Supply Chain Contract of Coles and Woolworths in the Australian Market - Case Study Example

Supply Chain Contracts: Case of Coles and Woolworths in Australian Market Name Institution Course Date The grocery market is an important sector in any economy. It employs many people and ensures that there is constant food supply in a country. In Australia, the supermarket industry is highly concentrated (Keith 2012, p. 48). Coles and Woolworths are the dominant players and this scenario presents negative effects on food production, and specifically, to their suppliers. As the two supermarkets holds market power, instances of abuse of the same are not remote. In 2011, it was alleged that the two giant supermarkets have been abusing their market power by intimidating suppliers in various ways. Formation of supply contracts that is fair to both parties is impossible when one party has a favourable balance of power and does not cooperate with a weaker party. Coles and Woolworths have been exercising their favourable balance of power against its suppliers in an unfair manner and Australian Competition and Consumer Commission (ACCC) investigate the issue and found them guilty. This essay covers supply chain contracts and explores an abuse of market power by Coles and Woolworths in the Australian grocery market. Nature of Supply Chain Contracts The business environment is a dynamic one and often changes due a number of factors in the market and the firm. For these reasons, strategic alliances and partnerships are important to the company’s success. Supply chain contract is one of the partnership agreements that a company enters with its suppliers. They should be established appropriately and managed effectively to ensure their success and stability (Mozafari & Tafazzoli 2011, p.42). A company needs to choose appropriate partner(s) in forming an integrated supply chain. A supply chain involves a linkage of two or more parties by the flow of funds, information and goods (Wang 2002, p. 302). In the supply chain contract, the partners need to be aware of the scale of their cooperation, risks, and benefits of the contract. This is crucial because when one or more of the supply chain partners attempts to optimize individual profits, there is a possibility that the system will be hurt. Competition is increasing and strategies should be developed to deal with it through a more beneficial supply chain. Supply chain contracts are one of the strategies that can improve performance of a company among other benefits. Supply chain contract is a mechanism for coordinating the provision of incentives to all the partners in order for decentralised supply chain to behave exactly or to a large extent as the integrated one (Wang 2002, p. 302). It is a mechanism by which partners are protected from the risks in the market emanating from various sources of uncertainty and those related to conflict of interests (Mozafari & Tafazzoli 2011, p. 42). Supply chain contracts exist to increase the total profit of a supply chain and led partners exploit the benefits inherent in the long-term agreement. Furthermore, it enables the partners to share the risks and improves system-wide performance (Hohn 2010, p. 21). Overview of Australian Grocery Market In Australia, the dominant food retailers are the major supermarket chains led by the duopoly of Woolworths and Coles. Others are Independent Grocers Australia (IGA) and the German ALDI. The Australian grocery market is among the most concentrated in the world with Coles and Woolworths dominating the retail food sector (Booth & Coveney 2015, p. 04; Keith 2012, p. 48). The grocery market plays an important role in the economy of the country with many people depending on it for their livelihood. However, the increasing market share of Woolworths and Coles has provided many Australian suppliers and farmers a challenging environment. Woolworths and Coles account for 80% of dry grocery market (Howard 2013, p. 15). The retailer, Franklins, left the Australian market in 2001 leaving Coles and Woolworths to dominate the market. The entry of ALDI in 2001 has not really affected the dominance of Woolworths and Coles with the two recently accused of abusing their market power. The concentration of the supermarket industry in Australia is not good for fair competition and also for consumers. The sizeable market power that Coles and Woolworths have gives them the ability to affect the entry barriers, establish the expectation level of the sector and to determine prices (Bariacto & Di Nunzio 2014). Local farmers and suppliers find themselves in a vulnerable position due to the decisions made by the two supermarkets involving pricing and volume of transactions. It is no doubt that Coles and Woolworths contribute immensely to the Australian economy through employment of many people and their function as primary markets for the produce of local farmers. It offers reduced prices to consumers and this is a relive to many individuals that are priced out by other retail outlets. Nevertheless, this comes at the expense of suppliers. They dictate the negotiating terms of the supply contracts due to their sizeable buying operations. They can obtain suitable produce from the farmers at low cost hence can afford to reduce their prices to consumers. The allegation of abuse of market power by Coles and Woolworths supermarkets in 2011 is a situation that has been built up several decades ago. Market Dominance by Woolworths and Coles The Australian grocery industry has become highly concentrated due to a number of factors such as a poor regulatory approach in terms of mergers and bungled expansion strategies of the grocery market. This concentration has led to public concern. Policy and regulatory decisions have been undertaken recently to curb the dominant position that Woolworths and Coles enjoys. Myer, Coles, Woolworths and Safeway, as well as an independent sector, were among the major retailers accounting for over 50% of the grocery sales share in 1980s (Howard 2013, p. 13). In 1985, a controversial decision by the competition regulator was made after it approved a merger between Myer and Coles. Woolworths and Safeway also merged in 1985 which left Franklins, a substantial retailer, to compete with the other two. This set the pace for the kind of concentration the industry faces today. The consumers’ behaviour changed over time as they opt for large supermarkets now run by Coles and Woolworths as opposed to smaller outlets. A wave of mergers between different wholesalers was also realised and Australian Competition did not oppose it. In 2001, a watershed occurred when Franklins discontinued its operations in the Australia and no new entrant was forthcoming to take its market share (Hoover 2007, p. 368; Howard 2013, p. 13). As a result of all these events, the market now is highly concentrated. The introduction of ALDI, Cole’s poor management and steady growth of Woolworth’s market share add another dynamic to the issue. The issue was not really addressed by the regulators until 2011 when Coles and Woolworths were accused of abusing their market power. Abuse of Market Power The key issue in competition law and industrial economics is the market power. Authorities regulating competition are mainly concern with a situation where some mergers or undertakings in the market possess the power of influencing both price and output. Marginal cost and monopoly price are the two benchmarks used to define market power (Kellezi 2008, p. 42). In a perfect competition situation, there is no firm that has the market power. In this case, marginal cost is equal to the market price. On the other hand, a firm that possesses a market power can raise the price above the marginal cost because it has that ability (Kellezi 2008, p. ). It has also the ability to dictate terms of the supply chain contracts hence giving a raw deal to the suppliers. For purposes of fair competition, a firm should not hold market power. A market share that is high indicates dominance (Cox 2012, p. 223). Both Coles and Woolworths control the largest grocery market share and, therefore, the dominant players. Factors such as barriers to entry and countervailing buyer power contribute to the possibility of firms holding market power and subsequently abusing it. Barriers to entry are obstacles preventing potential competitors from entering a market (Cox 2012, p. 223). A high cost of investments and ability to recover them when exiting the market prevents firms from entering into the grocery market in Australia. It may no t be possible to fairly compete with Coles and Woolworths because they tend to reduce their prices due to their dominant position. Moreover, they have strong bargaining position with its suppliers. Therefore, when a supplier increases its price, it responds by looking for an alternative one. Unconscionable Conduct and Undue Influence in Establishment of Contracts The Australian Consumer Law prohibits businesses from engaging in unconscionable conduct and undue influence when they deal with their customers, suppliers or other businesses. Unconscionable conduct deals with exploiting the bargaining weaknesses of the other party for excessive gain while undue influence pertains to abusing the relationship of confidence and trust (Chen-Wishart, p. 340). In some cases, courts are tasked with determining whether a party to a contract enters it through its own informed judgement or free will. However, the courts will not interfere when an individual, firm or a supplier for the sole reason that they did not make a contract that is advantageous to them (Dosen et al., p. 53). In this case, the other party should not have been in a position to influence the outcome of the contract. A business behaviour can be considered unconscionable when it is oppressive or harsh and beyond hard commercial bargaining (Australian Competition and Consumer Commission (ACCC) 2014). Courts use a number of factors to determine whether a conduct is unconscionable. It includes the parties’ relative strength, use of unfair tactics or undue influence by stronger party and its willingness to negotiate. ACCC took Coles to Australian Federal court after it was alleged in 2011 that the supermarket developed a strategy of improving its earnings through the acquisition of better trading terms from the suppliers of the supermarket. ACCC alleged that Coles provided its suppliers with misleading information about savings and their value and used unfair tactics and undue influence in obtaining rebate payments among other allegations from its suppliers (ACCC 2014). Compensation for the damages, a contract being declared either wholly or in part as void and financial penalties are some of the penalties and remedies available when courts have determined that unconscionable conduct and undue influence occurred. Balance of Power in Negotiation of Supply Contracts In the recent years, supply chain partnerships have become more popular and acceptable. Suppliers have been promised a partnership where the focus will be mutual benefit and an addition of value to their supplies, but because of lack of power balance, this promise never materialises. The partner perceived degree of dependency is linked to power (Woodburn & McDonald, p. 140). The Balance of power can either favour a seller over a small buying company seeking to establish itself and needs support in order to advance. On the other hand, it can favour a big buying company over its small scale suppliers as in the case of Coles and Woolworths. Notwithstanding the relative power positions, companies that are favoured by the balance of power still have the choice of how they can exercise the advantage at their disposal. The manner in which a buyer or supplier choose to exercise the balance of power in their favour has a profound effect on the kind of supply contract formed. Power can be used in a constructive or destructive manner (Woodburn & McDonald 2012, p. 140). For example, a buying firm can demand very low prices for the suppliers and probability of getting them is high because of its very powerful position. Alternatively, a firm can impose higher standards of trade practice or some specific strategies on the supplier because it would make it a better trading partner and benefit both supplier and firm. It is clear that the balance of power is crucial in the determination of the nature of the relationship between supplier and its customer. Big supermarkets chains such as Coles and Woolworths have a balance of power in their favour hence can dictate the terms of the supply contracts. Specifically, Coles was ordered to pay $10 million dollars as a penalty after it admitted to having engaged in ‘unconscionable conduct’ towards its suppliers (Bainbridge, McGrath, & Janda 2014). A collaborative relationship is, therefore, important in avoiding such kind of situation and the entity with a favourable balance of power should choose to behave in a manner that is cooperative. In our case, Coles and Woolworths should not intimidate but cooperate with its suppliers because the balance of power favours them. Conclusion The major concern in Australia is the market power, dominance and high concentration in the grocery sector. It is clear that Coles and Woolworths powerful duopoly presents a number of challenges to the local farmers as well as small businesses who struggle to fairly compete and co-exist with the big supermarket chains. Transparency and collaboration between supermarkets and suppliers need improvement in ensuring that supply contracts are formed with no unconscionable conduct or undue influence from either party (Singh & Power 2009, p. 189). Rather, they are formed for purposes of mutual benefit through collaboration from both parties, especially the one with an unfavourable balance of power. Recommendations The supermarket industry in the country is concentrated with Coles and Woolworths dominating the market. This is bad for expansion of fair competition and also to suppliers and consumers. A code of conduct that is mandatory in the industry need to be developed and should cover the whole supply chain. The code will be able to address market manipulation and prevent supermarkets from carrying out alteration of contracts. Consumer and Competition Act 2010 should be regularly reviewed in the wake of abuse of market power allegations. ACCC should always be ready to undertake modification of the policy and implement tough penalties in cases where the Code does not operate effectively. A New set of tough laws should be introduced to allow ACCC the power to apply for breaking up companies to courts in cases where there is an abuse of market power. Additionally, domestic farmers should have a consumer support so that they cannot be exploited by supermarkets. References Australian Competition and Consumer Commission 2014, Unconscionable Conduct, Australian Competition and Consumer Authority, retrieved 04 April 2015, . Bainbridge, A, McGrath, P, & Janda, M 2014, ‘Coles admits unconscionable conduct in dealing with suppliers; $10 million penalty agreed with ACCC’, ABC News, 15 December, retrieved 05 April 2015, . Bariacto, N, & Di Nunzio, J, ‘Market Power in the Australian Food System’, Future Directions International, retrieved 07 April 2015, . Booth, S & Coveney, J 2015, Food democracy: From consumer to food citizen, Springer, London. Chen-Wishart, M 2007, Contract law, 2nd edn, Oxford University Press, Oxford. 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