Competition in the Australian Market for Groceries - Assignment Example

Institution : xxxxxxxxxxx Title : xxxxxxxxxxx Tutor : xxxxxxxxxxx Course : xxxxxxxxxxx @2013 Question one The Australian retail grocery market is not a perfectly competitive market. A perfectly competitive market refers to markets in which there are several small firms operating in a highly competitive environment. It is normally assumed to have a number of characteristics. However, these characteristics lacks in Australian retail grocery market. According to Grant and Vidler (2003), a perfectly competitive market is a market that consists of a huge number of small firms that produce homogenous or identical commodities, contributes a small percentage of the final industry’s output, sell their commodities to consumers who perfectly understands the behavior of all firms operating in the market, understand well the behavior of other firms in the industry and are absolutely free to enter or exit the market. These views are also supported by Bernanke (2003). Bernanke (2003) adds that a perfectly competitive market is a market in which there are many buyers and sellers. Each of which purchases and sells a small proportion of the entire amount of commodities traded in the market. Therefore, by considering the above mentioned characteristics, it is quite evident that the Australian retail grocery market is not a perfectly competitive one. The Australian retail grocery market is characterized by few firms dominating the entire industry. It is believed that Coles and Woolworths dominate the Australian retail grocery market. The Australian Competition and Consumer Commission estimates that, in Australian retail grocery market, Woolworths and Coles account for approximately 70% of packaged grocery sales and 50% of fresh food product sales. This however, is not in line with what many economists believes to be features of a perfectly competitive market. As mentioned earlier, a perfectly competitive market is characterized by existence of many firms whose individual sales account for a small proportion of the entire amount of products that are sold in the market. However, this is not the case with the Australian retail grocery market. In this market, there are two firms that take a huge proportion of the entire sales in the market, thus making it not a perfectly competitive one. Gans and King (2004) argue that, in Australia, supermarkets are dominated by Woolworths and Coles. Other chains such as Foodland and IGA have a marginal presence (Gans & King 2004) Additionally, consumers in a perfectly competitive market are believed to have perfect knowledge regarding products prices. Similarly, sellers are aware of the available opportunities. This therefore makes the market be free and competitive, since buyers will always settle for the products that are low priced and sellers will always want to take the advantage of the high demand, thus making the commodities’ market price be controlled by forces of demand and supply. In most cases this prices are normally low and friendly to both buyers and sellers in the market. However, in Australian retail grocery market, the situation is different. The retail grocery market in Australia is characterized by high commodities prices, which has even attracted a lot of criticism. This therefore makes it not a perfectly competitive one. Bernanke (2003) argues that in a perfectly competitive market, individual firm does not have any influence on prices. He believes that both buyers and sellers in the market are price takers. In a perfectly competitive market, the commodities traded are assumed to be identical or homogenous. That is, differentiating products sold by firms in a perfectly competitive market is not easy. The products are similar in size, shape, colour, quality and even functionality. It therefore implies that buyers are willing to switch from one seller to another with an aim of getting lower prices (Bernanke 2003). This however, is not depicted in Australian retail grocery market. In Australian retail grocery market, the products are not homogenous. The retail grocery market has products that can easily be differentiated. The products include packaged grocery and fresh food products. Similarly, buyers are not free to switch from one seller to another since the market is widely dominated by two firms. This therefore implies that, with their dominance, the two firms can easily influence consumers to purchase from their stores, thus increasing their sales. To consumers, the state of Australian retail grocery market implies that the high commodities prices will persist, unless the government intervenes by setting a maximum price. The existence of few firms that have a greater proportion of the entire sales in the market implies that the firms will continuously increase the price of the commodities. The firms will act as price leaders and operate with an aim of maximizing profits. This therefore will see consumers persistently paying heavily for the commodities in the Australian retail grocery market. The state of the retail grocery market also implies that consumers will be less informed. With little information, consumers will find it hard to look for close substitutes which are cheaper. Question two Workable competition is a concept that came up from an observation that perfect competition does not really exist and that the theories which are associated with it do not provide essential guides for competition policy. The concept of workable competition was initially formulated by J.M. Clark in the year 1940. Clark was on the view that the main objective of a policy is to make competition “workable,” and not perfect. He therefore suggested criteria for evaluating if competition was workable, which triggered a number of revisions and counter-proposals (Zecchini S n.d). Clark mentioned three conditions that make workable competition explicit. One of the conditions is that in case firms are few, sufficient product heterogeneity should result to uncertainty regarding competitors’ reactions. Another condition is that the demand curve should be steep enough to allow entrepreneur to cover the average cost. Lastly, there should be a threat of possible competition and inter-commodity substitution (Barthwal 2007). Generally, workable competition refers to doing a business in a way that it results to reasonably satisfactory market performance. A satisfactory market performance entails the profit margins that are enough to pay for both risk reward and normal return on investment, a perfect scale of operation without prolonged excess capacity, and a realistic level of commodity quality (Bangkok United Nations Asian and Pacific Development Institute, 2003). According to Bangkok United Nations Asian and Pacific Development Institute (2003), workable competition does not need products’ standardization, perfect information among all firms, equal advantages among the firms, perfect action’s independence, free entry, frictionless resources movement and other perfect competition’s requirements. In a workable competition, there is no intentional reduction of output and survival of firms that are inefficient. Workable competition is relevant to the Australian retail grocery market since the firms in the industry are operating with an aim of maximizing their profit margins. The retail grocery market is also dominated by few firms that do not have equal advantages and perfect knowledge about the market condition, thus making workable competition relevant to this market. In order to evaluate if workable competition prevail in the retail grocery market, a number of indicators can be applied. One of the indicators is the market share for each firm in the market. This is essential since it will assists in determining if the firms in the industry enjoy equal advantages. Another indicator is the gradient of the demand curve. This will assists in determining whether the demand curve is steep enough to enable entrepreneur cover the average cost. Lastly is the degree of product differentiation and inter-commodity differentiation. This will assists in evaluate whether there is a threat of competition. Question three Vertical integration refers to merging of two firms or businesses, which are in various production stages. It is a strategy that enables an organization to have control over either its distributors or supplies as a way of enhancing its market power, reducing its transaction costs and protecting the distribution or supplies channels. This therefore implies that a firm can either engage in forward integration or backward integration. An organization will be said to engage in forward integration when it takes control of its previous distributors or customers. Conversely, a firm will be said to engage in backward integration when it takes over the control of its previous suppliers (Jurevicius, 2013). Therefore, being vertically integrated, as is the case with major retail grocery chains in Australia, implies the merging of the firm, with either the distributors or the suppliers. Vertical integration is a major strategic concern to firms when establishing corporate level strategy. When formulating a corporate strategy, the essential question to ask is whether the organization needs to involve in a single activity or several activities within the industry value chain. Therefore, before merging, two matters need to be looked at. These are costs and the firm scope. It is believed that a firm should integrate vertically only if the cost of producing the commodity within the organization is less than that of producing the same commodity in the market. Similarly, a firm needs to evaluate if extending into new industries will affect its competitiveness in the market (Jurevicius, 2013). Vertical integration has a number of implications to competitors. When firms integrate vertically, their activities integration normally enhances, resulting into cost reductions. With lower productions cost the merging firm can easily lower its prices and still make profits. However, to its competitors, selling at a lower price will affect their profit margins. It is believed that with vertical integration, an organization can reduce costs through doing away with duplicate sources of overhead and bypassing particular production or distribution procedures that are not essential. Additionally, in case the commodities are to be purchased regularly, activities that are expensive and time-consuming such as contracts negotiation and price shopping can be eliminated through vertical integration, thus saving the costs (Harrigan 2003). The competitiveness of any competitor in the industry can be affected by vertical integration. When firms integrate vertically, particularly through forward integration, it implies that they are enhancing their market share, thus killing the competitiveness of their rivals or competitors. Harrigan (2003) argues that vertical integration can be employed to enhance technological and marketing intelligence, gain a powerful control of the business environment and gain product-differentiation benefits, which cannot be acquired easily by the competitors. This therefore implies that with vertical integration, the competitiveness of other rivals or competitors will be reduced. According to Harrigan (2003), vertical integration provides organizations with an enhanced capability to foresee cost or changes in demand, thus minimizing fears of unforeseen activities. Harrigan (2003) further argues that the ability to control supplies of raw materials and markets for the commodities via integration strengthens vertically integrated firms against other competitors, thus making them more competitive. It is believed that, through vertical integration, firms can acquire intelligence relating to demand that allows them to change product mixes very fast. Similarly, vertical integration allows firms to make technological adaptations efficiently in every stage. This will assist in bringing investment expectations to an immediate convergence and enhance the competitive advantages of the integrated firms. The competitors on the other hand will experience a set back on their competitiveness (Harrigan 2003). A pricing strategy such as penetration pricing is an essential strategy for successful entry of a new competitor. Penetration strategy refers to a situation in which an organization decides to set prices for its commodities below the value of service to the consumers, thus acquiring a bigger customer base (Baker 2010). It is believed to be a trade-off between higher revenue and higher margins. According to Baker (2010), penetration pricing is an effective strategy, particularly for new entrants in the market. Penetration pricing strategy entails setting of the prices, below those of competing firms. Setting of lower prices assists the new entrants to penetrate the market and quickly acquire a huge market share (Pride and Ferrell 2007). Therefore, in Australian retail grocery market, the new entrants need to adopt penetration pricing strategy so as to successfully enter the market. The new entrants need to set their prices below those of the major retail grocery chains, which are vertically integrated. The strategy can be represented by a 2x2 pay off matrix as shown below. Rows represent strategy for new entrants, while columns represent strategy for existing vertically integrated firms. Each cells shows what happens if the players choose the two strategies. The first digit in the cell is the payoff for new entrants and the second digit is the payoff for existing firms. In the matrix, the top left cell displays what happens if both players choose high price, that is, no one will win. The top right cell shows what happens if the new entrants choose high price strategy and the existing firms choose low price strategy, that is, the existing firm will win while the new firms will lose. The bottom left cell shows what happen when the new entrants choose low price strategy while the existing firms choose high price strategy, that is, the new entrants will win. Lastly, the bottom right cell shows what happens when both the new and existing firms choose low price, that is, they will both lose. References Baker, J. R 2010, Implementing Value Pricing: A Radical Business Model for Professional Firms. John Wiley & Sons Bangkok United Nations Asian and Pacific Development Institute, 2003, A Glossary of Some Terms Used in Development and Planning. Abhinav Publications Barthwal R 2007, Industrial Economics: An Introductory Text Book. New Age International Bernanke, B 2003, Principles of Microeconomics. Gans, S. J. & King, P. S 2004, Australian Economic Review Policy Forum: Competition Issues in the Australian Grocery Industry, Vol. 37 No. 3, pp. 311–16 Grant, S & Vidler, C 2003, Heinemann Economics A2 for AQA. Heinemann Harrigan R. K 2003, Vertical Integration, Outsourcing, and Corporate Strategy. Beard Books Jurevicius, O 2013, Vertical Integration - What is it? Pride, M. W & Ferrell C. O 2007, Pride-Ferrell Foundations of Marketing. Cengage Learning Zecchini S n.d, GLOSSARY OF INDUSTRIAL ORGANISATION ECONOMICS AND COMPETITION LAW< http://www.oecd.org/regreform/sectors/2376087.pdf> Read More