Australias Supermarket Industry - Example

Coles and Woolworths dominate the supermarket industry in Australia as they account for more than 70per cent of grocery market with Metcash-supplied stores accounting for 20 per cent. A s such Australian market has a duopolist market structure with the ‘big two’ having the ability to influence quantity produced as well as prices received by suppliers and processors as well as farm-gate prices for farmers. These farmers take market prices as given by market conditions. The activities of the two supermarkets has led to exit of many small manufacturers in the industry and those remaining mostly depend on the two retailers for survival. One would be forced to think that being duopolists, the supermarkets would charge high prices to get more revenue. However, this is not the case as price undercutting (price wars) amongst them leads to low prices. This benefits consumers at the expense of farmers who get low farm-gate prices. TABLE OF CONTENTS Executive summary...................................................................................................2 Introduction...............................................................................................................4 Part 1 Australian Supermarket Industry Structure ...............................................................5 Oligopoly.........................................................................................................5 Market Power..............................................................................................................6 Part 2 Competition Between Coles and Woolworths.............................................................8 Price Reduction.................................................................................................8 Product Range..................................................................................................10 Product Quality................................................................................................ 1.0 Introduction Modern economies operate under the free-market ideology hence deregulation especially of the manufaturing and processing industries is the order of the day. This has led to intense competition in the market and emergence of large retailers who control the market. Australia is no exception as its retail grocery sector is the most concentrated in the world with Coles (Westfarmers Group) and Woolworths accounting for about 75 per cent of Australia’s grocery market and Metcash- supplied stores accounting for another 20 per cent (Cohen, 2013, p.2); Samuel & King, 2013). The ‘Big Three’ account for 95 per cent of grocery sales. This is a rate which is incomparable to other developed countries such as Canada, UK and Germany where the ‘big three’ account for 65%, 50% and 40% respectively. Due to high Australian dollar, increasing labor costs and supermarket’s behavior, food manufacturers in Australia find it hard to operate and those who dare operate do so at thin margins while others end up collapsing (Background Briefing, 2013). Aldi is one of the small retailers who are coming up but its market share is too low to be a threat to the ‘big two’. There is no doubt that Coles and Woolworth dominate Australia’s supermarket industry and wield considerable market power leading to low competition and sometimes anticompetitive behavior. What is of concern is whether these two supermarkets abuse their market power especially after a lot of complaints by small retailers and producers to the Australian Competition and Consumer Commission (ACCC). What is interesting is that even though the market is concentrated which in normal circumstances would mean low competition and high prices; this is not the case in Australia as reports indicate the profits for the two are not as high as expected as is the case with Tesco in UK or Walmart in US. Coles and Woolworths are oligopolies in the form of duopoly but they can also be considered duopsony as they have buying power in addition to selling power. This report is to evaluate the supermarket industry in Australia with special focus on Coles and Woolworths and by the end of the report, I hope to conclude that Coles and Woolworths have too much power in the Australian supermarket industry and that competition between the two is good for Australians now and into the future. 2.0 Australian Supermaket Market Structure In order to understand whether Coles and Woolworth dominate the supermarket industry or have much market power, it is imperative to understand the market structure that shapes firm’s production and pricing decisions or behavior. The dominant market structure in Australia is oligopoly and more specifically duopoly as Coles and Woolworths are the largest supermarkets. 2.1 Oligopoly An oligopoly is characterized by few sellers such that the actions of one seller have a large impact on profits of all other sellers (Gans et al. 2015, p. 386). In this sense, each form must act strategically to gain more market share and more profits as profits depend on how much the firm produces as well as what other firms produce. A duopoly is a form of oligopoly whereby only two firms dominate the market such as in Australia. The duopoly in Australia was a result of lax regulation that allowed mergers and acquisitions (Fels, 2010, p. 13). In the 1980s, there were four major retailers: Coles, Myer, Woolworths and Safeway but thse merged in 1985 leaving two major players. Coles merged with Myer whilst Woolworths merged with Safeway. The third retailer (Franklins) exited the market in 2001 leading to market concentration. Firms in this market tend to collude or form cartels that result in a monopoly thereby hindering competition although this behavior is prohibited by competition laws (Cohen, 2013). The market is characterized by barriers to entry and exit through such practices as predatory pricing and price discrimination. In Australia, Coles and Woolworths have consolidated their selling power and transformed it into buying power hence they can be regarded as duopsony. Oligopolies are also characterized by price undercutting of each other as they have influence over the price they receive for their products. 3.0 Coles and Woolworths Market Power Coles and Woolworths by virtue of being duopolists or duopsony have much market power in the retail grocery industry. For example, according to Loughnan, between coles and Woolworths they sell half of red meat sold in Australia (2012, p. 107). They are the big retailers alongside small independent retailers like IGA and ALDI as they account for 80% of dry grocery market whereas Metcash accounts for the rest. Aldi has 3-4 % market share and entered market in 2001. In 2011, Woolworths had 840 supermarkets in Australia whereas Coles had 741 (Keith, 2012, p. 47). Coles and Woolworths are being accused of anticompetitive behaviors or abuse of market power. Witnesses told Background Briefing that the two constantly revise terms of trade to put pressure on suppliers to meet their conditions or to squeeze more margins out of them (Background, 2013). Suppliers are forced to pay a premium price for their products to be on the supermaket shelves or be deleted. A behavior some suppliers like Danny the CEO of National Food Company regarded as blackmail (Cohen, 2013).Moreover, one had to agree on finacial concessions for product to stay on the shelf and despite this, the supermarket could remove the item from the shelf without prior notice. This is evidence of the buying power that the two giants possess. Moreover, suppliers have to rely on these two supermarkets to survive or exit the market. For example, Fawcett argued that while he owned Aristocrat, Coles and Woolworths were his main customers representing 62-63% of his products (BackGround, 2013). This behavior has pushed many small manufacturers out of the market. This is worsened by buying up independent grocers to minimise competition or charge low prices to bar entry as the duopolists have potential to endure losses for a long time unlike new entrants. Another show of market power is price influence. Coles and Woolworths are known for influencing suppliers and processors by retaliation. For example, Woolworths retaliated against bakers who supplied cheap bread to its competitors by removing their bread from its stores and refusal of further deliveries (Gans et al. 2015, p. 418). This is proof of buyer power the supermarket yields. This also shows lack of suppliers’ power in the market. They also negotiate long-term contracts with processors to supply huge volume of products. This in turn pushed small processors out of market as they cannot meet the scale required; it is either they get big, or get out. The worst case scenario was in 2011 when Coles slashed its brand milk prices by 33% to sell at $1 per litre (Samuel & King, 2013). This amounted to promotion of home-brand at the expense of branded milk which most processors relied on for revenue. Some claimed use of permeate on milk to make processing cheaper. This would eventually drive processors out of market and lead to low farm-gate prices. Another case in point was price-fixing by Safeway (owned by Woolworths) in Victoria in 1994 and 1995. In this case, Safeway responded to a smaller retailer who was undercutting it by engaging in price-fixing with plant bakers and removing its bread from its shelf (Fels, 2010, pp. 13-14). However, it was fined $ 8.9 million for abuse of power (Growcom, 2008). Besides the grocery market, these retailers also dominate liquor market and oil industry. Part 2. 4.0 Competition between Coles and Woolworths Competition in Australia is regulated by the Australian Competition and Consumer Commission (ACCC). Specifically, the ACCC makes it “illegal for firms with substantial market power to use that power to restrict or harm competition” (Cohen, 2013). That not withstanding, Australia retail industry is unique owing to the small, sparse and highly urbanized population thus favoring development of large metropolitan food retailers than smaller, locally based retailers (Keith, 2012, p. 58). It is also characterized by dispersed centres of habitation of key food producing areas. These two factors requires economies of scale to minimise distribution costs and this has favored development of a highly concentrated industry dominated by Coles and Woolworths. However, this does not mean that competition is low as the duopoly faces stiff competition from global companies like ALDI and Costco thus forcing it to strategize its competition efforts.This in turn has led to opening of new stores, price wars, quality improvement and also increased product variety to the benefit of consumers. As such, competition between Coles and Woolworths is good for Australians now and into the future. 4.1 Price Reduction Oligopolistic firms whether duopoly or more players are interdependent and it is this interdependence that shapes firm’s behavior. Unlike perfectly competitive markets where sellers are price takers and actions of one seller or buyer are insignificant in influencing prices, the actions taken by one seller in an oligopolistic market have large impact on the profits of other players (Gans et al. 2015, p. 386). Firms in this market have two options: cooperate or act independently. Firms may decide to cooperate by agreeing on quantity to produce and price to charge hence collusion or formation of cartels. This is advantageous to such firms as they could act as a monopoly maximising their total joint profits but producing low quantity of products to the detriment of the customer. Increasing production incurs more costs leading to decline in profits thus the firms are better off producing below optimum quantity. This would lead to higher demand than supply thus pushing prices up. However, this would not be good for consumers or Australians as they would have no other choice but to accept the given high prices. However, this is not so for Coles and Woolworths as they sell identical products. Instead of using differentiation strategy to gain competitive advantage, they are copycats hence any action taken by one retailer is followed by the other retailer (Samuel & King, 2013, p. 1). Moreover, collusion and cartels are prohibited by Competition and Consumer Act or what was previously referred as Trade Practices Act of 1974 (Keith, 2012). The result of using copycat strategy in this case is limited profit and customer loyalty and further reduction in prices for consumers. Instead of colluding, duopolies have the tendency of undercutting each other on price as is the case with Coles and Woolworths until they reach a Nash equlibrium. This refers to “a situation in which economic actors interacting with one another each choose best strategy given the strategies that all other actors have chosen” (Gans et al. 2015, p. 389). At this level, marginal revenue (price) equals marginal cost and equals zero. This will lead to efficient production and improved society wellbeing. This means firms engage in price wars as was the case in the “milk wars” of early 2011 in Australia. The milk or price war began with Cole’s ‘down-down’ campaign for food products in all its stores nationwide especially milk which is a private label (Background Briefing, 2013). On Australia Day 2011, Coles cut the price of milk to $1 per litreso as to cause discomfort for Woolworths and which according to Sydney Morning Herald caused Coles $60 million (Greenblat & Hawthorne, 2011). However, Coles CEO Ian McLeod asserted that the cut was a result of competitive tendering and aimed at offering low prices and consistent supply to customers. This was followed by Woolworths ‘price knockdown’ campaign and consequently, further reduction in prices of milk butter, cream, tissue and tea by Coles (Competition Policy Review, 2014, pp. 16-18). In 2013, Woolworths launched the’Everyday value’ savings campaign while coles launched the ‘Deeper down down’ campaign in 2014. The resultof these price wars according to the competition policy review was real savings for customers amounting to $17 billion over the last five years (Ibid, 2014, P. ii). The real price for food and non-alcoholic beverages dropped by approximately 1.3% per year while household appliances prices dropped even further. The report also indicated that customers paid 7% cheaper for a basket of goods in 2013 than in 2008. In addition, Coles and Woolwoth offer a variety of discount prices as form of competition such as Woolworths’everyday rewards and the discount petrol wars (Fuel change, 2007; Coles, 2014). 4.2 Product Range Competition between Coles and Woolworths has also been instrumental in provision of variety of products for Australian consumers. The supermarkets have engaged in expansion by establishing stores in different areas including rural and remote areas byutilizing economies of scales. One factor that has led to such expansion is expanded private labels and the need to offer customers fresh produce and pressure from global brands like ALDI (Competition Review, 2014). References Background Briefing (2013). Casualties in the Supermarket War. Background Briefing. http://www.abc.net.au/radionational/programs/backgroundbriefing/2013-03-24/458227#transcript Cohen, H (2013). Crunch Time for Supermarket Suppliers. Competition Policy Review (2014). Response to Competition Review Issues Paper. Competition Policy Review. Retrieved May 27, 2015 from http://www.competitionpolicyreview.go.au/filis/2014/06/woolworths.pdf Fels, A. (2010). The Regulation of Retailing: Lessons for Developing Countries. In E. Howard (ed). The Changing Face of Retailing in the Asia Pacific. Abingdon, Oxon: Routledge. Fuel Change on the Cards (2007). Australian Financial Review, September 2007. Gans, J.,King, S., Stonecash, R., Byford, M., Libich, J & Mankiw, N. G (2015) Principles of Economics, 6 ed. Australia: Cengage. Growcom (2008) ‘Submission to the Australian Competition and Consumer Commission on the Inquiry into the competitiveness of Retail Prices for Standard Groceries. Retrieved May 24, 2015 from http://www.accc.gov.au/content/item.phtml?itemId=812872&nodeId=7c45465bdf0ee17c9a9d769e8871a7f5&fn=069%20-%20Growcom%20 Keith, S (2012) Coles, Woolworths and the Local. The Australasian-Pacific Journal of Regional Food Studies, 2: 47-81. Loughnan, D (2012), Food Shock: The Truth about What We Put on our Plate...What We can do to Change It. Exisle Pty Ltd. McLeod,Ian (2015). Coles Cost of Living Report Spring 2013 :Why Keeping Prices Down is Important. Retrieved May 28, 2015 from http://www.coles.com.au Productivity Commission (2014). Relative Costs of Doing Business in Australia: Retail Trade. Research Report, Canberra. Samuel,G and King, S (2013) Power without Glory?Supermarket Competition in Australia. http://monash.edu/news/show/power-without-glory-supermarket-in-Australia Read More