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Tesco may be rolling out more giant stores but things remain very tough in the Irish retail sector, writes Fearghal O'Connor.

Driving out of Balbriggan towards the M1 motorway is something of a retro experience at the moment. The cranes, high visibility jackets and towering new retail palace emerging from a building site give a brief feel of 2006.

Tesco's huge new half-built store in north Dublin suggests that the UK multiple at least has some confidence in the Irish economy. It is also building a new store next to the M4 motorway at Kinnegad in Co Westmeath and it has continued to roll out its much smaller Tesco Express stores as well.

A cursory glance at the most recent retail statistics from the Central Statistics Office, which show that the volume of retail sales increased by 6% in April 2010 compared to April 2009, could also give the impression that Ireland's retail sector is bouncing back strongly. 

But if sales in the motor trade are excluded (it has seen a huge rise in the volume of its sales since the scrappage scheme was introduced) then the volume of retail sales actually only increased by 0.3% over the period.

This is probably still worth celebrating, given that it was the first rise in year-on-year retail sales (excluding motor trades) since March 2008.

But probably an even bigger problem is the continuing spectre of deflation. Customers will have welcomed falling grocery prices but deflation is making life very difficult for retailers and their suppliers.

The CSO figures showed that (again excluding the motor trade) despite the increase in volume, there was an annual decrease of 3.6% in the value of retail sales in the year to April.

In reality, the sight of a brand new Tesco store springing up is completely unrepresentative of the experience of most in the retail sector. The UK company is of such a scale that it has the cash to expand while virtually everyone else retrenches. The Irish multiples have had to radically alter the way they do business just to try and keep pace with their international competitor.

Shane Dempsey, head of consumer foods with Food and Drink Industry Ireland (FDII) says the sector has been through turbulent times in the last few years, with most companies taking at least 15-20% of costs out of their business. That, he says, accounts for 3,500 to 4,000 jobs lost in the sector last year.

"This cost cutting has also been very damaging to investment in innovation, branding, marketing and areas like that," he says.

The increased pressure has resulted in a huge amount of value promotions. This has seen the volume of sales generally rise in recent months. While this is obviously a good thing, the value of those sales has declined.

"If that trend continues, it would be a particularly worrying vista for suppliers because they are producing more and getting less and the margins are tight enough as they are," says Dempsey.

One senior executive of a major retailer did not mince his words when asked had he yet seen signs of recovery.

"No is the short answer," he said. "Retail is in the doldrums. It is not particularly going backwards but it is not going forwards either."

Grocers in particular are beginning to struggle with deflation which, in that sector, is still running at over 6% annually.

"So for selling the same basket of goods this year, we get at least 6% less money in the till which is a bit of a killer," says the executive. "We are actually seeing a recovery in customer numbers but this is just not coming through in spending."

Deflation brings huge challenges for a retailer and makes keeping percentage margins and percentage costs in line very difficult. Often the answer has been redundancies and ever increasing pressure put on suppliers which has a knock on effect on the wider economy.

 Franchisees in symbol groups face even greater pressure because of the added wholesalers' margin that they will have to pay.

"You will find at the moment that quite a lot of people in those symbol groups are being financially supported by the symbol operator," says the executive. "There is quite a lot of hidden distress there - it is not yet apparent through shops closing down but some of these people are up to their necks.

"They may have bought the freehold of the shop and taken out a big loan but it has now probably halved in value. They are not in a good position."

But while the past 18 months has been extremely tough, he is hopeful that the worst is now over. He says recessions and closures are always a last resort and that his company has a plan in place to deal with the situation as it exists at the moment.

"But we have to react to the circumstances as we find them," he says. "If the economy turns down again, we will have to reappraise everything and every business should be saying the same thing."

Not surprisingly, thoughts of expansion are not to the forefront of any of these plans even if suitable sites are now available for huge discounts on previous prices.

"While the likes of Tesco are opening new stores, you are not seeing any major new developments," says Marie Hunt, head of research at property adviser CB Richard Ellis. "There are only two or three small retail schemes that are due to open this year. There is a handful in the pipeline for 2011.

"Once you go into 2012 and 2013, numbers are hard to deduce because while we are aware of a lot of schemes with planning permission that are due to go on site, it is unclear whether they will be able to get funding. Definitely, the taps of development have been firmly turned off."

Nevertheless she says that such negativity does not exist across the whole sector and new units are being opened by those with the means. "The market is good for them because they can do really good deals. The landlords are willing to negotiate and grant rent reductions and do deals on turnover. There is good value if they are buying sites, so for some it is a good time to expand. Recently some of the foreign-owned chains are very aggressive and are bidding against each other on sites in prime locations."

The retail executive says it is true that retailers are being offered very good deals on sites.

"But you have got to be extremely careful taking a site just because there is a dowry with it," he says. "You can repent at leisure for doing that. You take a deal that looks very good and in the short term, it is all great because you get the shop for free or whatever. But if the location is not right and there are rents and other costs down the line, then you can very easily come to regret that decision."

He says that because Tesco has a gigantic amount of cash to invest, it can afford to take a very long-term view on these things.

"The projects they are building out at the moment were probably laid down three or four years ago so even if they have turned off the tap, there will still be things moving through the pipeline. And you will find that other retailers will also be opening sites over the next 12 months.

"But there is no question that most of us have pulled in our horns and are not looking for sites in the same aggressive way that we were two years ago."

Nevertheless, in other parts of the retail market Marie Hunt says there has been a lot of interest in Ireland from expansion-minded international outfits. She cites Disney, French retailer Decathlon and Skechers as three companies that have taken advantage of the depressed property market to get into the Irish market.

"There is quite a list of retailers who are entering the Irish market for the first time because they can do deals. They were probably looking seriously at Ireland for years but discounted it because the rents were too high and it just didn't make any sense. Whereas now, they can see an opportunity to get in while the going is good," she says.

But the going is certainly not good in groceries and it is unlikely that any new players will look to move in here any time soon, despite rumours over the years that the likes of Sainsburys and Walmart were keen.

But the retail executive believes that there will come a moment when Ireland will suddenly start to look cheap.

"You could find in six or 12 month's time, that Ireland looks a lot more attractive than Britain," he says. "Up to now, Britain has not suffered nearly as badly as Ireland. People have come out of the recession a lot more quickly there. Most retailers, for example, had a very good Christmas last year. But now there is a feeling that things might really soften.

"You will see in the figures for people like Tesco and Sainsburys how their sales are not growing much anymore. And now with the VAT increase in the budget, I think Britain could be in for a rough two or three years and at the same time Ireland might actually start to come out of its problems. So the tables might turn quite rapidly."

But this will be cold comfort to Irish suppliers struggling to live up to the retailers' ever increasing demands. The cost to suppliers of even getting products on to the shelves of the major retailers is likely to continue to increase at a time when most suppliers are already under severe pressure.

"This could in the medium term mean that suppliers will have to pull back on investment and perhaps on capacity and production itself," says Shane Dempsey. "This is a vicious circle that can only be tackled through the introduction of a code of practice that ensures fair play in the market."    

Massive retailer buying power results from a 70% market-share concentration between Tesco, Dunnes and Musgraves. Aldi and Lidl share a further 10% of the market.

"There is anecdotal evidence that the big retailers do apply retailer buying power in negotiations and suppliers also claim that this is abused," says Dempsey. "You will often hear suppliers talk covertly about lists of arbitrary demands that they receive from retailers. And if one large retailer demands something, then the others follow suit."

The effects of retailer buying power can also be felt down the line by smaller retailers. When big retailers demand more discounts from suppliers, then they, in turn, are forced to recover costs elsewhere and so drive harder bargains with smaller retailers.

"If this situation continues for another few years, you are going to be left with less suppliers and less smaller retailers," says Dempsey. "You then have a consumer who is faced with choice issues where larger retailers become gate keepers for the Irish population, ie, they can decided what products the Irish population gets, they can set the price and they can decide when they get them."

And, he says, another bad Christmas period would be disastrous for everyone in the sector - retailers, suppliers and processors - but also for the country as a whole.

"Because we have a very strong food sector in Ireland, it means that we have the entire supply chain from farm to fork," he says. "And if one of them is doing badly, they all tend to suffer and that is not good for any of us."

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