Competition in Australian Groceries Market - Essay Example

Competition in Australian groceries market Introduction The Australian retail grocery market has in the recent past been condemned for the rapid increase in the number of processed products as opposed to fresh farm products. The role of competition in the grocery sector was pointed out as one of the causal factors in the debate. The Australian Competition and Consumer Commission approximated that in Australia, Woolworths and Coles accounted for almost 70 percent packaged grocery sales and 50 percent of fresh food product sales. This paper seeks to evaluate the groceries market in Australia by employing microeconomic principles. Is the retail grocery market in Australia a perfectly competitive one? Reasons and implications to consumers Perfect competition is delineated in economic theory as market situations whereby there are no large participants in the industry who have the market power to enable them set the prices of homogenous goods (Nicholson, 2005). Due to the fact that the conditions of a perfectly competitive market are very strict, there are, if any, a small number of such markets. Perfect competition acts as a standard against which imperfectly competitive markets and real-life are measured (Nicholson, 2005). In general perfectly competitive markets exists whereby each participant in the market is a price taker and the prices of the goods are not in any way influenced by the participants buying or selling such products (Mas-Colell, et al., 1995). It is apparent that the retail grocery market in Australia is not a perfectly competitive one. One major reason as to why the market is not perfectly competitive is the fact that there different firms which has the capacity to reasonably differentiate themselves and gain economic returns. These firms, which include Coles and Woolworths supermarkets, though selling homogenous products, employ various strategies to enable them maximize their profits. One characteristic of a perfectly competitive market is that there are infinite sellers and buyers (Mas-Colell, et al., 1995). Infinite suppliers have the willingness and capacity of supplying goods at a specific price, and infinite buyers also have the capacity and willingness to purchase all the goods at a certain price. This does not exist in the Australian retail grocery market. Due to the existent of various retail grocery stores which sell closely related goods, buyers have the choice to switch between different sellers in case of increased prices of the products by other sellers. On the other hand, the prices of goods set by the suppliers are determined by various factors but not the degree of competition in retail grocery markets. Such factors include high production costs, increased domestic and global demand, and adverse weather conditions (ANRA, 2009). This means that suppliers have the willingness and ability to supply goods at a particular price when these factors are considered. Another reason as to why the Australian grocery retail market is not a perfectly competitive one is the fact that the firms operating in that sector are not price takers and this is another characteristic of perfectly competitive markets (Nicholson, 2005). As discussed above, the prices of goods are determined by the forces of supply and demand which are also influenced by a number of factors. As a result, retailers price their products depending on the prices of their suppliers. This leads to diversified prices for homogenous products in the retail stores (ANRA, 2009). However, in order to solve the issue of high prices in the grocery market, the ACCC has introduced unit pricing and grocery option price inspection (ANRA, 2009). This encompasses a compulsory nationwide-steady unit pricing system to be established and this will relate to standard grocery goods which are sold by key supermarkets such as Coles and Woolworths, both in print advertisements and in in-store price labels. Perfectly competitive markets are also characterized by zero entry and exit barriers (Nicholson, 2005). This means that it is fairly easy for firms to get into or leave this type of market. Nevertheless, this is not the case in Australian retail grocery market. There exist barriers to entry for new retail grocery stores in Australia. This is what has caused the high competition between the few firms which operate in the grocery sector. This is deemed to affect the consumers as few firms operating in the market have the capacity of setting prices which will yield them high profits. The ACCA however, suggested that the competitive environment in the Australian retail grocery market could only be improved if barriers to entry are reduced (ANRA, 2009). These include planning objection procedures which impede or discourage new entry and/or the terms of leases included in the MSC which hinder store managers from letting space to rival retailers, or which offer commercial deterrents to them if they do so (ANRA, 2009). The ACCC suggestion would improve the competition in the grocery market and this would be an advantage to the retailers. The fact that the Australian retail grocery market is not a perfectively competitive one has various implications to consumers. For instance, the fact that there exists entry and exit barriers from the market means that there may be few businesses operating in the market and they have the capability of setting high prices which will offer them maximum profits. This may also affect the ability for consumers to switch from one retailer to the other. This is evidenced by the fact that, these sellers may be selling their products at almost the same prices. Furthermore, the fact that these grocery stores are not price takers means that they will also set prices on the basis of other factors which include the forces of dead and supply, and production costs among others. It is true that consumers will benefit more if the grocery stores are perfectively competitive rather than workable competitive. Concept of workable competition and reasons why it is relevant in this market Workable competition is an aspect that arises from the examination that, given that perfectly competitive markets do not exist, then theories and models founded on it do not offer consistent guides for competition policy. Workable competition has been defined as a market situation whereby there exists a high level of monopolistic power although there is adequate rivalry between near monopolies which is meant to protect the consumers from monopolistic abuse, the objective being to make competition workable rather than perfect (Khemani and Shapiro, 1993). The ACCC 2008 report revealed that the Australian retail grocery market is workably competitive (Bowen, 2008). It is apparent that Woolworths and Coles are the main supermarket chains in Australia and although they compete on prices, the report revealed that the competition is not as vigorous as it should be (National Competition Policy, 1993). According to the Australian Competition and Consumer Commission in Australia, Woolworths and Coles accounted for almost 70 percent packaged grocery sales and 50 percent of fresh food product sales. This reveals some characteristics of monopolistic power in terms of sales and prices. The report put forth that Australian consumers could considerably benefit if Woolworths and Coles faced further competitive threats from new entrants who could encourage better aggressive pricing strategies (Bowen, 2008). The ACCC pointed out that the retail prices rivalry is keenest in linkage to: Goods which are known by the supermarket stores to be employed by buyers to evaluate value, and the kinds of goods sold by ALDI, was found to be a major driver of amplified rivalry in product lines and geographic area where it operates (ANRA, 2009). Significantly, the ACCC pointed out that the degree of competition in the Australian retail grocery market has not been a considerable contributor to the inflation in food prices. The increased food prices have been driven by a wide range of factors which include amplified production costs, high domestic and worldwide demand, and adverse whether conditions. These findings are only consistent in a workable competitive market (ANRA, 2009). Generally, this means that there exist various businesses which sell closely associated products and buyers have the capacity and willingness to switch to other alternative suppliers. Some of the conditions that are employed in judging whether a market has workable competition include: the number of companies should be large enough as permitted by the economies of scale, advertising should be instructive, and there should be low promotional expenses (Khemani and Shapiro, 1993). These are some of the indicators which can be used to assess whether there exist workable competition in the Australian retail grocery market. It is true that Coles and Woolworths are the two major retail chains in Australian. In addition, they are the market leaders in terms of market share, and sales. This has been contributed by customer loyalty which has a result has reduced on promotion expenses. Furthermore, the firms’ advertising strategies can be termed as informative and efficient. Such strategies focus on educating the consumers regarding benefits of the products, ingredients used and where they can obtain such products which add value to their lives. Vertical integration and its implications for any competitors in the retail grocery industry In microeconomics, the aspect vertical integration illustrates a management control style (Conlin, 2007). Vertically integrated firms in a supply chain are usually connected by a common owner. Generally, every member in the supply chain manufactures a diverse product and these products then merge to satisfy a common want or need. The use of vertical integration is deemed to promote efficiency and financial growth in businesses. Vertical integration is defined as the level to which companies own their upstream buyers and downstream suppliers (Machosky, 2006). There are three types of vertical integration which include upstream (backward) vertical integration, downstream (forward) vertical integration and balanced vertical integration (Conlin, 2007). A firm exhibits upstream vertical integration when it has the control of the subsidiaries that manufactures inputs employed in the production process. Downstream vertical integration on the other hand exists when a company controls its retailers and the distribution centers whilst the control of all these components is what is termed as balanced vertical integration (Machosky, 2006). It is apparent that the Australian retail grocery chains are vertically integrated (Main, 2011). This is evidenced by the fact that such major chains like Coles and Woolworths controls their retailers where there products are sold, and their distribution centers. The fact that these chains are vertically integrated has various implications for any competitors in the retail grocery industry. Evidently, vertically integrated firms enjoy the benefits of economies of scale. Nevertheless, this results to low competition between firms. This is contributed by the firms’ capability to monopolize the markets by market foreclosure throughout the chain (Machosky, 2006). The existent of monopolistic characteristics or market monopolization means that there are high entry barriers for any new entrant to the grocery industry. Furthermore, one of the benefits of vertical integration is that vertically integrated firms experience lower costs of transaction (Conlin, 2007). It is apparent that transaction costs are one of the factors that are employed by firms while setting the prices of their products. In this case, the major players in the retail grocery industry (Coles, Franklins, and Woolworths) can set low can set low prices for their products, and still maximize on their profits, compared to those of their competitors (Commonwealth of Australia, 2009). The competitors on the other hand may suffer losses if they try to compete with these key players by setting low prices. The key players in the retail market deal directly with the suppliers whilst the competitors are usually supplied by wholesalers. The fact that the vertically integrated structure of the key players is geared towards attaining highly effective distribution systems, with advanced technologies which enable the commodities to flow efficiently from the suppliers to the final buyers posses a major threat to the competitor firms (Commonwealth of Australia, 2009). These firms must rely on associated systems for both ordering and distribution which may result to delays thus inconveniencing the consumers. Due to the nature of the retail grocery industry in Australia, a new entrant in this market requires to use an effective entry strategy in order to emerge successful. In this case, the best strategy is through acquisition. This means obtaining control of a corporation by purchase, stock or exchange (Lymbersky, 2008). Presumably, it is more beneficial to take over the operations of an existing firm rather than entering a new (Lymbersky, 2008). Comparison between major chains and independent sectors References ANRA (2009). Grocery competition – just how competitive is our grocery sector? Retrieved from http://www.anra.com.au/policies/grocery-competition.html Accessed September 21, 2011. Bowen, C. (5 August 2008). ACCC Grocery inquiry press conference Melbourne Commonwealth parliamentary offices. Retrieved from http://www.dpm.gov.au/DisplayDocs.aspx?doc=transcripts/2008/039.htm&pageID=004&min=ceb&Year=2008&DocType=2 Accessed September 22, 2011. Commonwealth of Australia. (2009). The retailing sector. Retrieved from http://www.aph.gov.au/senate/committee/retail_ctte/report/c02.htm Accessed September 22, 2011. Conlin, J. R. (2007). The American past: A survey of American history. Thompson Wadsworth. 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