In a previous post we discussed the Halo effect, and how the Warehouse was trying to claim it was their own idea. Since then, the Halo effect has taken on special importance as Woolworths Ltd (Aus) and Foodstuffs decided to appeal the Commerce Commission’s decision to refuse to let one of these firms buy the Warehouse.
Now the Warehouse’s definition of the Halo effect was a little different from the Wikipedia definition. It was:
“Goods as complements: By putting more products under one roof, a firm can reduce the consumers’ transaction costs (or increase their shopping benefit), allowing the firm to increase sales and prices for the initial set of goods. ”
Now both the Warehouse and Foodstuffs have recently stated that, if they purchased the Warehouse, they were at least as likely to create super-centres that provide the Halo effect as the Warehouse would be if it was left to its own devices (*) (*). I can buy this claim from Woolworths, as they originally said that they wanted to set up superstores (they already own Dick Smith and are looking at ways of incorporating that into their supermarkets). The Foodstuffs co-operative did not initially say they wanted to set up superstores (they really wanted to block Woolworth Ltd from expanding), and as a result this new position is not convincing.
Do we believe that Woolworths or Foodstuffs may have the incentive to set up superstores? I don’t see why not. If the Halo Effect does exist, then Woolworths and Foodstuffs are well placed to take advantage of this. In fact, I find it likely that one of these firms would expand into the general merchandise industry, if only to take advantage of economies of scope.
Originally when the Commerce Commission made the ruling to refuse any merger, they believed the loss of the Warehouse would substantially lower competition in the future. Although recent sounds out of the Warehouse have suggested that the Warehouse Extra concept is going to sit on the back-burner as domestic consumption slows, this does not impact on their long-term plan to compete in the grocery market. As a result, if the decision is over-turned it must be because the Commerce Commission made a mistake when it determined that the loss of the Warehouse would hurt the competitive process. This could occur by preventing the development of superstores, or by removing a competitor that could add efficiency to the market.
In its ruling the Commerce Commission used the ‘superstore’ argument as the main reason for rejecting the merger, which will leave their ruling on shaky ground when it comes to appeal. Deep down the reason the commission wanted to stop the merger is because it believes it made a mistake when it ‘let’ Woolworths (NZ) merge with Progressive Ltd. If they had admitted their faults and then said that they believe there should be three competitors, but there are significant barriers to entry which only a large entrant like the Warehouse can circumvent, then their decision might hold.
Update: I just heard from a more competent economist (William Taylor, who posts here) that the high court has reversed the Commerce Commission (CC) decision. In fact, it did so weeks ago. They haven’t given the reasons why they have reversed the decision, it will be interesting when that comes out. My guess is that it had something to do with the current level of effective competition being higher than the CC thought. Still, wasn’t this a fun thought experiment 🙂
Update 2: Seems like the decision isn’t until November 29th, how about that this thought experiment was useful 😉
Update 3: And now the decision was overturned by the high court. Once they release information on why I might write about it 🙂