Issues on Economics of Competition - Essay Example

Economics of Competition of the School] of the Introduction Present paper looks at the evolution of competition in retailindustry in the United Kingdom over a period of time. Specifically it describes the process of concentration of capital in the British grocery sector in the 1980s, and examines the significance of sector by static, and by dynamic criteria. An analysis of the national implications of the process focuses on new store development programmes, retailer-supplier relationships, labour productivity, net profit margins and price discrimination from the point of view of competition. 1. Overview of British retail industry During the 1980s, Britain experienced a massive and sustained concentration of capital within grocery retailing. The trend towards concentration had been present for the previous twenty years, but the 1980s were characterized, most notably, by the emergence of a small group of retail corporations whose turnover, employment levels, profitability and sheer market and political power came to rival the largest industrial corporations in any sector of the UK economy. Between 1982 and 1990, the market share of the top five grocery retailers increased from under 25 per cent, to 61 per cent of national sales, on one estimate, and a "super league" of just three firms began to separate out in terms of growth, profitability and annual capital investment. During years which have been described as the "golden age" of British grocery retailing, the immense oligopsonistic buying power wielded by the retail corporations came to condition all aspects of retailer-supplier relations, and created new corporatist relationships between the retailers and the regulatory state. Nowadays, there are many retailers who are trying to enter the competitive grocery market. However, it is difficult to gain substantial market share as the industry is very saturated and requires a lot of efforts for companies to become leading competitors. Below, the market share of the UK retail industry is presented. Table 1: Market Share in the UK Grocery Industry1 Great Britain % Tesco 30.3 Asda 16.4 Sainsbury 15.9 Morrisons 11.7 Somerfield 5.8 Waitrose 3.7 Iceland 1.9 Others 14.3 Total 100 As we see from the table, only a few retailers present competition on the UK grocery market. The "Others" that include hundreds of retailers constitute 14.3% and are relatively small shops that do not present a threat to the retails such as Tesco or Asda. The evolution of grocery industry and the competition in it reflects significant changes over the time. As we will see further in this paper, the competition in the grocery industry used to take place between the small shops which did not take a dominant position on the whole market of the country, but rather were located and competed on the small area. In present time, the situation is changed as big retailers try to capture the whole market of the industry. 2. Main grocery retailing competitors To understand how the competition of British grocery retailing evolved, it is first necessary to appreciate some of the key features of the retailer-dominated UK food system which emerged during the 1980s, for it was those features which drove that internationalization. Four features will be picked out. In practice these are intimately interconnected, but for purposes of discussion it is useful to separate them. In the early 1980s the top three firms-Sainsbury, Tesco and Asda-held a combined market share of around 20 per cent of national grocery sales. They had recently been joined by two other firms, the Argyll Group and the Dee Corporation (later Gateway), which were growing rapidly by takeover and merger. Between 1982 and 1988 the dominance of this "big five" group increased considerably. Their combined market share reached approximately 43 per cent by 1984 and 58 per cent by the end of 1988. By 1988, Sainsbury, the largest food retailer, had surged up the rankings of British companies by turnover, from 51st position a decade earlier, to 14th position. It had increased its workforce from 32,000 to 88,000 and had sustained net profit rises and shareholder-dividend increases of more than 20 per cent per annum throughout the period. The late 1980s saw a continuation of this remarkable progress. By 1990, on one estimate, the top five grocery retailers held 61 per cent of national sales, although other estimates, calculated on different definitions of the total national food market, place the figure closer to 50 per cent. However, what is indisputable is that a "super league" of just three firms-Sainsbury, Tesco and Argyll (the operators of Safeway)-had begun to separate out in terms of growth, profitability and annual capital investment. The latter was particularly important, for the critical arena of competition between the major grocery retailers had become the new store development process. By the late 1980s the major grocery corporations were generating no less than two thirds of their annual increases in sales from the new stores they had opened in the previous twelve months, and those new stores were operating at higher netprofit margins. The new store-expansion programmes thus became vital to the maintenance of the substantial annual increases in turnover and profit which the capital markets had come to expect. Given the rationing of sites for large-scale development by planning constraints, competition for the most attractive development sites became intense. The late 1980s were therefore an era of "store wars" in which strategic capital investment and an ability to ground that capital became the engine of corporate growth and ever-increasing concentration. 3. Internationalization as a response to changing competitive conditions The spectacular performances of the major grocery retailers in the 1980s brought in their train a certain fragility of position and, as the 1980s came to an end, that fragility became both more obvious and more significant for the internationalization of the industry. Two aspects of this issue are worthy of attention. The engine of corporate growth during the 1980s was strategic capital investment in new store-expansion programmes. The replacement of "non-conforming" (often High Street) space by new more capitalintensive space in out-of-centre superstores "ensconced and dominant in their own market(s)enjoy(ing) a degree of protection from all" (Moir 1990:112) provided one of the pivots on which the increases in labour productivity and net-profit margins rested. However, as the decade advanced, those store-expansion programmes became progressively more expensive in real terms. In the case of Sainsbury, for example, annual capital expenditure increased no less than tenfold during the 1980s to over 500 million per annum by 1989, an increase five times greater than the retail prices index. By 1991/92 it had increased to 800 million per annum. The new store-expansion programme of Tesco rose even more markedly and had reached 1 billion per annum by 1991/92. Despite net-profit margins which had risen to quite unusual levels by the end of the 1980s, even the hugely increased pretax profits being achieved by the "big three" grocery retailers were rapidly becoming insufficient to fund these expansionary programmes from retained earnings. Yet there was no simple way of disengaging from a corporate trajectory ("chosen path of accumulation") which was threatening to become a treadmill. The capital markets had, over the decade, come to expect and discount continued substantial annual increases in turnover and profit, yet those annual increases have been shown to be intrinsically dependent upon the new store-expansion programmes. As a result, "failure to meet these exacting annual new store-expansion targets (could) have a marked effect on year-end results, and any slip (was) compounded by failure to meet unrealistically demanding stock market expectations" (Wrigley 1992:1286). By the beginning of the 1990s two of the "big five" grocery retailers, Asda and Gateway, had indeed fallen victim to the demands of this exacting treadmill. In the case of Asda, failure to drive forward the critical new store-expansion programme with sufficient pace resulted, in 1989, in an attempt to compensate in one leap via the purchase of 61 superstores from Gateway for 700 million at the time of Gateway's leveraged buyout by the Isoceles consortium. The purchase, aimed at gaining market share in critical regions of the UK, proved ill advised. It overextended the firm and, burdened by debt as the recession of the early 1990s began to bite, Asda's performance crumbled. The capital expenditure programme had to be cut back savagely, profits declined, its share price fell dramatically, its Chief Executive left the company, and by 1992 it was announcing an annual pre-tax loss of 365 million. As Gateway and Asda faltered and dramatically curtailed investment, a massive gap opened between the "big three" grocery corporations (Sainsbury, Tesco and Argyll) and the second-tier retailers. In 1991, at the bottom of a services-led recession in the UK, the "big three" raised 1.4 billion of new capital in a wave of public rights issues (Wrigley 1991) to fund their accelerating expansion programmes. They were also active raising capital in the bond and sale-and-leaseback markets. Pumping over 2 billion per annum into store-expansion programmes, the "big three" announced plans to increase their floorspace by 8-9 per cent per year during the 1990s. Yet the sheer scale of this investment served merely to raise even more strongly the doubts that had been growing in the late 1980s about the long-term viability of this strategy and the return on capital which would be achieved by the major grocery corporations. The Financial Times (19 June 1991:22) raised the question of "how long the likes of Sainsbury, Tesco and Argyll can continue to reap attractive returns from their enormous investment programmes", and ventured the opinion that: "The trouble about food retailers is not the immediate outlook; it is rather the way all possible good news is taken for granted. One of these days, it must surely all go wrong". Similar doubts were expressed publicly by growing numbers of retail analysts in the City of London, and were given increased substance by the sharp divergence of values which had emerged between the foodretail property market and the general UK property market in which property values had fallen by over 20 per cent (Wrigley 1992). Indeed, Shiret (1992) suggested that, if the overvaluation of the grocery retailers' property was corrected via depreciation, and a procedure known as the "capitalization of interest" was discontinued (Wrigley 1992), the pre-tax profits of the "big three" would decline by between 10 and 20 per cent, placing yet more question marks against the accelerating store-expansion programmes. By the late 1980s and, more starkly, during the deepening recession and property crisis of the early 1990s, it became clear, therefore, that the hugely increased funding requirements of the major grocery corporations were raising significant doubts about the trajectory of corporate growth in British grocery retailing. Clearly, if the major corporations were not to become victims of their past successes in the "golden age" of the 1980s, they needed to look to sustain their past levels of performance in new ways. Diversification, into other sectors of retailing, or into grocery retailing outside the UK, offered obvious routes. In particular, internationalization offered the opportunity to establish bases which could "be used defensively to provide opportunities for capital investment in an era in the mid-1990swhen UK-based profits growth at the levels which the stock market has come to expect and discount may become more difficult to sustain" (Wrigley 1992:288). 4. High margins, excess profits and price competition As the profit margins of the major grocery retailers rose to ever-higher levels in the late 1980s, the conditions of competition in the UK grocery market came under closer scrutiny. This came first from overseas retailers, envious of the much higher margins being obtained in British grocery retailing (particularly in comparison to mainland Europe and North America). They sensed the emergence of opportunities for aggressive low-margin, low-capital-intensity, operations. Secondly, scrutiny came from retail analysts, consumer groups, and the press, who were all becoming increasingly alarmed at the growing disparity between UK profit margins in the grocery sector and those elsewhere. In particular, they were suspicious that ever-increasing concentration in UK grocery retailing within a benign regulatory environment had resulted in conditions supportive of the extraction of "excess" (shared monopoly) profits. In the popular press, articles drawing attention to the high net-profit margins, lack of real competition, and the "scandal of Britain's high food prices" to finance "the building of cathedral-like supermarkets, as store chains compete toincrease their control over the retail food market" (Sunday Times, 25 August 1991) started to appear. In the trade press the grocery corporations were reminded that they were "turning in the highest net profits in the world" and cautioned to remember the issue of "real price value" (The Grocer, 10 August 1991). Such articles coincided with increasing academic concern over shared monopoly and the possible extraction of "excess profits". Moir (1990:93-7), for example, noted that the years following the period (1979-83) studied in the OFT's Competition and retailing investigation were characterized by very different conditions: by marked and sustained increases in both gross and net-profit margins. He also suggested that a pattern of increasing gross-profit margins and increasing net margins sustained over time was strongly indicative of the possibility of "excess" profits. In response, the major grocery retailers maintained adamantly that the increased margins merely reflected added value and changed commodity mix. Furthermore, they argued that, in comparison with overseas grocery retailing (in particular North America), higher margins were necessary in Britain to repay the higher investment required on expensive British land, and that the true comparison should be on the ROCE (return on capital employed) measure, which was very similar in British grocery retailing to elsewhere. Nevertheless, the exposed margins of the major grocery retailers had become a matter of public concern, and into the debate were drawn Members of Parliament and members of the House of Commons Select Committee on Agriculture (Wrigley 1991). An OFT or MMC referral began to seem a possibility. In addition, there was sensitivity to the fact that a tightening of the benign regulatory environment in which the major grocery retailers had operated might flow from any UK government commitment to reform the Fair Trading Act 1973 and the Competition Act 1980 along the lines of Article 86 of the Treaty of Rome in pursuit of wider EC harmonization objectives. In many ways the conditions of the early 1990s were ideal, therefore, for the penetration of the UK market by overseas retailers stressing a "value platform" of aggressive pricing and low margins. First, the established "big three" grocery retailers had adopted a corporate strategy of raising entry barriers by hugely increased investment and differential access to capital. With the minor exception of Argyll's Lo-Cost operation, they had totally abandoned the low-margin discount sector and, despite their protestations, the "price wars" of the late 1970s were merely faded memories. The low-margin, low capital intensity, limitedline discount sector of the market which they had abandoned had, in turn, developed its own corporate giant, Kwik Save, the 6th/7th ranking UK grocery retailer. The corporate performance of Kwik Save in the 1980s had been immensely impressive. Pre-tax profit had grown by 19 per cent per annum in the 5 years to 1990, accompanied by the highest return on capital employed (ROCE) in the UK food retailing sector. However, Kwik Save had grown in a relatively protected market niche. Despite its low-margin, low operating-cost image, and a corporate policy of re-investing profit-margin gains into competitive prices, its netprofit margin of 5.9 per cent in 1990 was high by international standards. In addition, it had begun, quite distinctly, to move away from its initial, restricted-range, very low-capital-intensity, format towards a broadened product range, slightly higher cost operation (County NatWest WoodMac 1991). Moreover, it was clearly untested by serious competition offering a similar "value platform" in the same market niche. That is to say, the possibility existed that its impressive growth was partly an artifact of being the only strong player in a rather protected niche within a general food sector which was, arguably, lacking "real" competition. Furthermore, unlike the high entry barriers presented by the capital-intensive strategies of the "big three", the low capital intensity of the Kwik Save format presented only low barriers, of both entry and exit, to new competition. Secondly, the enhanced risks of the high capital-investment trajectory of the major corporations had left the two weakest members of the old "big five" in a seriously debilitated state, struggling to service major debts of 678 million in the case of Asda, and over 1 billion in the case of Gateway, in 1992. Thus, the second tier of the industry was potentially highly vulnerable, particularly in urban/industrial regions in which consumers were becoming increasingly price sensitive as the deepening recession of the early 1990s took hold. Asda and Gateway found themselves at a critical juncture without the capital necessary to mount either a challenge to the "big three" or to defend themselves with sufficient vigour against determined low-margin challengers in increasingly "value sensitive" urban/industrial markets. Thirdly, the bouts of public concern over the excesses of retailer dominance of the UK food system which surfaced in the early 1990s left the incumbent grocery retailers highly exposed over the issue of the benign regulation of competition in the industry and threatened the corporatist nature of retailer-regulatory state relations. Into this potential market gap rode the European limited-line discounters, notably Aldi and Netto. They were attracted to the UK by the logic of their own long-term corporate expansion trajectories and by static (saturated) home markets. Undoubtedly, they were also attracted by the high ROCE it appeared possible to achieve in UK discount food retailing, and by general "margin envy". High and consistently rising profit margins achieved in Britain suggested to these European food retailers, as much as to the UK press and some UK academics, the extraction of excess profits. Indeed, some retail analysts have suggested that the European limited-line discounters may have succumbed to some sort of "conspiracy theory" as the major reason for rising UK profit margins (Kleinwort Benson 1990), allied to the influence of the retailers' oligopsonistic buying power. However, whatever the reasons for the attempt by the European discounters to penetrate the UK market in this way, they were clearly sensitive to public concern over conditions of competition in the UK grocery sector, and willing to test and exploit the rather exposed relations between the retailers and the regulatory state. Indeed, by 1991, two formal complaints to the OFT had been lodged by Aldi, and the challenge to the sensitive relationship between the incumbent retailers and the regulatory authorities was being used as a market entry tactic. 5. Characteristic of evolving competition of retail grocery industry in the UK It is impossible to analyze British retailing-that dynamic and central part of the UK service economy-without being acutely aware that a third phase of the spatial switching of retail capital has been entered. As the international scale of switching unfolds, it has profound consequences for the competitive structure of the industry. In this chapter, two facets of that internationalization have been considered. Outward movement of UK retail capital has been viewed as a response by the largest grocery retailers to growing doubts about the long-term return on capital from seemingly ever-accelerating UK superstore expansion programmes. In particular, it has been shown that capital-investment opportunities in growth areas are required for an era, in the later 1990s, when expansion opportunities in UK food retailing can be expected to decline, capital-expenditure requirements will fall, but huge cash-flows from the multi-billion turnovers of the top corporations will continue unabated. Sainsbury's expansion into the USA provides, as yet, the best illustration of these themes. Significantly, however, Sainsbury's internationalization has more recently been mirrored by Tesco who, in December 1992, purchased the Catteau chain of 90 supermarkets in northern France for 176 million. Although a relatively small purchase in terms of Tesco's total annual capital budget, the move into mainland Europe has been regarded as immensely significant. It is viewed as indicating the beginning of a major long-term continental European diversification strategy by Tesco, and as signalling slowing growth prospects in the upper end of the UK grocery market. Moreover, after many years in which the corporate trajectories of the two largest UK food retailers have been very similar, the geography of diversification-that is to say the chosen route of internationalization-has suddenly become a critical dimension along which future corporate performance will be assessed. Inward movement of retail capital into UK food retailing has been seen to be concentrated into the lower-end, discount sector of the market and to come principally from mainland Europe. In contrast to the raising of entry barriers by hugely increased investment and differential access to capital, which characterized the corporate strategies adopted at the upper-end of the market, low capital intensity but high ROCE became the key to market success in the discount sector of the market. This in turn implied low barriers, of both entry and exit, for new competition, and that competition was attracted by envy of high and rising net-profit margins being achieved in UK food retailing and by a sense of the emergence of opportunities for aggressive low-margin operations. It has been seen that some of the initial fears of pricecompetition ripple effects and destabilization of profit margins which would result from the entry of the European limited-line discounters were rather overstated. Nevertheless, although during the initial phase of European discounters' expansion, direct price-competition effects of the extremely low-margin Aldi-type operations do not appear to have crossed market-segment boundaries, they have prompted a potentially highly significant secondary effect. By triggering the emergence in the UK of discount food-warehousing, and by drawing into that sector the highly pressurized, second-tier retailers, the conditions have been set for much wider price-competitive ripple effects, particularly in certain "value sensitive" urban/industrial regions. In turn, this throws into sharper focus the long-term returns on capital which might be achieved from the major corporations' multi-billion superstore-expansion programmes in those areas, is compounded by the consequences of the overvaluation of their retail property portfolios (Wrigley 1992), and becomes a significant factor prompting the search for diversification via internationalization. In this way, internationalization at the upper and lower ends of UK food retailing is intrinsically interrelated, and must be viewed as a single process. Given the centrality of international diversification to the future trajectory of corporate growth in British food retailing, what is surprising, however, is how very little is yet known about the key features of that internationalization. The available literature in geography and planning, indeed the available literature from any source, is remarkably sparse. This chapter has summarized what is currently available and has attempted to provide a framework for future analysis. Two types of research are now required. On the one hand, detailed case studies of market entry and competitive response will provide insight into "the spatial expression and manifestation of retail restructuring" and the manner in which "retail capital penetrates specific spaces" (Ducatel & Blomley 1990:225). On the other hand, attempts must be made to position the study of the internationalization of British food retailing within broader theoretical debates on the interaction of corporate restructuring and market structures, and to understand the internationalization of retail capital within a framework which places it as a subform of commercial capital within the larger circuit of total capital. Bibliography: 1. Buckwalter, D.W.12005. Effects of competition on the pattern of retail districts in the Chattanooga, Tennessee, metropolitan area. Southeastern Geographer29, 26-41. 2. County NatWest WoodMac 1991. Focus on European food retailing. London: County NatWest Securities. 3. Ducatel, K. & N. Blomley 1990. Rethinking retail capital. International Journal of Urban and Regional Research14, 207-27. 4. Kleinwort Benson 1990. Aldi: the eagle has landed. London: Kleinwort Benson Securities. 5. Moir, C.1990. Competition in the UK grocery trades. In Competition and markets: essays in honour of Margaret Hall, C. Moir & J. Dawson (eds), 91-118. London: Macmillan. 6. OFT (Office of Fair Trading) 1985. Competition and retailing. London: Office of Fair Trading. 7. Shiret, T.1992. How much hot air do you like in your accounts Food retailer property valuations and their effect on the P & L. London: Credit Lyonnais Laing. 8. Silbertson, A.2004. Textile markets and the Multi-Fibre Arrangements. In Competition and markets, C. Moir & J.A. Dawson (eds), 63-76. Basingstoke: Macmillan. 9. Wrigley, N.1991. Is the "golden age" of British grocery retailing at a watershed Environment and Planning A 23, 1537-44. 10. Wrigley, N.1992. Sunk capital, the property crisis and the restructuring of British food retailing. Environment and Planning A 24, 1521-7. Read More