Estonia's tax hikes and stagnant economic environment have led to three years of contraction in the country's second-largest sector - retail. Consumer confidence is at a historic low, and although bank analysts have been predicting a return to growth every year, that prediction has not come true. This year, any potential growth was swallowed up by tax increases going into the state coffers, and cheap goods from China are quickly taking market share.
In this environment, ideas about the need to change the business model have begun to be voiced. Consumer purchasing power is in reality not as low as the negative backdrop makes it seem. Consumers are simply spending more on services, buying more from abroad and saving more. So it is in retail's own power to bring more exports and service sales alongside conventional product sales, and to help boost consumer confidence.
Retail is not usually thought of as an exporting sector - probably because Estonian retailers operate mainly on the domestic market. But with their online stores or even physical shops, with sufficient appetite for risk and good marketing, they can also enter other markets. It is true that nobody is waiting for them out there, but the trend is clear: the Estonian market is shrinking. Fixed costs are increasingly hard to cover with a shrinking sales base - the only solution is to expand the sales base. Cutting fixed costs to a minimum is something all store operators have been doing for several years already. Today, even the largest retailers are no longer looking for savings on cost lines of 1,000+ euros, but on lines of just a couple of hundred euros. Cuts are made wherever possible, but in the long run only growth in sales volume helps - something the Estonian market can no longer provide.
The state has been unable to scale itself back, and the ever-growing cost of state borrowing brings ever-greater interest payments to lenders for decades to come. Against this backdrop, tax cuts, even with the aim of supporting the economy, are difficult to push through. Quite the opposite - there is talk of raising taxes even further to plug holes. The European Union is currently looking for additional revenue for its budget and is considering further turnover-based taxes on companies, including loss-making ones. For retail, which has historically been a sector of thin profit margins but high turnover, this idea would be especially painful. In food retail, margins are the thinnest. For the past 10 years, profits at Estonian food stores have been around 2%, half the EU average.
Price hikes have a very large impact in such a low-margin sector - that is also why retailers always resist tax increases. They know that a tax increase means a price increase, which leads to higher input costs and reduced purchase volumes. Since fixed costs do not shrink, the pressure on already thin margins gets even tougher. In recent years, most of the growth in retail's own price markup has come from growth in sellers' wage bills and from rising energy and service prices. Retail is like the centre of an ecosystem that consumes a lot of services - from banking and communication services to security and cleaning services. A lot of money goes into IT development, marketing and store renovation to keep pace with all kinds of new regulations and requirements. When consumption falls but all these inputs become more expensive, the retailer's thin-margin business is quickly thrown into a position where it may no longer be sustainable.
In Estonia today, we are used to retail that is exceptionally convenient by European standards. Shopping is accessible and convenient throughout Estonia. Our stores are easily reachable on a daily basis - in terms of logistical location, online services and opening hours. More and more is being invested in opening new stores in rural areas, which brings more choice and a varied assortment also outside the larger urban centres. Estonian retail has also been a demanding client for technology companies. A range of self-service solutions, smart scales, digital deposit receipts and age verification through technology are widespread in stores. Our stores are clean and modern.
Given today's economic climate, this kind of world-class service can no longer be taken for granted. We can see that the market is now being taken by discount stores, private labels, cheap imports and discounts. If consumers prefer cheaper channels and consume imported products, this will mean lower economic growth for Estonia and the risk of fewer jobs in stores, services and the related supply chain and service area, whether that is marketing, music, logistics or something else.
The middle-class segment of retail is shrinking today. At the same time, the middle class's purchasing power has not actually disappeared. We have to restore the middle class's confidence and offer them what they cannot get from a Chinese discount platform: high-quality services. Retail's opportunity is to complement its business model with the sale of services. To some extent this is already visible. Many stores have opened their own cafes; some host events. The number of intermediaries and service providers has been cut, and some services that had become expensive are now being provided in-house. Retailers have started selling their own space to other companies for advertising and for the sale of secondary services to consumers.
As for tax policy, from the retailers' perspective it is important that tax policy take into account retail's role in the economy. More than a tenth of all the country's tax revenues flow through retail; retail is the largest county-level employer - one in ten Estonians works in the retail sector. Retail keeps the economic life of small towns and villages alive. If the tax burden becomes unbearable, it will hit hard not just the retail sector, but also the surrounding ecosystem of companies, smaller local governments and, most importantly, the consumer.
If we are looking for the quickest tax-policy change to help ease the downturn, that would be cutting VAT on basic foodstuffs. A citizens' initiative to that effect was sent to the Riigikogu in autumn. Less tax burden on basic products means a cheaper dinner table and better competitiveness for domestic food producers. If the tax burden were reduced, we as retailers promise that the resulting benefit will also reach the consumer.
There is a simple reason for this: in Estonian retail, it is not possible to keep a tax cut to oneself. When the state cuts VAT, strong pressure to lower prices arises immediately, because otherwise the store loses customers to competitors who roll out the new lower price more quickly. Thanks to fierce competition and price-comparison portals, the impact of a tax cut quickly reaches the end consumer.
If the state wanted to do even a single thing to help Estonia's second-largest sector curb price hikes, cutting VAT on basic foodstuffs would be that step.