Monday, June 24, 2013

ACCC supermarket battle must put consumers first

Despite the views of politicians and regulators, consumers are driving prices lower through changes in supermarket business models that favour efficiencies, competition and scale.

There's no prescription for perfect competition.  That's why the marketplace should be left to provide what consumers demand.

What's poorly understood is how consumers change business models.

According to survey data in the Australian Competition & Consumer Commission's 2008 grocery inquiry, the two most important factors in their decisions are quality and price.

Quality is reflected in price, and is a subjective measure.

By comparison, price is directly comparable.  Survey data included in the same inquiry showed 60 per cent of Australians were likely to change their supermarket based on a 5 per cent discount.

Considering Australians are some of the least loyal supermarket consumers in the world, it's hardly a surprise that there's an ongoing price war.  That price war has been driving changes in supermarket business models to enable them to compete.

Supermarkets are a high-volume, low-margin business.  Whether they are Aldi, Coles, IGA or Woolworths, they sell millions of items and take small margins on each product.

Only convenience store arms operate on higher margins and lower volumes.

Considering 75 per cent of a supermarket's costs come from purchasing from suppliers, that means the remaining 25 per cent — which includes transport, storage, logistics, wages and profit — is traditionally where they have focused efficiency gains.

Even modest savings substantially increase the competitiveness of a retailer.  Investments in logistics and supply chains more than a decade ago enabled Woolworths to increase its market share against Coles.

By increasing scale, supermarkets can fractionalise their overheads across millions of sales and so reduce prices.

In achieving the efficiencies of scale, not all supermarkets operate on the same business model.

Aldi provides a streamlined, limited product range and leverages its global supply chain.

Smaller, local IGA and Supa IGA stores co-operate and bulk purchase through Metcash wholesaling.

Coles and Woolworths offer a broad product range but use their market size to keeps prices low.

The key focus to date has been to reduce costs directly within their control.

Competition and scale have delivered price reductions of at least 5 per cent in comparison with the decade-long trend in Australian food prices, which is equivalent to nearly $10 a week for the average worker, or $500 annually.

Unless supermarkets can find a new business model, attempts to break up the scale of any of the four major chains will be met with higher prices as costs will be fractionalised over fewer sales.

With a growing demand for convenience, supermarkets are also using the efficiencies of scale to deliver lower prices despite the high-cost structures of smaller, convenience-orientated stores that have longer opening hours and therefore higher overheads.

To continue meeting consumer demand for lower prices, supermarkets are now shifting their focus towards costs outside their direct control.

That's led to putting pressure on suppliers and public spats between the major supermarkets and alcohol companies and Coca-Cola.

Similarly, recent arrangements between the major supermarkets and milk suppliers to provide cheap private-labelled milk were designed to cut middle-man costs while securing reliable supply.

For consumers, the greater concern should be barriers to entry that harm competition.

While capital costs are high, the establishment of 300 larger-format stores over the past decade suggests market-based barriers to entry can be overcome.

Meanwhile, non-market barriers such as government-imposed wage increases, shop trading hour restrictions and planning restrictions that halt the development of new sites make it harder for new competitors to establish themselves, and

add costs that will be passed on to consumers.

It brings into question the role of the ACCC.  Should it be focused on deciding which supermarkets can meet consumer demand, or removing the barriers so that there are more supermarkets?

Last year ACCC chairman Rod Sims argued the sector was at a competition ''critical decision point''.

Sims is right.  The critical decision point is between whether the ACCC puts consumers first and allows the market to meet demand, or whether it casts aside consumers and interferes to achieve non-price objectives.

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