearney’s 2010 nation. However, over the years, Global Retail Development Index (GRDI). gold and diamond production  According to a Global Agricultural Information Network has lost some of its luster and (GAIN) report, retail sales volumes were US$72 billion in sheen. South Africa, which held 2009 despite severe recessionary conditions. the No.1 position in gold  With blacks constituting 79.4% of the nation’s population production for over a century, (49 million), the emerging black middle class - estimated at was relegated to the second around 3 million - is currently the largest spending group. position by China in 2007. It is now only the fifth largest producer of diamonds in the world after Russia, Botswana, Canada and Angola. Though the mining sector continues to be the largest employer, it is expected to contribute only around 8% to the GDP in 2011, according to a report by Business Monitor International. The services sector is now the largest contributor to South Africa’s GDP. While the nation has seen remarkable advancements in the financial services, tourism and telecommunications markets, retail is now emerging to be a strong contender. Growing affluence among the nation’s black majority, particularly the emerging black middle class, has provided the much required fillip to this sector.

Growth in the retail sector over the years has been due to steady economic growth, an increase in disposable income and high consumer confidence. Retail sales grew briskly from around US$28 billion in 1998 to US$92 billion in 2007. However, this sector too succumbed to the global financial crisis in 2008. Nevertheless, with consumer spending rebounding in 2010, a survey by the Economist Intelligence Unit has forecasted retail sales to touch US$117 billion in 2011.

Higher Consumer Spending

South Africa fell victim to the global economic meltdown in the first quarter of 2009 – the country’s first recession since 1992. A slump in export demand and lower household spending plagued the economy until the end of 2009. Encouragingly, the economy took a turn for the better as it gingerly entered the year 2010. The effect of the government’s counter-cyclical fiscal policies coupled with increased infrastructure spending programs and tourist arrivals fueled consumer spending in the run up to the 2010 FIFA World Cup, cushioning the economy. According to the Minister of Tourism, foreign visitor numbers grew 16.8% year-on-year between January-September 2010.

The Consumer Confidence Index (CCI) as measured by FNB/BER had spiraled to 6 at the peak of the recession. However, the index climbed to 15 in the first quarter of 2010 and held steady throughout 2010, mirroring the resilience among South African consumers.

According to a study by the United Nations, growing urbanization and an increase in the number of economically active individuals is expected to augur well for South Africa’s retail industry. More than 64% of the population is expected to move into the urban category by 2015. While the proportion of the economically active population, in general, is slated to reach 64.3% by 2015 from 64.1% in 2005, those in the age group of 20-44, who are vital to the

Source: First National Bank, Bureau for Economic Research

2 retail sector are forecasted to constitute 38% of the population by 2015, compared to 36.8% in 2005.

Growing Consumer Goods Sector

Most of the consumer goods markets in South Africa are underdeveloped and are import-driven. While markets for white goods, such as PCs, and apparel are heavily dependent on imports, the cosmetics and toiletries (C&T) segment is the only one that has remained self-sufficient. C&T markets have a good mix of domestic players such as Adcock Ingram, Beige, and Avroy Schlain, and international players like Unilever, Revlon, L'Oréal (France), and Procter & Gamble, among others.

The consumer electronics segment accounts for the lion’s share of the consumer goods sector. Audio/video devices, mobile phones and computing devices are most popular, with computing devices leading the market share. Laptops, notebooks and more recently Apple’s iPad are extremely popular with South Africans. Mobile communication is experiencing a phenomenal growth in Africa, according to Ericsson CEO Hans Vesberg. Smartphones are making waves in Africa and according to consulting firm Gartner, their penetration in South Africa is expected to reach 80% by 2014. A testimony to this is that even the Massai veterinarians are using these phones to track the spread of animal diseases and provide preventive vaccinations. GPS enabled smartphones were donated by Google through a Vet Aid charity program.

Another emerging trend is the growing demand for “green” or energy-efficient appliances in the small domestic appliances segment such as irons, kettles, and vacuum cleaners. Demand for washing machines and refrigerators continue to dominate the large household appliance segment, thanks to a drop in retail selling prices. Amalgamated Appliances, Nu-World, LG Electronics, Hewlett-Packard, Dell and IBM are some of the leading companies.

According to a study by Business Monitor International, consumer electronics sales are forecasted to reach US$9.63 billion by 2015 from an expected US$7.51 billion sales in 2011. A recovering economy, an increase in household spending and a shift in the spending towards more technologically advanced goods are anticipated to boost sales.

Rise of the “Black Diamonds”

South African blacks have come a long way after several decades of apartheid oppression. Apartheid had severely fractured the nation along the lines of racism as well as wealth distribution. According to Statistics South Africa, the majority of the economy was controlled by a small minority of whites comprising 10% of the population. However, the country turned the corner in 1994, when it achieved democracy. Nevertheless, the majority of the population, particularly the previously disadvantaged groups consisting of black Africans, Indians, coloreds (mixed race), and Chinese, have been still grappling with poverty. With a view to raise the living conditions of these groups and have them actively participate in the economy, the South African government launched the Black Economic Empowerment (BEE) program.

3 The first signs of black Africans making their presence felt in the middle-income bracket were shown in research by the Financial Mail in 2004. The survey data showed that around 300,000 South African blacks had risen to the middle-income status over the period 2001-2004. This emerging black middle class population was dubbed as the “black diamonds.” Further, the survey also found that 500,000 had risen to the lower middle-income level, albeit a very small number relative to an unemployed population of 4-million.

A study by the University of Cape Town has cited that the black diamonds, whose combined spending power is presently around $250 million dollars, are expected to grow at an annual rate of 30%.

Source: Statistics South Africa

What’s more, there was also a rise in educational attainment among South Africans, who had been fighting illiteracy for a long time now. A survey by Statistics South Africa showed that among Africans in middle-class households, 29% attained a BA/Diploma or higher in 1998-2000 and in 2004-2006. This was comparable to 44% of Whites in middle-class households having a BA/Diploma or a higher degree in 1998-2000 and 37% in 2004-2006. However, 85% of the White households were middle-class in 2004-2006.

Higher disposable income in the hands of the black up-and-coming professionals known as “buppies”, in addition to favorable economic conditions, resulted in a spending spree. Demand for motor vehicles, furniture, media, clothing, property and cell phones was strong among the buppie class. Of course, topping the list of priorities was to buy a new home, and move out of townships into more affluent neighborhoods. A survey by Financial Mail also showed that the buppies were far more fashion-conscious than their white counterparts. 20% of the richest blacks spent 3.5% of their household income on clothing compared to 1.5% by the whites. Retailers such as Woolworths, Truworths, Massmart and Shoprite cashed in on this trend. The opening of 4 the Maponya Mall in 2007 by Nelson Mandela, in Soweto, the largest township of Johannesburg, celebrated the growing black spending power. This mall housed multiple cinema screens and high-end retail stores previously found only in Johannesburg’s suburbs largely inhabited by rich whites.

Another factor mirroring growing consumerism was an increase in vehicle demand. According to a research report, BMWs are found to be the most sought after cars among South Africans and are also at times referred to as “Be My Wife.” Vehicle sales, particularly local car sales, are expected to touch 130,000 units in 2011 according to the National Association of Automobile Manufacturers of South Africa (NAAMSA). Car sales had hit a low of 94,379 units in 2009 due to the global recession.

Source: National Association of Automobile Manufacturers of South Africa (NAAMSA)

Retail Industry – A Closer Look

The South African retail industry is the largest in the sub-Saharan region and is positioned as the 20th largest retail market in the world. It is more or less an oligopolistic market with five South African companies, namely Shoprite, Pick n Pay, Spar, Massmart and Metcash, constituting 80% of the retail sales.

Food Retail

The South African Food Retailing market is dominated by Pick n Pay, Shoprite, Woolworths and Spar, which trade under several store names and also operate discount outlets.

 Shoprite Holdings Limited, the largest food retailer in South Africa, was founded in 1979 with the acquisition of eight Cape Town-based supermarkets for R1 million. Over the years, the company has followed an inorganic growth model and other expansion strategies such as franchising. The retailer now operates over 1,800 stores in South Africa and Southern Africa. With a market share of around 34%, this retail giant caters to the middle-and lower-end consumer markets.

5  Pick n Pay Stores Limited is the second largest retail chain. Founded in 1967, this family- controlled retail business operates in South Africa, Southern Africa and Australia via its Franklins stores. Its retail formats include larger supermarkets, hypermarkets and family franchise stores, with hypermarkets being the largest. This retailer caters to the middle- income class of consumers and hopes to improve its presence in the black diamonds consumer markets, according to a South African media report. In 2007, Pick n Pay underwent an extensive brand transformation in a bid to retain its position in the local retail market. The new signage after rebranding dropped the apostrophe before the “n” (Former signage: Pick ‘n Pay).

 SPAR Group Limited (ZA), South Africa’s third largest retailer, was formed in 1963 when a group of eight wholesalers were given rights to the SPAR name to service 500 small retailers in an emerging grocery chain market. SPAR Group adopted an acquisition-driven growth model and presently operates around 800 SPAR stores in South Africa. It is chiefly a franchise operation focusing on smaller stores. The SPAR group has three store formats namely: SPAR which represents neighborhood shopping, SUPERSPAR – known for competitive prices and bulk purchases and KWIKSPAR – more of a convenience store format. SPAR also owns the largest of the liquor store chains in South Africa called TOPS. As a part of its commitment to the BEE program, Spar is planning to sell 10% of the company to its black employees. The value of the transaction would be R1 billion.

 Woolworths Holding Limited, founded in 1931 is a South-African retail chain that operates through its subsidiaries Woolworths (Proprietary) Ltd and Country Road Ltd in Australia. It owns over 400 retail outlets and caters to the high-income segment. The group contains both corporate-owned stores as well as franchise stores. In line with its philosophy to incorporate new initiatives across its businesses, Woolworths is looking to strongly focus on an organic food venture, which was launched in 1999. The organic food market in South Africa is the second fastest growing sector following the segment for baby food. According to a report published by a trade body which focuses on the South African retail industry, Woolworths’ goal is to increase its organic food sales to R1 billion by 2011.

Pick n Pay and Shoprite have also forayed into the organic food segment. According to market reports, while Shoprite expects its organic sales to account for 10% of its fresh produce sales by 2015, Pick n Pay has already been reaping benefits from its wide range of organic products.

Non-Grocery/General Retail

Metro, formerly known as Metcash Africa, is the leading wholesale distributor of fast moving consumer goods (FMCG) in Africa. It has over 150 outlets open to business customers, located mostly in and around black townships. They offer a wide range of merchandise including general goods and also operate liquor stores such as Liquor World and liquor Warehouse offering imported liquor.

6 Massmart Holdings Ltd. is the third largest distributor of consumer goods in Africa and also one of the leading retailers of general merchandise and other goods. The retailer has around 250 stores and caters to a broad consumer base ranging from the lower-income to high-income groups. Its focus is on high volume, low margin and lost cost distribution of quality consumer goods. Makro, Game, and Jumbo are among its many brands.

Notably, the U.S. retail giant Wal-Mart’s bid to acquire a controlling stake of 51% ($2.3 billion deal) in Massmart was recently approved by South Africa’s Competition Tribunal amid tough opposition from trade unions.

Truworths International is South Africa’s premier fashion retail chain targeting the fashion/quality conscious youth of the country, who are keen on matching up to international standards of styling. Founded in 1917, this fashion retailer has over 500 stores and now commands a larger market share than Pick n Pay. A few of its brands include Truworths Man, Identity, Ginger Mary, YDE and Uzzi. In addition to its existing style-conscious consumer market, this fashion retailer also stands to benefit from the emerging black diamonds segment who are becoming more style-conscious.

The Foschini Group Ltd., formerly known as Foschini Ltd. is one of the specialty retailers offering clothing, jewelry, accessories, and home furnishings. Founded in 1924, the company is considered to the first of the independent chain store groups in the country. With over 1,500 outlets, Foschini caters to consumers ranging from middle to upper-middle income groups. Markham, donna-claire, @home, DueSouth are some of Foschini’s brands.

Foreign Entrants

South African retail has thus far been dominated by large home-grown holding companies, due to apartheid and the subsequent allied international sanctions. Given the present competitive landscape, an invitation to join the BRIC (Brazil, Russia, India, China) group, and the opportunities presented by the nation’s emerging economy status, the retail industry has been put on the international radar screen.

The sub-Saharan market is considered to be lucrative, given the aggressive expansion by domestic retail giants such as Shoprite, Spar and Pick n Pay in the food retail segment and Truworths and Foschini in the clothing segment. The rise of the black diamonds, which appears crucial to the economy’s recovery, has also added cheer to this sector’s performance. Wal-Mart has been the first international retailer that has managed to gain ground in the South African market, through its bid to acquire a 51% stake in the Massmart, the third largest retailer of consumer goods. In addition, Chicago-based collective buying website Groupon acquired Twangoo, a South African e-commerce provider, to gain from Twangoo’s reach across various South African cities.

As of now, foreign investments are flowing into retail equities as foreign portfolio managers have taken a shining to this sector. According to a report by Home Goods Retailer, a leading

7 South African retail publication, equity investments are likely to continue to be the area of primary interest in the coming years.

Trends in the South African Retail Industry

Convenience Store Format to Dominate Retail Trade

Changing consumer lifestyles have led to the relatively new trend in the South African retail market-- the emergence of convenience stores as a shopping destination. These stores are typically owned by wholesalers and retailers. With convenience stores open for longer hours, South Africans have been found this format to be a safer and more time-saving shopping experience.

With this, South Africa’s leading retailers have jumped on to the bandwagon, introducing new store formats to cash in on this growing trend. According to a market research survey by Euromonitor International, Woolworths Holdings led the convenience stores market in 2009. Woolworths Food outlets are located at Engen Petroleum’s forecourt stores (or gas stations), which are becoming popular thanks to the convenience shopping drive. Others in the fray include Pick n Pay, which introduced Pick n Pay express outlets through British Petroleum forecourt stores in 2009, and Sentra Value outlets owned by Shoprite and Sasol forecourts focusing on restaurant chains.

Sites/Outlets Company 2007 2008 2009

Woolworths Foods Woolworths Holdings Ltd 102 120 110

Sentra Value Stores Shoprite Holdings Ltd 66 58 55

Woolworths (Engen Gas Station Outlets) Woolworths Holdings Ltd 35 39 42

Others Others 416 400 455

Total Total 619 617 662

Source: Euromonitor International

Informal Retail – The Significant Other

Informal retail is also referred to as “the second economy” within the South African retail sector. This market is still a crucial supply channel of goods predominantly in black townships, which were largely ignored during the apartheid era. Informal retail concepts vary from taverns to tuck shops (small food-selling retailers). In particular, spazas, or small retail stores most often run from home, are making inroads in the local retail arena, offering both food and non-food products. A study by University of South Africa (UNISA) found that some spazas also have direct contact with product manufacturers; for instance some spazas receive Coca Cola goods on

8 a cash basis. Still, the spazas face certain challenges, including funding access, theft, high transport costs, and competition from the developing formal retail outlets in these areas.

Hawkers, street stalls, fast foods, kiosks and take-aways are among the informal market retailers. According to a study by the Bureau of Market Research (UNISA), the informal retail sector is comprised of around 750,000 informal spazas and street vendors, which account for revenues of R32 billion.

E-Commerce Gaining Momentum

E-commerce and online retailing, which remained unpopular until 2007, have grown encouragingly over the past four years. An increase in the number of sellers and traditional retailers developing online retail sites, coupled with growing internet access in South Africa, has fueled growth. According to a survey by World Wide Worx, the number of South Africans with access to the internet grew to 5.3 million from 4.6 million, between 2009 and early 2010. Though VCDs, CDs, DVDs are the most sought after purchases online, airline ticket purchases dominate the virtual shopping space. Pick n Pay Home Shopping, Woolworths, Kalahari.net, Exclusive Books, NetFlorist, OnSaleToday are a few of the largest online retailers.

Some of the retailers benefiting from this growing trend include Bidorbuy, whose online sales grew 40% during the 2010 holiday season compared to 2009 sales levels. Kalahari.net launched an online marketplace where consumers could purchase new as well as used items, similar to eBay. Nokia also announced the availability of the N8 model of smartphones through OnlineStuff, a company partnering with Nokia to provide order and payment services. The early 2010 introduction of PayPal, a premier online payment system, is also expected to spur growth.

Though online retailing has shown growth potential, a large percentage of the population continues to buy from the traditional brick and mortar outlets. Factors such as high broadband access costs, relatively low internet penetration, and low confidence in the postal system, are expected to impede growth in the medium term.

Conclusion

In summary, the South African economy is a consumer-driven economy, much like the United States where consumer spending accounts for two-thirds of the GDP. The retail sector has managed to overcome the worst of the recession thanks to the resilience of South African consumers and the improving spending power of the emerging middle class, albeit at a slow pace. The fact that interest rates have held steady at 5.5% and consumer inflation has eased to 3.5% towards the end of 2010 bode well for the economy. However, the nation has been plagued by its high unemployment rate (24% in 4Q2010), which could throw a wrench into the works. Now what remains to be seen will be any positive effects of the initiatives presented by President Zuma’s government, such as the allocation of US$5.4 billion towards tax breaks and job creation programs, to battle unemployment and poverty in South Africa.

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