The Warehouse merger

So the commerce commision has released documentation on their refusal to let Foodstuffs or Progressive buy the Warehouse. They believe that the merger would not influence the general merchandise or wholesale foods market, but would negatively influence supermarket competition.

Do you think that a merger would negatively impact supermarket competition, and if so how?

It is important to note that one of the significant factors behind the increase in the value of retail sales in the past few months has been rising supermarket prices. But is this the result of a lack of competition, or a result of the success of the Warehouse grocery chain (given that the Warehouse sells their grocery products at a higher price).

  • agnitio

    Given that there are only two Warehouse Extra centers currently operating and that they price somewhere in between the full service and discount brands of food stuffs and progressive I think it’s a bit of a leap to suggest that the warehouse’s entrance into market for groceries is driving the increase in supermarket prices.

    The competition issues is interesting. If a merger doesn’t happen and the warehouse extra format is a success then competition will increase which is a good thing. Thus on that grounds, allowing a merger to go through is essentially eliminating possible future gains from having another major player in the market. On the other hand if the merger does go through, the combined firm will probably take one of two actions: kill off the warehouse extra project and continue to tacitly collude with the other firm (which seams to be what the commission is assuming will happen), or it could continue with the warehouse extra program.

    If the combined firm continues with the warehouse extra stores,I think that allowing the takeover to happen is a good thing as the warehouse extra would be much more efficient in the hands of one of the supermarkets because it would be able to obtain much better supply deals for groceries from leveraging off its large parent.

  • rauparaha

    agnitio’s comment is interesting: he suggests that a merger might allow the Warehouse to leverage off the parent supermarket chain to get better supply deals. That may be treu, but is it necessarily a good thing from the point of view of the Commerce Commission? Cheaper input prices don’t necessarily translate into better deals for consumers and the increased profits for the merged firm must be weighed against the potential loss of competition and the harm that would cause to consumers.

    Economists often talk about welfare as the sum of consumer surplus and firms’ profits; however, governments seem to weight consumer surplus higher than profits. This seems to be a case where the Commerce Commission has done the right thing for consumers. Whether it is welfare improving in an economic sense is another question…

  • Matt Nolan

    I think I agree with rauparaha. If we read the commerce commision reports (from the supermarkets and from Commcomm themselves) we see that this merger isn’t an issue of wholesale competition, in fact the Warehouse has very little presence in the wholesale grocery market. We see that this is an issue of retail end competition. The commerce commision is fantisising that the Warehouse will turn into a Hypermarket.

    The real question to me is, will the merger increase the speed with which a hypermarket appears in NZ (eg by turning progressives into a walamart equivalent) or is the Warehouse the only player that could commit to creating a firm in the hypermarket type structure.

    Also note that a hypermarket is only preferable if increasing returns to scale exist, would increase returns to scale exist in a market like NZ’s, which is only a 100th the size of the US market?

  • agnitio

    I think the main question is actually whether or not hyper markets and supermarkets operate in the same market. If it can be proves that hypermarket is actually a separate market than groceries, the merger should precede as competition in the hypermarkets won’t be reduced by the merger. market definition is the key point I think the appeals will be based upon

    Sorry if I have been misunderstood, I’m not trying to make arguments about the effect of merger on the wholesale market, an argument there would have to be along the lines of a merger would increase the market power of the merged firm int he wholesale market which the commerce commission has dismissed as matt pointed out. What I was trying to point out is that woolworths and foodstuffs have market power in wholesale the warehouse doesn’t, so like rauparaha pointed out, if the firms merged the the warehouse would have benefit from that market power int he form of lower input costs, which would allow it to be a more effective competitor as it would have to cost advantage relative to the case where the merger didn’t go through.

  • Matt Nolan

    Interesting. The way I understand it is that the the wholesale market the Warehouse faces is a different market to the wholesale market that the supermarkets face, except (as agnitio points out) in the grocery market. It is true that allowing the Warehouse to merge would allow cost savings for the Warehouse grocery section (as pointed out in the foodstuffs report). However, I don’t think it would significantly influence the market power of Foodstuffs or Progressives in the wholesale market, as the Warehouse grocery section is still so small. In fact, if Progressives or Foodstuffs buys out the Warehouse, they would likely shift the supermarket operation to be under their name.

    I am sure that supermarkets and hypermarkets operate in the same market, as hypermarkets are simply are supermarket and a department store put under the same roof to reduce the transaction costs of consumers. Progressives main point is that it wants to broaden into department stores, but I think even they were not thinking about establishing a hypermarket.

    The real question for we is if a hypermarket is feasible in NZ, with our small population. Hypermarkets take advantage of increasing returns to scale, and possibly returns to scope (tenuously). If it is feasible, and if the Warehouse is going to provide that medium is a reasonable timeframe, then the choice to prevent a merger may make sense.

  • agnitio

    Let me equivocally state that I don’t think the merger will change the balance of market power in the wholesale market, I’m just pointing out that the warehouse will have access to lower grocery prices if it merged because the two bidders already have market power.

    I’m not convinced that they operate in the same market. Hypermarkets offer a different “good” or “service” than supermarkets. Because they lower transaction costs to consumers they would be able to implement a SSNIP without losing demand as long as that SSNIP didn’t outweigh the benefits of reduced transaction and travel costs from being able to purchase everything at one store.

    If Hypermarkets rely on returns to scale then surely they are much more likely to be a success if they are able to draw on the scale that food stuffs or progressive have in the wholesale market.

  • Matt Nolan

    Firms can offer a different ‘good’ and still be in the same market, its monopolistic competition. In this case we have firms selling differentiated ‘grocery goods’.

    I agree that a hypermarket will be able to extract some of the surplus from the reduction in opportunity cost, however it would be constrained by the prices set by the supermarket competitors. Firms in monopolistic competition are allowed to charge different prices after all. In a sense we can see this in the fact that the Warehouse is able to sell groceries, even though they sell them at a higher price than the supermarket.

    I agree that a hypermarket would require access to a large wholesale network equivalent to that owned by foodstuffs or progressive. That is why I’m not particularly keen on the idea that the Warehouse will become a hypermarket by itself.

    I think there is an argument that a grocery firm from outside the country might buy-out the Warehouse, and with its connections to the wholesale market, make it a competitive hypermarket. This could occur if the Warehouse joined either foodstuffs or progressive, however that way of achieving a hypermarket would lead to a reduction in competition for grocery goods.

  • agnitio

    All interesting points. The fact that you have doubts over the ability of the warehouse to compete as a hyper market without access to scale in the whole sale market suggests that without being taken over by a big firm that has scale in the wholesale market it would be an ineffective competitor. The fact that allowing a takeover to happen would allow the hyper market to be effective suggests that not letting the takeover happen would actually decrease effective competition 🙂

    As a quick aside I think it’s important to note that the warehouse only charges higher prices than budget brands of progressive and wool worths, it is still undercutting the premium brands prices.

    I think the focus should be more about effective competition rather than simply the number of firms operating in the market.

  • Matt Nolan

    I don’t believe that not letting the takeover happen will decrease effective competition, I just don’t think the Warehouse will enter the market in a lot of regions. I just think the commerce commission has over stated the case that the Warehouse will become a hypermarket. Unless a large overseas supermarket chain purchases the Warehouse, I have serious doubts that the Warehouse extra model will succeed.

    I agree that the focus should be on effective competition, and that is where the commerce commission and the two supermarkets differ. The two supermarkets believe they are playing a bertrand game, and so prices are being kept down (i’m actually looking at some data to do with that now, and so far it seems like a fair case). However, the commerce commission believes that the two firms are extracting rents, and that the introduction of a competitor will lower prices.

    However, the commerce commission also thinks that the only way we can have more competition is if the Warehouse remains, as it already has established infrastructure and a brand name, things that a new competitor will find difficult to establish.

    I’m suspicious that maybe there are other players that the commerce commission wants to take over the Warehouse, it will be interesting to see how that unfolds.

  • agnitio

    The interesting part about that is I seam to recall that in their decision they said something about how they didn’t think any foreign buyers were interested in the warehouse, but I could just be imaging things.

    I think if they did merge, the warehouse brand would remain and be used to compete against which ever firm missed out on taking it over

  • Matt Nolan

    Progressive said that they would use it to expand dick smith electronics and get more involved in merchandise sales. Foodstuffs said they would let it keep running as a separate business, but would develop the Warehouse stores in Auckland.

    No matter who takes it over the Warehouse brand will stay there. The commission said in the report:

    “E13. The acquisition would foreclose the potential for The Warehouse to be used by any other independent party as a springboard to entering the market.”

    That is the situation I can see the commission envisaging when they talk about a future hypermarket.

    I think another issue involves how the two supermarkets interact. When they let Progressive and Woolworths merge it was because Foodstuffs was a dominant player in the Wholesale and retail markets. Now that they are on even terms I don’t think the commission wants to give either of them an edge, which a merger with the Warehouse may give.