The Halo Effect: Round Two

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 🙂

  • Kimble

    Do we as consumers really want this sort of Walmartisation in NZ? Are there costs beyond our individual sight that would outweigh the benefits of slightly lower prices and improved convenience?

  • Matt Nolan

    Any costs to the individual consumer will be taken into consideration by the individual.

    People who do not like the ‘idea’ of a large corporation will always have smaller, more expensive ’boutique’ firms to shop at. What I found interesting when I was working at the Warehouse as a student was how many anti-capitalism types would come in and buy products there. Obviously the cost savings were sufficient for them to forget about their ‘morals’.

    Now there are other social costs, as mentioned in

    Whether we want these more inefficient firms to be shut down as a result of our consumption decisions is a value judgment. If government cares about small and relatively inefficient local businesses more than the consumers of that product, then they should stop such mergers.

    Now in your question you say ‘beyond our individual sight’ I can take that to mean two things:

    1) The way the products are put together, so there is some health risk, etc
    2) Predatory pricing

    In the first case we always hear about bad multi-nationals with bad products, as local retailers are stuck in the society and are more responsible about the quality of their products. However, this will be incorporated in the price we as consumers pay, we know that there is some risk. Also, local retailers often sell a load of crap for higher prices, I know that was the case in Otorohanaga.

    Predatory pricing requires barriers to entry and the level of effective competition. Barriers to entry may seem large in the super/mega-market industry, however this industry many different product types. At the product level competition can be fierce with effective competition from all over the show (butcheries, dairies, smaller retailers, etc). Entry into many of these smaller industries is not so difficult, and so the only constraining factor comes from cost (firm and transaction) advantages for the incumbent superstore (economies of scope and scale).

    However, many of these cost advantages are disappearing with the appearance of internet shopping. Also as NZ is small, it is always possible for large foreign firms to enter the market if there are supernormal profits hanging around. As a result, predatory pricing does not seem to be a risk.

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