Session 2. Competitiveness in the marketing and retail sectors

:RUNVKRSRQ(QKDQFLQJ&RPSHWLWLYHQHVVLQWKH$JURIRRG6HFWRU0DNLQJ3ROLFLHV:RUN -XQH9LOQLXV/LWKXDQLD Session 2. Competitiveness in the marketing and retail sectors *52&(5<5(7$,/,1*$1'/$79,$1)22'0$5.(7,1*&+$,1 %\0V,QJ QD*XOEH )22'&+$,1 )22'&+$,1&21&(37 The concept Food Chain has not been addressed widely in Latvia yet. The definitions of food chain vary, and no one has been universally accepted. Similarly, the performance and competitiveness of the food chain are difficult to be measured by quantitative ratios. The interests of food chain participants are divergent and often competing. The competitiveness of the food chain can be expressed by the ability to deliver the right product at minimum cost. In a broad sense, materials flow along the food production chain from the primary producer - farmer or grower - to the end consumer through processors, marketing organizations, wholesalers and retailers. This supply chain is becoming more closely integrated with greater emphasis on quality management, safety assurance and traceability, with farm producers working as part of the chain to meet the needs of consumers in a rapidly changing marketplace. The total food chain can be divided into detailed separate structural layouts for each commodity type, or even a particular product. The structure and parts of various food chains may differ depending on a specific product. For example, the sugar beet food chain includes also industrial consumers. Imported banana food chain includes overseas growers, packers, shippers, maturing facilities, importers. Historically, after becoming of an independent economy, the parts of the food chain were rather set one against another than worked together in the interest of the consumer. The competitiveness of the Latvian Food Chain depends almost entirely on consumer confidence in the quality and value of domestically produced food products. The role of the Government this far has been limited by addressing single stages of the food chain - farm support, antitrust measures in mergers and acquisitions, retail trade regulations, food safety. Sometimes the policies favor one part of the chain at the expense of others (support to sugar beet growers and refineries at the expense of confectionery and soft drink producers; high import tariffs on pig meat supporting domestic pig producers at the expense of meat processors). )LJXUH3ULQFLSDOOD\RXWRI/DWYLDQIRRGPDUNHWLQJFKDLQ 1

)22'&+$,125,(17$7,21 Increased concentration at all stages of food chain is defined "food convergence". Several forms of a food convergence are identified. In the United States powerful processing companies with internationally recognized branded products and economies of scale exert control, because consumers are loyal to brand and retailers must offer this brand in their stores. In United Kingdom powerful retailers exert control, mainly because of "own label" brands. Consumers are loyal to store, and processors, in turn, are very willing to contract for products with retailer labels. Control in the primary farm level is not so common and happens mostly in case of powerful grower s cooperation like "Sunkist" citrus growers in the US. 7DEOH5HWDLOHUEX\HUVHOOHUSRZHUPDWUL[LQVHOHFWHGFRXQWULHV Many Latvian food chains develop towards a few large and powerful companies, and some chains are dominated by a single actor. However, retail concentration in Latvia still lags behind Lithuania, and buying power retailers exert over manufacturers is not that marked. 35(6685(6,17+()22'&+$,1 The domestic food chain is permanently faced with the need to adapt to changing circumstances due to several major reasons. First of all, the impact of the competition in a global marketplace grows. As the production cycle for most agricultural commodities is relatively long, it is difficult to keep the balance between supply of a raw material for processing and declining consumer demand of a particular processed product. The resultant necessity of the cost reduction is felt along the entire chain backwards from retailers to processors, and ultimately, primary producers, whose income and margins are already low. New retail market entrants and further retail market consolidation puts additional pressure on farm producers. Trying to offer the lowest prices to the consumer, retailers and processors can easily increase sourcing of cheaper imported raw material and products. '$7$$1',1)250$7,21,668(6,1'(7(50,1,1*7+(3(5)250$1&( 2)7+()22'&+$,1 Publicly available data on food convergence are usually available as summarized and data on company level provided by Governmental Statistics are limited. In some sectors with high concentration even aggregate data are not available because of confidentiality. Companies output volumes by product type are subject to non-disclosure by Law. No data are available on specialist stores sales in bakery, dairy, meat, fish, confectionery segments. Information on production and consumption of selected products is often incompatible because of different classification. Retail market product specific information offered by a few commercial companies is very expensive and, in cases, outdated either on domestic or international markets. Turnover and sales estimates usually do not correct firms non-food sales. Open air market places still attract plenty of customers, but data on volumes sold are not available. When gathered, information is often not compatible to data from other countries. After joining the EU, data on trade with other EU countries are no longer available. )$50,1* The Latvian farming sector is rather fragmented with many smallholds still present in the market. The amount of commodities produced and consumed on farm is comparable to agricultural sales to processors. 2

)LJXUH/DWYLDQDJULFXOWXUDOVDOHVWRSURFHVVRUV0/V )22'352&(66,1* Food processing is an important part of Latvian food chain, as it purchases about 60% of total farm output, and, in turn, provides about 60% of total grocery retail supply. The existing level of retail concentration still has left some selling power to manufacturers. However, rather fragmented major meat, dairy and bakery sectors will consolidate and concentrate further in the nearest future in response to retail concentration. A rather distinctive sector is fish processing with almost 90% of total output being exported. )LJXUH/DWYLDQIRRGPDQXIDFWXULQJRXWSXW0/V 5(7$,/ The last decade has witnessed considerable changes in grocery retailing in Latvia with the growing prevalence of retail chains and improved logistics. The retail consolidation process is still continuing and, similarly to other European countries, merger proposals are investigated by competition authorities because there is a growing concern large retailers may be able to command market power over suppliers and consumers alike. The rise in concentration is mainly associated either with development through internal growth or acquisitions. 3

5(7$,/'(9(/230(17,17+(%$/7,&6 Food retailing turnover steadily increases in all three Baltic states. )LJXUH)RRGUHWDLOLQJWXUQRYHULQ%DOWLFVWDWHV0/V After the decline in 1996, Latvian retail food turnover increases. However, total retail turnover grows faster, reflecting price increase for utilities, housing and services. )LJXUH)RRGUHWDLOLQJDQGWRWDOUHWDLOWXUQRYHULQ/DWYLD0/V The concentration level has rapidly been increasing in all three Baltic states. Over the last 5 years, CR3 has grown from 10-15% average to more than 60% in Lithuania. Concentration process has mainly been driven by foreign actors in Latvia and Estonia while in Lithuania by large local retail chains. Grocery market is growing in line with moderate growth of population income level and launch and development of new food retail concepts - hypermarkets, discount stores. No single actor has strong position in all three states. However, VP Market with "Maxima" and "T-Market" concepts has captured about 25% of Baltic grocery retail market. )LJXUH6KDUHRI930DUNHWLQ/DWYLDQJURFHU\UHWDLOLQJ0/V The sector is still rather fragmented in Latvia, where a few buyer groups supply a large number of independent grocery retailers, who benefit from buying in bulk. Joining a buying 4

group is an important element in the survival of small retailers. A member of a buying group operate autonomously and are united only with respect to purchasing activity. 5(7$,/&21&(376 The supermarket and convenience store segment will expand only moderately and mainly due to a regional expansion. Hypermarket and discounter segments will grow faster because the relative share of these concepts in total retail scene is still low. The growth in these segments will happen in line with the decline in number of specialist stores and small over-the-counter family stores. So far, two major retailers have opened their own discount stores. 6725(6,=(6 Total number of grocery stores in Latvia has been stable over last five years floating around 5,000. Number of small outlets decline, while number of hypermarkets increase drastically. )LJXUH1XPEHURI/DWYLDQJURFHU\VWRUHVE\VL]H 5(7$,/6833/< Wholesalers mostly supply regional stores, while Riga stores buy directly from processors. VP Market chain apply direct imports. On the average, Riga stores have about 90 suppliers, regional stores are supplied from about 40 companies. The closeness of domestic suppliers and almost immediate availability of their products are the main advantages of local products. However, if compared to importers products, domestic suppliers are less flexible with respect to packaging differentiation. Sometimes supply interruptions happen. Limited marketing budgets allow sales promotion to a lesser extent. 5(7$,/(5%8<,1*32:(5 Buyer power arises from the ability of retailers to obtain more favourable terms from suppliers. Vertical restraints which retailers are able to place on suppliers include: slotting allowances (fees charged for store shelf space allocation); fees to ensure that products once established will stay there; demanded discounts on goods already sold but no paid yet; contractual obligations for the supplier not to sell to another retailer at a lower price; insistence on exclusive supply arrangements. Often buyer power of retailers is linked with their selling power. However, in the case of concentrated buying by group on the selling side retailing is highly fragmented and retailers exert less selling power. 5

)LJXUH6DPSOHIRRGFRQYHUJHQFHLQIRRGFKDLQ The large food retailers take their purchasing decisions on the basis of a two step procedure. In the first stage, the supermarket carries out a selection among prospective candidates using as criteria price (for comparable products the lowest cost supplier would normally win); interest in the brand (if product would not sell or it does not fit in with the store image, even low price would not help); guaranteed continuity of supply; continuous product quality. Putting out purchases to tender, given an acceptable level of quality sales usually go to the lowest bidder, is not a common practice in Latvia yet. Price is considered as the most important factor in the retailer decisions when forming an assortment, especially is stores located outside Riga, where purchasing power by inhabitants is markedly lower. Generally, retailers rate customer purchasing power as low and medium. Quality usually is connected with the "acceptable price". Quality issues are considered important for the store image and customer loyalty. A distinctive feature of Latvian customer behaviour is favouring of domestically produced goods. Latvian products are viewed as fresh, healthy and safe. In regions, also regional preferences exist, and geographical closeness to retail outlet is manufacturers advantage. Brand awareness is considered more important in regional stores. Most retailers favor uniqueness and distinctiveness of new products, if these features are supported by attractive and convenient packaging. A trial period for a new product is applied by every store to a new product for a period up to three months. Final decision is taken based upon the analysis of demand, customer response and margins. Some stores are introducing new products on the regular basis, usually over a quarterly period. Based on the performance, the weaker 20% of brands are replaced with new products. Some suppliers similarly monitor their product on-store performance. Mostly retailers tend to work with large suppliers. However, in cases, small producers are considered as more flexible. The trend is seen that small manufacturers more supply smaller stores of the same chain. The second step is the elaboration of concrete conditions of the supply relationship. Usually a listing fee exists which is paid simply for store presence and slotting allowances for shelf space. Additional allowances are paid to locate products in end-of-aisle displays. Retailers demand for long terms of payment. Stretching the terms of payment to suppliers by retailers allow getting financing without interest for expansion. Suppliers are required to return unsold units, especially fresh food and vegetables. Special promotions, like "3 for 2 deals", are at manufacturers expense. If retailers make bulk purchases, they demand discount. Contributions are paid in the case of store openings, remodelling, extensions, mergers. Fixed end-of-year payments linked to certain volumes of sales achieved are not common, as target levels of sales are not strictly planned. Nevertheless, in cases, retrospective discounts over previous year s sales take place. Manufacturers refilling the shelves with their products by themselves are not 6

paying fee. Exclusive purchase arrangements are not required by retailers. Opening of new outlets is not restricted, as authorization for the construction of large stores is not based on existing coverage and retail saturation. Only permits from the local authority are needed. Hypermarket opening hours is not limited, and there are no regulations to slow down the rate of closure of independent outlets. There are no domestic alliances to lobby on behalf of Latvian-owned retail businesses. &21680(56 Per capita expenditures on food have stagnated or even slightly declined over the second half of nineties, while total expenses increased at the same time in absolute value terms. Food expenditures surged in this decade. Nevertheless, the share of expenses on food in total expenditures has declined from 51% in 1996 to 35% in 2002. )LJXUH6KDUHRI/DWYLDQIRRGH[SHQVHVLQWRWDOH[SHQGLWXUHV While per capita consumption is unchanged or slightly growing, continuously declining population number does not allow significant overall food market expansion. The number of retired persons with stable yet relatively low income increase. Self consumption still is high in almost all main product groups, especially fruits, berries and vegetables. In rural areas, milk, eggs and meat are consumed on-farm. Only 22% of household members whose responsibility is food purchases are using cars when shopping. On the average, 41% of Latvians make food purchases every day, 47% are buying several times per week. The most popular outlets are small stores, supermarkets and open air market places. Shopping centres and hypermarkets are not still as popular. The frequency of warehouse shopping is declining. Gas stations, kiosks and mobile truck stores are not favoured at all. 7

)LJXUH%X\LQJIUHTXHQF\PLQLPXPRQHVKRSSLQJSHU\HDU The reasons motivating buyers are: location close to place of residing, good prices, discount prices and price deals as part of product promotions, wide assortment, fresh farm produce, bulk shopping at one stop. )LJXUH0DLQUHDVRQVLQUHWDLORXWOHWVHOHFWLRQ The most efficient product promotion is product tastings, as Latvian consumers rate taste factor as superior above all other product values. Mostly tastings are provided on-store by supplier. General price discounts and specific product type discounts are rated next. Games and lotteries are also attracting customers. )LJXUH/DWYLDQJURFHU\EX\HUSURGXFWYDOXHUDWLQJV 8

6800$5<$1'&21&/86,216 The Latvian food marketing chain has not been yet conceptually viewed as both vertically and horizontally integrated structure. Pressures in the food chain in rapidly changing environs will raise the necessity to address the issue with the objective to determine the present status of Latvian food marketing chain and elaborate proposals to increase it s competitiveness. The main problems limiting the competitiveness of Latvian food marketing chain are: x lack of communication and understanding between sectors of the food chain x fragmented and inefficient farming sector x rather fragmented food processing x low consumer purchasing power x limited data on cost structure necessary for in-depth analysis of the food chain performance x growing impact of cross-border alliances within grocery retailing x limited possibilities to protect domestic agricultural production Proposals for increasing the competitiveness of Latvian food marketing chain: x creating of a constructive dialogue between partners in the food chain x better communication with the consumers, including more targeted media coverage x assistance to producers, better equipping them to meet the needs of the major players in the market The objectives mentioned above can be reached by developing a Food Marketing Chain Development Scheme, which would be elaborated by involvement of senior representatives of all sectors of the food chain: x Ministry of Agriculture x Association of Farmers x Federation of Latvian Food Processors x Traders Association 9