Countdown and wholesalers: Are consumers the ones benefiting?

There has been a bit of discussion about Countdown hurting wholesalers to get prices down, flexing their muscle shall we say (here and here).  The Commerce Commission is concerned about this and is investigating.

Via Twitter I noticed that the concerns about supermarkets being bullies has led to an increasing desire to do something about supermarkets in general in our papers.

Now having a government run supermarket enter and then arbitrarily mess around with the price and availability of goods and services “for our own good” makes me throw up in my mouth a little – honestly the anti-obesity rhetoric thrown in the piece is beside the point, and shows how a desire to “do something” can be taken too far.  Note:  A lot of the suggested policies such as “removing GST” or “adding vouchers” exist without randomly owning a supermarket, the point should be actually asking if they are a good idea in the first place – a point that seems to escape our columnist, unless she believes the analysis is well covered off by merely going ‘obesity is bad man’.

But there is a broader point here.  For some reason the author seems to have this vision where, given her policy suggestion, the wholesalers win, the government (taxpayer) wins, and the consumer wins – and some baddies in Australia lose somehow.  This view stems from a presumption that there are massive issues of competition.

Of course the competition issues are important, hence why the Commerce Commission rolls around looking at this industry!  However, before we just assume this I think it is interesting to also think about how entry by a big player failed, namely look at the Warehouse Extra saga (here, here, and here).  If the Warehouse couldn’t manage to break into the market, perhaps a duopoly IS competitive.  [Note:  Supermarkets is one place where I would like more of a focus on regulation – whether they are competitive is a big issue, and an important one.  But again, this becomes an issue of appropriate regulation – given there are sufficiently large firms around that can enter, I’m not buying the idea the government needs to enter due to “barriers to entry”.  This is also definitely not a reason to have the government fighting obesity through its very own supermarket!!!]

In that case, there are winners and losers from changes in policy – even if we ignore these Australian’s that we don’t seem to like, with all their dirty foreign investment and integrated supply chains 😉 .

Let us think about Progressive vs Foodstuffs a bit here.  If both organisations are thumping around their wholesalers, and the duopoly is competitive (due to the organisations selling a homogeneous product where consumers have good information about prices), then the lower cost for products is PASSED ON TO THE CONSUMER!

If Progressive is bullying, and Foodstuffs isn’t, then Progressive has a lower cost structure than Foodstuffs.  As a result, Progressive can bid down prices, but is likely to keep a large part of the surplus to themselves.  In this case, Foodstuffs is squeezed, and may lose market share, so they have an incentive to bully their wholesalers as well!

If neither firm bullies their wholesalers, they both just charge higher prices, and the consumer pays the difference.

So here is the thing.  We feel bad for the wholesaler being bullied by these big companies – understandably!  However, if we look at the issue more broadly, their bullying activity may well be reducing the price of some goods and services for the consumer.  If we force them to give up their bullying, the consumer then pays a higher price.  There are always trade-offs, let’s at least make a slight attempt to remember that – instead of pretending that government ownership will somehow come in and make everything magically better.

Sidenote:  What is with all that tripe in the article about the “profit motive” and being “freed from” it.  Isn’t this the same “motive” that ensures that supermarkets stock what people desire, in a convenient place, and with sufficient variety.  The key idea should be to use regulation to prevent excesses of market power and rent seeking, and price in things that aren’t captured in trade between supermarkets and consumers – not to undermine these benefits through excessive managerialism.  This was the key benefit from the reforms – with the shift from direct government management to a broad regulatory framework which allowed voluntary trade we went from a country with very little variety in the goods and services available, to one with huge variety, which is massively valuable given that people are very different in terms of tastes and preferences.  Urg, I despise the untransparent nature of this anti-choice rhetoric we get sometimes …

Update:  Dim Post comments here, and I reply here.

 

 

 

  • Mike Graham

    “then the lower cost for products is PASSED ON TO THE CONSUMER!”
    Some of the lower cost will be passed on to consumers, but I’m sure that the retailer will keep some margin as well. There needs to be consideration of the longer term view – if suppliers are being squeezed then they cannot pay their employees what they are really worth etc and so we end up with cheaper goods, but lower wages – not a great way to build a strong economy.

    • “Some of the lower cost will be passed on to consumers, but I’m sure that the retailer will keep some margin as well”

      This depends on how “similar” the goods the supermarkets sell is. In the extreme case, where the supermarkets sell exactly the same stuff and are right next to each other then the entire surplus is passed onto consumers. Given supermarkets are one industry that is pretty close to this extreme case – then if both firms are doing this, a lot of the surplus is indeed being paid over to consumers.

      A way to think about this, if you are happy with looking at a little bit of game theory, is to ask how close the duopoly is to a “Bertrand duopoly” (http://en.wikipedia.org/wiki/Bertrand_competition).

      “If suppliers are being squeezed then they cannot pay their employees what they are really worth etc and so we end up with cheaper goods, but lower wages – not a great way to build a strong economy”

      Supermarkets build long term relationships with their wholesalers, but because they are often a single buyer (monopsony) they can extract all the surplus from what is going on. This isn’t just an issue in NZ, it exists right around the world.

      Mixing it up with wages, investment, and a “strong economy” is a touch beside the point – we have to ask exactly what it does to investment incentives for this to happen. As supermarkets do have a long-term relationship with wholesalers, and wholesalers still earn enough to stay open, I don’t buy this argument in this circumstance!

      So given it is not an efficiency/growth argument, instead our key concern is one about supermarkets using their market power unfairly. Of course, given it is a duopoly it may be supermarkets using market power to the benefit of consumers – so we have consumers bullying wholesalers with the supermarkets an intermediary (consumers as a group can be viewed as the monopsony)! In this case we can say that it isn’t fair, and intervention to help wholesalers is – but let us be honest that these actions then imply higher costs for consumers.

      • pete

        Any duopoly where the players are going concerns is going to be a long way from a Bertrand duopoly. Based on that Wikipedia link, it looks like the supermarkets would charge the monopoly price.

        • Price collusion you say – remember there are two things here:

          1) The threat of entry,
          2) The ability to sustain collusion (observability of prices, capacity setting, the return in different parts of the economic cycle, ability to communicate)

          In the NZ context we have at distinct threat of entry by a big player, with the added impact of having relatively easy regional entry at the retail level – the key difference, and the main impediment to having “more firms” is the efficacy of the supply chain! This in itself provides a roof on the prices supermarkets can charge well below the monopoly price.

          Furthermore, we have an incredibly high rate of floor space per consumer, which is a definite sign of firms using high levels of capacity to “commit” to competition (this is called strategic commitment, and is a form of dynamic competition that does lead to lower prices for consumers – but overinvestment by firms).

          With a relatively homogenous product, high levels of capacity commitment, and threats of entry from the Warehouse and overseas supermarkets it isn’t terribly surprising to run into Shamubeel’s fact – that net profit margins in the industry are small.

          We would all love supermarkets to charge less, and if we had greater scale (larger cities) they would! Furthermore I am personally a fan of the idea of having the CC watch supermarkets – a duopoly is something that we need to be careful of

          But given the low net margins, and the logic of supermarket competition given good types and the nature of dynamic competition, arguing that instituting a policy that will increase the unit cost for supermarket (by lifting returns to those further up the supply chain) would not be passed onto consumers does not pass the smell test!

          • Vanilla_Thrilla

            The threat of entry?

            So you’re saying an entrant could easily absorb all the upfront RMA costs and establish in short order a nationwide supermarket chain of sufficient size to enable it to obtain the necessary ecos of scale in logistics and sufficient buyer power over suppliers to enable it to do battle with the existing duopoly? This being a duopoly that has reasonable density coverage over all existing urban areas and, you suggest, has committed to excess capacity.

            And there’s a constant threat of entry. Really?

            As for the homogenous product and observability of prices, one could suggest that facilitates collusion within a duopoly rather than prevents it.

            Sure, the idea of a govt-run supermarket is as harebrained as making existing supermarkets pay their suppliers higher prices. But are you trying to tell us this market is effectively competitive and that there’s nothing to see here?

            • There is undeniably a threat of entry – the Warehouse attempted given their scale (but the big issue there was the supply chain) and at a regional level there are competing firms. However, in both cases the supermarkets have the advantage of there well developed supply chains – as a result, any surplus they make comes directly from this. Threat of entry isn’t a catch all to say the market is competitive – and I in no way hold the view that it is completely competitive – it just tells us that trying to treat the industry as a form of monopoly without reference is going to exaggerate the degree of market power.

              “As for the homogenous product and observability of prices”

              Observability of prices does imply greater scope for collusion, yes – that was the direction I was linking it in my comment. And given the amount the two firms invest in observing each others prices this is an important thing to keep in mind. However, I also noted other factors that do influence collusion – and that fact that we have overinvestment in supermarket space is one of the clear indicators against it.

              There is no way this post is suggesting the market is competitive in an ideal sense. And as I note in the post, I would like to see the Commerce Commission look at supermarkets, I always have. But the assumption that pushing in another supermarket would be the best, or even a positive, way to deal with any perceived uncompetitive behaviour misses the point of trying to analyse what it was.

              Honestly I am amazed how much people seem to take it as given that since we have a duopoly it HAS to be anti-competitive – this question can only really be answered by having the Commerce Commission look into the details in full.

              In the post I said that the Warehouse’s inability to enter was a sign that “perhaps” the industry was competitive – this was supposed to be a little contentious, but was also a note that the Warehouse’s inability to enter had led me to change my own priors. Until the Warehouse tried and failed, and Tesco said they wouldn’t enter because of the low profit margins in NZ, I was convinced the industry was uncompetitive – now I simply leave my mind open.

              • Vanilla_Thrilla

                I guess we disagree regards how serious the threat of entry actually is, I don’t give the Warehouse experience the same weight you do for various reasons I wont go into here, but I appreciate you were being a little contentious – always something to be encouraged IMO ;-). And I wasn’t aware of Tesco’s comments, which perhaps would give me greater reason to perhaps adjust my priors, which are influenced to some extent on ComCom’s previous position.

                Perhaps the supermarket sector is more like the market for domestic flights. Competition in some geographic areas but not others, large sunk costs (RMA) and economies of scale that effectively block a proper 3rd entrant, but nevertheless still with some fringe competitors (vege stores, dairies or farmers markets playing the role of buses). Whilst obviously not a totally anti-competitive, monopoly type market, we are to some extent likely suffering once again from our small population and low population density.

                As for whether ComCom can help, they are constrained by the law as it currently stands. However, that’s probably a matter for another day…

                • “I guess we disagree regards how serious the threat of entry actually is, I don’t give the Warehouse experience the same weight you do for various reasons”

                  This is a fair call, and is something I definitely could be overselling here. It is one of those areas where my priors can easily be swayed by new evidence 🙂

                  “which are influenced to some extent on ComCom’s previous position”

                  Indeed – the fact the CC has indicated that they would not have allowed the merger if they were following current regulatory standards is a huge point, and one I definitely am not disagreeing with (given they are the experts). This is part of the reason I’m concluding everything by saying I would like them to look at it 😛

                  “Whilst obviously not a totally anti-competitive, monopoly type market, we are to some extent likely suffering once again from our small population and low population density.”

                  Indeed, low population density making it difficult to have real competition in industries that have large scale – this type of argument I buy, but of course if we go down that track the entry of a government supermarket doesn’t in of itself make sense.

                  Actually, it is a damned interesting issue. I remember when Woolworths entered my hometown, it significantly undercut the competing stores. But now it is really the only supplier left. Do we view there entry and initial pricing as predatory pricing? In what way does effective competition really hold in a rural town where competing supermarkets are still 30 mins away?

                  “As for whether ComCom can help, they are constrained by the law as it currently stands.”

                  Indeed. Perhaps the concern about wholesalers will inadvertently lead to greater focus on the industry from the regulatory angle?

                  It piggybacks well on the Productivity Commission discussing the importance of giving the Commerce Commission more scope (and in that case hopefully a lot more resourcing) to deal with competition issues in “service sectors”!

  • Shamubeel Eaqub

    Just looking at prices is a little fraught. Another way to look at is to ask are they making super normal profits. According to the Woolworths annual report (pg 111, http://www.woolworthslimited.com.au/icms_docs/137198_Annual_Report_2013.pdf), net profit margin was 4% of sales in 2013. At face value, profiteering/anti-competitive seems hardly the issue – rather it seems people are asking if the sector is too competitive? I wonder if they would welcome less competition, if it meant higher prices for their groceries.

    • A very fair point – as I sort of point out in the post, people need to keep in mind that by undermining the monoposony benefit from dealing with wholesalers this implies higher prices for consumers! You point reinforces that I believe.

      It also helps to explain the hard time the Warehouse had in trying to enter the market, even given their special starting point!

    • VMC

      I think this 4% statistic can be misleading. If the supermarket paid for the items then sold them at 4% margin, that would be one thing. But, if they dont pay until after the goods are sold, then the wholesaler takes all the risk, in fact its offering a 0% interest loan.

  • Paul Walker

    I have to say that as a consumer I want the supermarkets to play tough with their suppliers. As Adam Smith pointed out more than 240 years ago that “Consumption is the sole end and purpose of all production” and that the measure of a country’s true wealth, is the total of its production and commerce. That is, a country’s wealth is what the people of that country can consume. The great 19th century French economic pamphleteer Frédéric Bastiat wrote, “Consumption is the end, the final cause, of all economic phenomena, and it is consequently in consumption that their ultimate and definitive justification is to be found.” So if the supermarkets are keeping the price of consumption goods down then I say all power to them. The suppliers, firms, are just a way of converting factors of production into the outputs we want, they are an institutional arrangement utilised to achieve the conversion because they are a more efficient at such activities than market transactions, nothing more and we should not enact regulation just to protect them from the forces of competition. Our concern should be with the welfare of the consumer not the producer. I have never understood the mercantilist like obsession with the protection of producers that some people have.

    • I get confused about why people often think we can increase the claim on resources of people within the value chain without reducing the claim on other people at the same time – so I agree with you.

      I think the key thing is people don’t like supermarkets, they offer a big faceless “bad” that makes you pay for “stuff” – so it is naturally appealing to hate on them. As economists, hopefully we can just say “stop for a second, and lets consider this a bit” 🙂

      • John McGee, a student of Aaron Director, wrote that the history of cartels is the history of double- crossing.

  • VMC

    Some interesting points here. Something not mentioned yet is the possibility that individuals in a supermarket are committing a type of blackmail – possibly unknown to the supermarket owner. In which case the rest of us are paying.

    • Why are the rest of us paying? The owner can still view the accounts, and so will see a lower cost structure, and if they are competing that will then get passed on to the consumer.

      • VMC

        If the producer has to pay a middleman (A supermarket employee) a ‘bribe’ to get their good through the door of their local supermarket, then the owner of the supermarket would not know and it will not show up in the official paperwork associated with the transaction. Some of the talk milling around seems to suggest that this sort of thing is widespread.

        • Interesting, so instead of being anti-competitive some supermarkets are just straight out corrupt? It would be in the supermarkets interest to start sacking people if this was the case ….

          • VMC

            Yes – it would be a good idea to move those folk on – if they can be identified. Actually the whole supermarket investigation process should be pretty interesting.

            • Agreed, looking forward to seeing what the CC turns up!

  • deepred

    Why not a TradeMe of groceries? Oh wait, it’s been tried before.

    https://en.wikipedia.org/wiki/Webvan

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