FOCUS: THE ELUSIVE SHOPPER - Meltdown on the high street

The economy is booming and we've got money to spend - so why are retailers feeling the pinch?

It's carnage out there. Consumers are holding off spending until the last minute hoping to get a bargain. We are having to cut prices to the bone just to get people through the doors. I've never seen trading conditions like it."

So said one retailer on London's Oxford Street this week. It is a view widely held in Britain's beleaguered retail sector. As millions of shoppers head for the stores to start their Christmas shopping this weekend they will find shop windows festooned with "Pre-Christmas Sale" signs offering 20 per cent or even a third off.

It is not just the smaller stores that are succumbing to the discount frenzy. Marks & Spencer has been cutting 20 per cent off all cosmetics, toiletries and childrenswear this weekend following its promotion on menswear and its "Autumn windfall" voucher campaign. House of Fraser, the department store group, ran a "One Day Spectacular" on Thursday offering up to 20 per cent off selected items.

C&A has cut up to a third off some ranges such as men's suits. Struggling Bhs is gearing up for major price-cuts as part of its desperate fight to maintain its market share.

The severity of the situation should not be underestimated. Storehouse, the retail group which owns Bhs and Mothercare, reported a pounds 22m loss earlier this month and the group now faces break-up. Arcadia, the former Burton group, which owns Top Shop and Dorothy Perkins, is also suffering as profits fall. Smaller rivals could be forced to the brink of bankruptcy.

According to Richard Hyman, head of Verdict, the retail consultants, these conditions are here to stay. "We are at a major watershed in the development of UK retailing," he says. "Major structural changes are taking place that are not part of the normal cycle. This is how it's going to be; much more competition and constant downward pressure on prices."

But why is this happening? Why is the high street apparently in the grip of recession when the economy is so strong? Official figures show that retail sales in October were 4.7 per cent up on the same month last year. That is very healthy demand. It is true that the value of those sales was only 3.5 per cent higher as stores had to cut prices to sell their goods but even this figure is perfectly respectable.

UK households are also feeling wealthy. Wages are up, unemployment is falling and house prices are rising strongly. There is also an increase in "equity withdrawal" whereby homeowners cash-in on the rising value of their property by increasing their mortgage and spending the proceeds.

According to Mr Hyman of Verdict, UK retailers had life relatively easy right up until the 1970s because Britain had one of the lowest ratios of shopping space to population of any major industrialised country. All retailers had to do was open more shops and sit back and take the money.

As they grew, their expansion was balanced by the closure of smaller retailers allowing the larger players to clean up market share. But since then there has been an explosion of retail space leading to a chronic over-supply problem.

Mr Hyman says: "Competition is now more intense and so retailers have to drive more sales through their existing outlets. To do that they either have to have a brilliant competitive edge or offer the lowest prices. UK retailers aren't used to that."

This over-capacity has been made worse by the twin effects of the Government's "Rip-Off Britain" campaign and the arrival of Wal-Mart, the giant US discount specialist which took over Asda in June. The Wal-Mart threat has forced not just the major supermarkets such as Tesco and Sainsbury's to cut prices but high street retailers such as Boots too. The "Rip-Off Britain" campaign has struck a chord with consumers turning Britain into a nation of bargain- hunters.

This has had a huge effect on the high street. Broadly speaking, the discounters such as Matalan, New Look, Primark and Peacocks are doing well at the bottom end of the market. The quality branded chains such as French Connection, Oasis and Zara are doing well at the top. The middle ground, which incudes Marks & Spencer and Bhs, is being relentlessly squeezed.

Indeed retail experts say the days of M&S-style mass-market retailing are over. "M&S cannot seriously expect a 20-year-old woman to shop at the same rack as a 60-year-old grandmother. They will have to segment their ranges," one says.

Barry Gibson, chief executive of Littlewoods, says shoppers now want to buy "what they want when they want and how they want". Instead of being dictated to by shops they are demanding, and getting, more control through newer channels such as direct mail and the internet.

There is also a shift in spending patterns as an ageing population spends more on services and household items and less on physical goods. Also, as an economy develops, we have more of the things we already need. It is harder to persuade consumers to replace them.

This helps explain why household goods are one of the few strong parts of consumer spending at the moment along with foreign holidays. Retailers like Dixons are doing well as sales of electrical goods are being driven by developments in digital technology and the increasing popularity of mobile phones.

Indeed, the increasing demand on household "wallets" is a key factor affecting clothing sales. Households are spending an increasing proportion of their disposable income on mobile-phone contracts, satellite TV subscriptions and healthclub memberships. This money has to come from somewhere.

Retailers have not helped themselves by being slow to adapt to consumer demands. A wander down Oxford Street and Regent Street, two of London's busiest shopping thoroughfares, reveals several big-name stores, such as Hamleys and DH Evans, that look as if they haven't rethought their marketing strategies since the 1970s. As Nathan Cockrell, retail analyst at Morgan Stanley, says: "UK retailers have done a pretty poor job. They stick to the same old seasonal routine with mid-season and end-of-season sales."

But new challengers are changing their stock much more regularly. European companies such as Zara and Hennes & Mauritz change some of their range every fortnight.

Where will all this lead? According to Jim Hodkinson of New Look, the pace of change means that several UK retailers will have to merge. "There are too many clothing retailers and we will start to see some consolidation," he says. This is also likely to happen in the department-store sector where companies such as Allders and House of Fraser are seen as merger candidates. In the meantime, consumers can reap the benefits of the retailers' pain as prices fall lower and lower. We have never had it so good.