The battle of supermarket aisle

Is this the beginning of trench warfare in the supermarket aisles? There has been some light sparring over the past five years against a backdrop of economic recession and falling food demand both here and in the UK. But the real battle may be just about to start.

A cutthroat pricing battle which started last year between the big supermarkets in the UK has contributed to the first annual drop in the amount people spend on food since records began in 1989.

Last year, Asda, which controls about 17% of the British market, launched the first attack, saying it would spend £1bn cutting prices over the next five years. Tesco followed, saying it would spend £200m cutting prices. Then Morrisons, with 10% of the UK market, said it was “investing” £1bn over the next three years to cut prices in an attempt to get back all those customers who started shopping at Aldi and Lidl. Now the discounters have responded, with Aldi recently cutting the price of some fresh produce.

In the past, life was simple. There was Tesco and Dunnes Stores, and at the premium end there was Superquinn and Marks & Spencer. Everyone was happy. But over the past five years, Germany retailers Aldi and Lidl have emerged as serious challengers. Not only have these discounters been expanding aggressively, they have lost their ugly duckling image to become popular with the middle classes. Together, they now control 17% of the Irish grocery market.

Supermarkets, like Charolais bulls, are big beasts. And when a red rag is waved, there is only one reaction. Their way of making money is limited. They can either sell more than their rivals or bargain harder with suppliers. Neither bodes well for primary producers.

Pricing strategies

In order to drive volume, a supermarket can offer lower prices than every other store, but the obvious result is that this strategy keeps profits permanently low.

Therefore, previous battles have been fought on special offers largely funded by suppliers eager to get on the shelf. According to rating agency Fitch, discounts could account for nearly all of a supermarket’s operating profits.

Supermarkets have thousands of suppliers, and relationships are often fluid and informal. Buyers change regularly, keeping relationships weak.

Pricing strategies, similar to Tesco’s “every little helps” campaign focus on cutting prices on everyday items. This involves sacrificing some profit to drive sales. High-demand items such as milk, meat, coffee or bread are often sold at low prices, even if those prices require taking a loss on that particular item. The ultimate goal is to attract shoppers in, and those bargain hunters out of convenience will then fill their baskets with higher margin items such as wine and snacks.

Discounting is a volume play where at first glance it seems everyone wins – the retailer’s margin improves as long as suppliers sell more goods. That is, until the retailer, strapped for cash, uses its power and makes suppliers offer extra rebates, effectively pulling forward income from the following period. This is exactly what happened at Tesco last week. Management hoped the next period would be better, everything would balance out and investors would be none the wiser. The fallout for Tesco was coming clean about a €321m hole in its profits.

European grocers such as the Netherlands’ Ahold and France’s Carrefour have suffered similar setbacks in the past. For example, in 2003, Ahold announced its earnings had been overstated by at least $500m (€405m). However, both have shown it is possible to turn the trolley around. Ahold sold underperforming units and cut prices to lure shoppers in. Carrefour similarly slashed prices and pulled out of struggling markets.

With disposable incomes flat, price has become critical for most shoppers. This adds further ammunition for Tesco to launch the first major attack in this price war. To put the wheels back on, it will go for volume and leverage its enormous size and buying power. This is not good news for suppliers or farmers.

Dave Lewis, the new boss at Tesco, will most likely focus on slashing prices and throw the estimated £800m saving from cutting the dividend at the problem. Although this will hurt Tesco’s high margins, it will cause other supermarkets to react and compete.

But what will a price war achieve? The big four British supermarkets – ASDA, Tesco, Sainsbury’s and Morrisons – are plcs. Aldi and Lidl are privately owned, and they can do what it takes without having to keep shareholders happy.

Who will win?

Even though the primary producer is hanging proudly in the aisles of every supermarket, it seems everything is currently being fired at him and he will become the first victim of this war.

For big boys such as Tesco, profits will likely be eroded and balance sheets weakened with little impact on sales.

While it is unclear who will win the battle of the supermarket aisle, one thing is certain as they fight for market share – food prices will fall.

Supermarket power

In the UK, Tesco, Sainsbury’s ASDA and Morrisons control 75% of a €206bn grocery market. Similarly in Ireland, Tesco, SuperValu and Dunnes Stores control 75% of a €9bn market. We exported €4.1bn to the UK last year and supermarkets have become critical to Irish farmers both locally and for our exports. For example, Tesco alone bought 7% of Irish food and drink exports last year, which included €177m of beef and €178m of dairy products.