Absence of real competition led to retail boom

Business Opinion/John McManus: Food currently accounts for one euro in every five spent by Irish households. It is a massive amount of money - almost €6 billion a year and rising.

It's not surprising then that the 13.6 per cent increase in the average price of food and non-alcoholic drinks over the last three years has attracted a lot of attention. Given that the price of food at the farm gate has risen by only 6.4 per cent over the period, it would appear that somebody has been making a great of deal of money at the expense of consumers.

So, who is it? Well, according to the analysis of food prices published last week by RGDATA and IBEC, it certainly wasn't any of their members, who comprise the independent food wholesalers and retailers as well as the food processors.

Tansey Webster Stewart (TWS), the consultants who carried out the work, looked at the margins made by food manufacturers, wholesalers and independent retailers. The large supermarkets were not included as their financial results were not available.

What TWS found was that, although sales had risen strongly across all three sectors, so had costs. As a result, they were able to conclude that "there has been no material widening in the net profit margins of independent food wholesalers and retailers in recent years".

While the report does clear food retailers of profiteering - as defined by excessive margins - it also provides strong evidence that the lack of real competition among retailers has driven up prices.

TWS looked at the profit and loss accounts of the three large food wholesalers between 2000-02. Sure enough, their gross margins only increased from 10.5 per cent to 11.2 cent, but their net profits jumped by a whopping 53 per cent to a total of €61 million.

The same pattern is repeated across the independent food retailers where TWS looked at a sample of 50 independent food retailers who were members of groups such as Spar, SuperValu, Mace, Centra and Londis. Gross margins fell across the sample from 21.8 per cent to 20.3 per cent, but net profits rose by 5.4 per cent to €5.6 million.

What is really interesting about these figures is not that margins did not go up by much, or remained more or less unchanged. It is the fact that they did not fall significantly from these high levels which is remarkable.

And the reason that they were able to sustain margins - and thus boost profits as sales grew strongly - is because there was no real competition. If there had been strong competition, we would expect to see wholesalers and retailers accepting smaller margins in order to retain market share and drive profits in that way.

With hindsight, there is nothing surprising about what happened, if you accept that the large supermarkets drive competition in food retailing. As the boom took hold in the second half of the last decade, the supermarkets gradually abandoned low-cost models.

Mr Ben Dunne, arguably one of the most successful retailers the State ever produced, estimates that Dunnes Stores and the other large players are now operating on gross margins in the region of 26 per cent on food, compared with the 11 per cent gross margin that he claims was the norm when he ran the family business in the early 1990s.

It is not surprising then that the deep discounting German chains Aldi and Lidl are making such dramatic inroads into the Irish market.

From a standing start, they have taken 5 per cent of the market in the last five years and Mr Dunne believes they could easily grow that to 25 per cent in the next five years. But they may yet have a fight on their hands. One thing that the TWS analysis reveals is that the independent sector has considerable scope to cut margins and take on the likes of Lidl and Aldi.

There is also plenty of anecdotal evidence that the large retailers have woken up to the challenge. Dunnes Stores has incurred the wrath of the Director of Consumer Affairs a number of times since the summer as a result of cut-price food promotions which appear to be aimed at testing the ban on below-cost selling implicit in the Groceries Order.

But TWC's analysis also indicated what may be the biggest competitive disadvantage of the independent sector - and perhaps the multiples - with respect to Aldi and Lidl. Wage costs among independent retailers have risen by 31.9 per cent and unless productivity has risen by something similar, they can expect to have their eyes wiped by the German retailers with their strong emphasis on productivity.

It is hard to feel sorry for Irish retailers. They have had a very good spell since the mid-nineties. While they may not have been profiteering in the strict sense of the word, they did not break their necks competing with one another, and grew fat in the process.

The stage now looks set for a new wave of competition, which should drive down prices. But one further ingredient is needed. Irish consumers - who have become much less price conscious in recent years - need to start looking at shopping bills again.