Nele Peil, CEO of the Estonian Merchants' Association, confirms that, just like consumers, retailers are short of breath because of the weak state of the economy, the general rise in costs and the VAT increase. The increased markup on products' final prices visible in the statistics does not, in her words, reflect reality, because it does not take into account promotional and discount prices, at which more than 50% of food items are sold. According to retailers, only a cut in the VAT on food would bring meaningful price relief.
Why is food in Estonia 5.3% more expensive than the European average, and why are we ranked 8th in Europe for food prices?
Retailers actually do not like at all that food is so expensive, because it affects their results too. When looking at how food prices are formed, you have to consider the cost components. One of the biggest reasons is that Estonia is a small and remote market, which means that goods orders do not benefit from economies of scale that would allow purchase prices as favourable as those of a large international retail chain in another country with much higher sales volumes. Another reason is logistics, where, again because of the small size of the market, no volume savings emerge.
There are domestic reasons as well. Around 60% of the assortment in food stores is made up of domestic products, whose prices are higher because small producers simply have higher costs. Energy prices in Estonia are also rather steep. Then there is VAT, which is among the highest in the EU. If VAT were, say, 10% lower, food would be that much cheaper.
We will get to VAT, but let's look at the study by the Centre of Estonian Rural Research and Knowledge (METK) covered in Eesti Päevaleht (Why are Estonian food prices so high? VAT is not the right answer. The data tells a different story), the results of which show that food stores' share in a product's final price has grown significantly in recent years compared to other components. How do retailers explain this?
It is very well explained by changes in the structure of consumption in recent years. Because price hikes have been very sharp, more and more agreements are being made with producers to sell products at promotional prices. Three or four years ago, around 25% of goods were sold at promotional prices; now it is 50% or more. But because the retailer's costs are still the same, the markup on regular-priced products is higher.
METK's methodology only looks at regular prices - it does not factor in discount, promotional or loyalty card prices. For example, perhaps only 30% of customers now buy cheese at full price, while 70% buy it at the promotional price, which means the retailer actually earns a very small profit margin. METK's methodology suggests that store markups have grown, but this is only true for regular-priced products, the sales of which offset the extremely low margins on discounted goods. In reality, food retailers' margins have actually decreased.
People are buying less, purchasing power has fallen sharply, and this is also a major problem for retailers, because food is a volume business and profitability suffers. Over the last ten years, retailer profitability in Estonia has been around 2%, almost twice as low as the European level.
If sales volumes and margins have been falling for years, the question arises: why have food stores been built at turbo speed? In 12 years the number of stores has grown by 53% and store space by 56%, meaning 270 new stores and 240,000 m2 of retail space. Consumers foot the bill for both construction-related investments and all running costs. Yet Estonia's population, which would cover those costs through purchases, is not growing.
The rapid growth in retail space mostly happened before COVID. Earlier, chains really did open several stores a year, but in recent years it has been one or two stores annually, while at the same time stores are also being closed. If you look at all the costs related to retail space, they make up 6-8% of revenue. If, in the densely competitive areas around the larger cities, around a hundred or so stores were closed across Estonia, the resulting savings would translate to roughly a 1% price reduction - the impact on the shopping basket would be very small. But cutting food VAT by 10% would be far more noticeable. One culprit has been found - the stores - whom everyone can pile on in the village square, but who actually cannot change very much.
Right now, intense competition has kept prices from rising even higher, but if, for example, in some area there were one store instead of three, prices could immediately be raised. The consequences of the lost competition from store closures are far greater than the potential 1% price gain. This is something to weigh - which option is likely to cause less harm.
Let me give a concrete example. In a town of 12,000 residents that has seven chain stores plus two non-chain stores, one of which is large, yet another large food store is being planned. Is that sustainable?
Is this a real town?
Yes, an entirely real Estonian town.
If such a town lies along a transit route and the stores also serve the surrounding municipalities, then probably yes. Yes, in some places it does seem to me that there are too many stores, but that is more the exception, and in the context of grabbing market share it is unavoidable.
At the same time, if some of the nine stores in this town were closed, why do we assume that the owners of the remaining stores will not raise prices? Finland's experience with two large supermarket chains clearly shows that less competition leads to higher profits for retailers. The current very low profitability of Estonian stores is actually not good or sustainable for anyone.
An analysis by Eesti Pank claims that Estonia has more retail space than elsewhere in Europe. We currently have 780 food stores with 670,000 square metres of sales space. Building and maintaining all of these has come out of Estonian people's wallets - this is the profit that food stores have earned from customers' purchases. Has all of it really been reasonable and necessary?
To start with, I deeply doubt that we have the most retail space in Europe. In Estonia, more than 90% of the market is consolidated into chains. There are many countries in Europe where the market is not so heavily chain-based and where there are more small players - I would estimate around twenty percent or so. Depending on who runs the study and which methodology is used, non-chain stores are not reflected in the official retail-space statistics. If only chain store space is measured, statistics in some countries make it look as if there is less retail space than there actually is.
Estonia, however, is a sparsely populated region. The least profitable stores are, as a rule, located where there are fewest people - in rural areas. If you tell stores to scale back the network, the most economically sensible thing is to close the less profitable rural stores. One can ask why there are so many stores in cities. But those stores are evidently doing well, and they often subsidise the rural stores, so closing them does not make economic sense from any angle.
The cost of building a single store is in the order of one million euros, which is spread over several years. The impact of that investment and of running costs on an individual shopping basket is very small - we are talking fractions of a cent. But the opening of new stores has already slowed; entrepreneurs themselves see that the market is saturated. When it is decided to open a new store, it is weighed very long and thoroughly.
In reality, the impact of excess retail space on the final price of products is so small that there is no point dwelling on the topic. Rather, it is an attempt to divert attention from other components that affect prices more. In the government's case, of course, that means above all the tax component, which truly has a major financial impact. Instead of tackling the big problem, they say: look at this small one, and the attention has been diverted.
Rasmus Kattai, head of the Economic Policy and Forecasting Sub-department of Eesti Pank, has pointed out in his opinion piece (Rasmus Kattai: a lower VAT rate does not mean lower food prices) that 22 of the 27 EU member states apply a reduced VAT rate to food, but in all the countries with a lower rate, food in stores is by no means cheaper. Only in eight of them is the relative price level of food below the European average.
I have not read this article and would need to study the underlying data to comment on it. Of course, tax policy is not the only thing that affects food prices. It is just that in Estonia the tax component is very large - 24%, which is the second highest in Europe. To say that if food VAT were cut to 10 or 14%, nothing would happen, is completely unrealistic. Whether the entire tax cut would reach product prices, that I obviously cannot say, but we really do have very, very strong competition. I cannot imagine a situation in Estonia where one chain comes out with the message that we have lowered prices by the amount of the VAT cut, and the others would not do the same. It would be unthinkable - they would immediately lose their customers.
In large European countries, yes, food really is sometimes cheaper, but we cannot lift Estonia into the middle of Europe. Estonia is exactly where it is, it is not going anywhere, nor is it going to get any larger. We have around one million people. We cannot really propose: let's bring in four million more people, then we will get better purchase prices and thanks to that be able to sell food more cheaply.
We have to look at the components we can influence. A quarter of the price of food going to VAT is a very large slice, which is why we have also proposed piloting a VAT cut on a particular product group with a very high domestic share, such as milk. Then we would be able to see what happens, and the financial impact on the state budget would not be that big either.
What the sector itself can do is increase efficiency and reduce its own costs, which is being worked on continuously. The assortment could be reduced, as Jurgen Ligi has also suggested - fewer choices for consumers. The more products, the bigger, more complex and more expensive the system. In that case, the most popular and often cheaper products would be kept, which means that smaller and medium-sized Estonian food producers, as the least competitive, would lose their main sales channel.
One of the counterarguments against cutting VAT on food has been the claim that, even if retailers initially passed the cut on to prices, over time it would creep into store profits. Who can guarantee that this will not happen, and how?
Prices are determined mainly by two things: how much consumers can afford to pay and how strong competition is. Consumers' purchasing power has taken a very heavy blow, but competition, especially after Lidl's entry, has become significantly sharper. How long a price cut stays in prices depends on how sharp competition remains. Competition is the best protection for the consumer. If one chain starts pocketing the VAT savings to boost its profit, the others will immediately use that in their advertising messages.
Selling food is not the kind of business where the consumer is willing to pay more for a brand. A retail chain's brand does not generate the kind of marketing-driven sense of value and emotion that allows for higher markups, as is the case, for example, with clothing. As long as competition is strong, a kind of "neighbourhood watch" operates between food stores. That is far more effective than any state oversight.
Good to know
- Estonia's 780 food stores have a total of 670,000 m2 of sales space. That is one food store for every 1,756 people. If all Estonia's residents were placed in food stores, each would have about half a square metre of space.
- The VAT on food in Estonia is 24%. By comparison, in Finland it is 14%, in Sweden 12%, in Germany 7%, in Belgium 6% and in Poland 5%.
- Estonia is among the European countries with the fastest food price increases: in 2022 food prices rose by 19.4%, in 2023 by 15.2% and in 2024 by 3.2%.
Source: Statistics Estonia, Selver, Rimi
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