Thursday, May 09, 2013

Regulating supermarkets does not checkout

The failure of the ACT's supermarket competition policy is further evidence that government cannot plan competitive markets.  They have to evolve from businesses meeting customer demand.

Earlier this week, the government announced it was jettisoning its 2010 supermarkets policy introduced after the 2009 Martin review into competition.  It was designed to drive down prices by using planning regulations to favour individual supermarkets in the hope it would boost competition.

Its failure was driven by a misunderstanding of supermarket retailing.  The dominant supermarkets are Coles and Woolworths.  The 2008 Australian Competition and Consumer Commission review into grocery retailing found they t share about 60 per cent of the groceries market.  Their share is likely to have fallen since with the rapid growth of competition from Costco, and particularly ALDI.  Both have significantly increased competition,

driven innovations such as the growth of private labelled goods, and proven that market entry barriers barely exist unless government creates them.
Similarly, the two majors don't just compete against other supermarkets.  Data from research firm IBIS World shows their market share is 61 per cent for fruit and vegetables, 58 per cent for liquor, and 38 per cent for meat, fish and poultry.

In 2010, my Forcing Prices Up report analysed the likely impact of the ACT's supermarket plans.  ACT Treasury data showed that out of 30 surveyed supermarkets in the Territory, the 20 least expensive were Coles and Woolworths stores.  The 10 most expensive were those that the competition policy tried to help the most — Supabarn and IGA.  Supabarn was the ninth and 10th most expensive stores;  IGA stores filled the final eight spots.

Using the ACT Treasury's data the analysis concluded the mean price of an average basket of groceries was likely to rise around $1.05 because of the policy, and be around $8 more expensive than the cheapest basket in Canberra.  As ACCC head Rod Sims conceded in an interview with the Australian Financial Review earlier this year, increases in regulation flows through to higher prices for consumers at the checkout.  It was clear the supermarket competition policy was designed to boost the commercial opportunities for Canberra-based Supabarn.  In practice that meant already financially struggling families were asked to suffer less competition and likely higher prices to boost the commercial interests of Supabarn.

The policy sought to cut the price of groceries in the ACT by preferring the entry of higher retail cost supermarkets.  The policy broke one of the principles of economic reform — the government should remain neutral.  Which business wins is up to customers, not government.  The other failed assumption is that retailers only compete on price.  They don't.  Competition is also achieved through different product offerings.  Surveys of ACT customer attitudes included in the Martin review showed consumers understood not all supermarkets offered the same value proposition.  ALDI and Costco both meet the demands of price-sensitive consumers.  Super IGA, Coles and Woolworths deliver for consumers who want a mix of low prices, convenience, parking and location.  IGA stores are demanded by customers who value convenience over price.  So while IGA and Supabarn prices may generally be higher, people shop there because they want to support a local retailer, or because they support their local sporting club or simply because they are open later at night.

But the key driver for consumer choice is price.  Research shows most of us shop at multiple supermarkets and 60 per cent are prepared to swap stores for a 5 per cent discount.

Consumers hunting for cheaper prices are driving an expansion of discount loyalty programs and reductions in prices for staples, particularly milk.  Against competition from ALDI and Costco, Coles and Woolworths have had to heavily compete by cutting prices.  Now they are focusing their energy externally and targeting food manufacturers and wholesale suppliers to push prices down the supply chain.  Suppliers have understandably been miffed at cutting their margins.  A supplier backlash has prompted the supermarkets to import goods, including those initially made here, more cheaply than they can buy wholesale locally.

To provide a comparison, two litres of Coca-Cola in Canada costs around $1.78, in the US around $1.61, and in Australia $4.25.  At between double and triple the price there is a significant difference and not all occurs in retail margins.

A 2011 Productivity Commission report into the state of the Australian retail industry concluded retail margins were roughly the same in Australia, Canada and the US at 25 per cent.  That means a lot of the cost difference sits at the wholesale end.  Getting these prices down requires bargaining power based on demands from consumers, not preferential regulation as the former ACT government policy imposed.

No comments: