UK Boom in Pound Shops: An Austerity-Proof Business Model?

A member of the public walks past a pound shop
Jeff J Mitchell | Getty Images
A member of the public walks past a pound shop

Pound shops in the U.K. are reporting massive increases in profits across the board showing that the formula "pile 'em high and sell 'em cheap" has particular resonance in Britain's current age of austerity.

Names like "Poundstretcher," "Poundland" and "99p Stores" in the U.K. have become high street stalwarts as other brands go bust. The chains, immediately recognizable on price point, are opening new stores and reporting record results reflecting the increasing public demand for cheaper goods.

U.K. based "Poundland" is one such chain reporting steep sales growth as its range of 3,000 items -- from umbrellas and pregnancy tests (it sells 14,000 a week) to bird feeders and bags of crisps all priced at one pound – resonates with cash-strapped Britons.

(Read More: No 'Happy New Year' for the UK)

In the year to April 2012, the Warburg Pincus owned company said its turnover increased 22 percent to 780 million pounds ($1.25 billion) and profits increased by 50 percent to 18.3 million pounds from last year's figure of 12.2 million.

The model has been so successful that some pound store chains are looking to venture into Europe and beyond. "Poundstretcher", for instance, has already exported its "every penny counts" motto and pound sign logo to the Middle East, opening its first store in in the affluent Madina Mall in Dubai in May.

UK Consumers Cut Spending

Discount stores' sales in the U.K. have risen as wage growth in the country fails to keep up with rising consumer inflation.

The figures are borne out by British shopping behavior. According to the Office of National Statistics (ONS), the average weekly expenditure of a U.K. household in 2011 was 483 ($780), up from 473 in 2010. But adjusted for inflation, that spending was down 2.9 percent in real terms in 2011.

It is the sixth year of declines in real household budgets and the Bank of England reported last week that 11 million U.K. households are "very worried" about their household budgets.

An increasing number of the British public are turning to discount stores as a main place to do their weekly shopping. While pound stores don't sell fruit and vegetable, they do sell basic groceries. It's a big opportunity because groceries, are the fourth biggest expense for the U.K.'s 26.4 million households, taking up an average 44 ($25) a week In 2011.

Research has showed that most customers who visited pound stores came from the "working class", but data for 2011 also shows that that one in eight customers came from the A and B socio-economic group of white-collar professionals.

The growth of pound stores comes at a time when other retailers are reporting sales drops. Supermarket giant Tesco, Britain's biggest retailer and one which accounts for more than one in every 10 pounds spent in British shops, shocked investors earlier in the year with its first profit warning in over 20 years.The company reported a tiny rise in second quarter sales after 18 months of underlying sales declines.

(Read More: Tesco Launches Strategic Review of US Stores)

Tesco has 6,351 stores and serves more than 20 million customers aweek. On the other hand, Poundland has just 400 stores and serves 4 million customers aweek. It is somewhat ironic, perhaps, that the phrase "Pile them high andsell them cheap" is attributed to Tesco's founder Jack Cohen.

David Coxon, international development director at Poundland, told CNBC that the chain would expand further, taking advantage of European demand for cheaper goods.

"As an organisation we have evidence that our value products and price proposition are an attractive concept to European consumers, and have every intention to open stores in mainland Europe," he said. "We recognized a demand from European customers for our value product offering, and launched "Dealz" in Ireland in 2011." The chain plans to open 10 more stores in Ireland after popular demand.

A 'Winning Formula'?

Dr Ben Voyer, Assistant Professor of Marketing at ESCP Europe Business School, calls pound shops a "kingdom of temptations" that trigger impulse buying and have changed the way consumers behave.

It's all too easy, he said, for consumers to buy products they will never have any use for just because they're cheap.

"Consumers now adjust their brand and product preferences to what is available to them at a discounted price. Pound shop environments can trigger impulsive buying due to the unusually low price," Voyer, who is also a visiting Fellow at the Institute of Social Psychology at the LSE, told CNBC.

"Consumers typically start losing control when they are confronted with a highly unusual discount. This is because it alters the traditional decision making process - and we end up making decisions we would not have made in a traditional shopping environment."