Speak to many Irish food manufacturers and they will tell you the UK retail sector is among the most sophisticated and highly developed in the world, and certainly the most sophisticated in Europe. As such, it’s no surprise Ireland’s agri-food sector is so reliant on the UK market, with its retail sector providing such an efficient route to a market of more than 65m people.

The UK imports 40% of its food. Ireland provides a significant share of this, including 270,000t of beef, 116,000t of cheese and 35,000t of butter. In 2015, Irish food exports to the UK were €4.4bn, with 60% (€2.6bn) of this sold through the retail grocery channel.

However, in recent years the grocery retail market in the UK has been transforming as a result of new market dynamics, changing consumer behaviour and increased competition. The traditional “big four” (Tesco, Sainsbury’s, Asda and Morrisons) supermarkets in the UK account for about 70% of the £165bn grocery market.

While this may seem like a massively dominant position for just four supermarket chains to control in a single market, the reality is that their dominance has been eroded somewhat in recent years, with all four retailers bleeding market share to the German discounters Aldi and Lidl.

In 2013, the big four’s share in the UK was over 75% of the market, while Aldi and Lidl held a combined 7%. Today, the big four’s combined market share has reduced to 70% while the German discounters now account for almost 11% of the market. This means in the last two years, Aldi and Lidl have taken almost £6bn in sales away from the traditional big four.

The evolving dynamic of the UK grocery retail market really began to accelerate after 2014, when the big four adjusted their strategy to combat the rise of the German retailers. Recognising the threat that Aldi and Lidl’s discount model presented to their market share, the big four set about investing in price cuts across their food and drink ranges in a bid to match Aldi and Lidl on price.

This new course resulted in a supermarket price war in the UK that saw the cost of food reduce significantly over the past two years. For the past 18 months, food costs have been deflationary, at an average rate of about 2.5%. And in May 2016, the cost of food in the UK decreased 2.8% over the same month in the previous year.

Cutting margins

In order to defend market share, the supermarkets consciously cut prices to attract shoppers. This had the effect of reducing margins.

In 2013, Tesco, Asda and Sainsbury’s all achieved an operating margin above 4%. Morrisons actually made an operating loss in 2013 but a year previous the group had a margin above 5%. In the last two years, Tesco, Sainsbury’s and Morrisons have all seen their margins eroded as a result of the price cuts across product lines in-store

Sales falling

The price cuts across product lines led to prolonged periods of quarterly sales declines for Tesco, Sainsbury’s and Morrisons as all three battled to retain market share and transform their business model at the same time. As you can see from Figure 2, the quarterly sales figures for each have stabilised, with the exception of Asda.

Asda was the only big four supermarket which maintained its operating margin above 4%. However, it continues to struggle and has seen quarterly sales declines for the last seven consecutive quarters. At the same time it has lost its position as the second-largest retailer in the UK to being the third.

This strategy of maintaining margins has not paid off for Asda, and it could be about to change.

David Cheesewright, chief executive of Walmart International, Asda’s parent company, said the focus of the business would need to switch from “protecting profit to protecting share.”

Cheesewright’s announcement prompted suggestions that a renewed supermarket price war was about to break out in the UK this summer. Should Asda start to slash prices by investing as much as half its 4.4% margin in cuts, competitors like Tesco, Sainsbury’s and Morrisons would all be forced to match this investment in an effort to maintain store footfall.

This will be of concern to many food manufacturers who have been dealing with the deflationary food environment created by the UK supermarkets over the last two years. They are now potentially faced with a new wave of competition should Asda follow the other supermarkets. This could force them to further cut already thin margins, in order to win business.

Brexit impact

The outcome of the referendum result last month is likely to further complicate the trading environment for UK retailers and by extension Irish food manufacturers. Some analysts are forecasting that the UK could see no growth or negative growth before the end of this year. This will have the effect of weakening consumer confidence and therefore the demand for food. Furthermore, the weakness in sterling right now is making the 40% of food imported by the UK more expensive. In such an environment retailers will be reluctant to increase food prices.

As the industry waits to see if Asda will pull the trigger on a nuclear price war to end all price wars, suppliers will wonder where they can make further cuts to support retailer margins.

History has shown that supermarkets expect suppliers to support their margins. The last time sterling weakened, suppliers and food manufacturers here cut costs and reduced prices which were passed on to the supermarkets.

The UK supermarket sector has been unique in the world with 4% margins. So there was scope to reduce margins once they got the volumes.

While margins appear low, it’s important to understand the strategy of how supermarkets arrive at their overall margins. Their key performance indicators (KPIs) do not focus on single product margins, rather on a margin per basket of goods each shopper brings to the till.

Therefore in a bid to recover reducing overall margins and defend market share, the supermarket war today focuses on wooing innocent shoppers in through its doors with the promise of a bargain on milk, beef, chicken or bread.

Captured

Once captured inside, they are not particularly interested in selling them milk. At 75c a litre, it doesn’t necessarily leave much for the supermarket. It’s what else is in the basket that matters – the Persil, Nescafé or sauvignon blanc.

Food producers are being asked to deliver products to a higher and higher standard under increasing regulations to then be sold as a loss leader. Whose interest does this best serve and is it sustainable?

In reality, no one has learned how to deal in the new Aldi and Lidl world. Tesco has said any improvement won’t be a volume-led recovery, yet have re-introduced their slogan – Every little helps.

The big UK supermarkets are 40 times larger than the average large supplier or food manufacturer.

With a new grocery regulator in the UK along with new grocery code regulations in Ireland, do these bodies have the necessary powers to regulate and protect food manufacturers and primary producers? Is it time to introduce minimum pricing as a way to protect primary producers?

Support

With Food Wise 2025 less than one year old, the Government must be willing to support its ambitious growth targets. As governments rarely interfere with retail prices it is unlikely and unrealistic that minimum pricing will be seen for goods such as milk or meat.

More practical supports would be cheaper access to capital and finance, local grants and supports to improve efficiency that would drive scale. The reduction of uncompetitive energy costs would also help. Considering the UK decision to leave the EU, an EU-wide regulatory body is also unlikely to be a viable option, which puts the emphasis on doing something on a local level here.