1.0 EXECUTIVE SUMMARY
This research paper extends my earlier research work into retail supermarket competition, Consumer-first supermarket reform: Consumers, not government, knows how to best meet consumer demand, published in January 2013. (1)
Business models drive lower prices
- The vast majority of supermarkets compete on price and achieve those lower prices through scale, using a high-volume, low-margin business model that allows the fractionalisation of costs.
- Indicatively, competition and scale delivers price reductions of at least 5.03 per cent in comparison to the decade-long trend in Australian food prices, equating to an average saving for Australian workers of nearly $10 per week or $500 annually.
- While modest, 60 per cent of Australians have identified that they are sufficiently price-sensitive to change their supermarket for a 5 per cent discount.
- ALDI achieves scale to deliver lower prices by leveraging its global supply chain and its expanding negotiating power.
- Coles and Woolworths achieve scale to deliver lower prices through having large market shares that delivers efficiencies in supply chains and logistics and negotiating power with suppliers.
- Smaller IGA stores achieve scale to deliver competitive prices through collaboration, using Metcash wholesaling.
- Supermarkets that compete on convenience, quality or location have a lower-volume, higher-margin business model.
- Increasingly supermarkets that can achieve lower prices because of their scale are leveraging it to provide convenience through dedicated stores or those attached to fuel retailers, and quality through dedicated stores and premium offers, to meet a diversification of consumer demand.
- The high-volume, low-margin business model of supermarkets is highlighted on their EBIT to market capitalisation and revenue which varies from 3-7 per cent for the majors, lower than comparable international competitors and other industries.
- Higher profits would require fractionalising increased profits across their high-volume of sales which would make them less competitive.
The market is extremely competitive
- Arguably, Australia now has four major supermarket chains in ALDI, Coles, IGA and Woolworths.
- In a little over a decade ALDI has grown its stores to 300 larger-format options and are increasing at a rate of around 10 per cent per year and has a market share of 2-5 per cent.
- Coles has 749 stores and a new store growth rate of nearly half of ALDI with a market share of less than 30 per cent.
- Woolworths have 883 stores and a new store growth rate nearly half of ALDI, with market share of around 33-36 per cent.
- Metcash has the most retail stores at more than 2,000, with market share of 15 per cent.
- CostCo is a modest competitor with three stores with an expected expansion of 100 per cent.
- Supermarkets compete against each other, as well as fresh food markets, internet retailers and speciality stores.
- Market concentration is part of a longer-term trend as mergers and acquisitions have occurred over decades so supermarkets can achieve the scale to deliver lower prices.
Business models are driven by consumer demand
- Supermarkets primarily compete on multiple grounds including price, range, quality, location, convenience, experience and parking.
- Quality and price are the most important drivers of consumption behaviour. Combined, they reflect a consumer's value proposition.
- Quality is subjective, but price clearly impacts consumption behaviour with surveys concluding 60 per cent of Australians will change supermarkets for a 5 per cent discount and Australians being some of the least loyal supermarket customers in the world.
- The expansion of ALDI has driven innovation and responded to increasing price sensitivity through the expansion of private labelling, that other supermarkets have been able to follow.
- Price sensitivity for Australians is unsurprising with the average household spending between 15 and 20 per cent of their income on food and non-alcoholic beverages.
- Price disproportionately impacts on lower income households and those dependent on fixed-income welfare and pension benefits. They spend around 20 per cent of their income on food and non-alcoholic beverages.
- Further lowering prices will require supermarkets using their scale to continue innovation in their logistics and supply chain to reduce costs, particularly with wholesalers and suppliers.
- Expansion by supermarkets into liquor, convenience stores and fuel retailing is responding to consumer demand and being able to deliver lower prices through their scale with convenience.
- Liquor is a highly competitive business with Coles, IGA and Woolworths owning a number of sub-brands to compete based on price, convenience, range and quality to compete with the remaining quarter of the market that is largely independent.
- Based on industry research data, three-quarters of a supermarket's cost structure is driven by the cost of wholesale purchases.
- Wholesale suppliers are in a competitive position to strongly negotiate with retail supermarkets on price, often enjoying a much higher market share than the supermarkets themselves.
- Based on Productivity Commission data, Australian wholesalers secure a larger margin than those in the United States and Canada.
Regulation drives risk and increases prices
- The regulator — the Australian Competition and Consumer Commission — is increasingly moving toward deciding what choices consumers have, rather than allowing the market to meet consumer demand.
- The ACCC has decided that competition is at a "critical decision point", in practice it is whether market players are allowed to meet consumer demand, or whether the regulator will interfere to achieve non-price objectives.
- Concerns by the regulator about the state of the market, market concentration and market power against suppliers and wholesalers, and market-based barriers to entry can't be made out.
- Competition has increased following the entry of ALDI, and to a lesser extent, CostCo.
- No supermarket has a dominant share in the convenience or liquor market where competition is healthy.
- Consumers want competition to drive lower prices. Lower prices are being achieved through supermarket business models that harness scale.
- There's no evidence that organic evolution of supermarket chains and sites weaken competition.
- The ACCC's requirement that competition is achieved when there are three players in close vicinity is an essentially unsupportable, ambit claim.
- The entry of ALDI, and to a lesser extent, CostCo, show market barriers to entry are low.
- Concerns by the regulator about the state of non-market barriers to entry can be made out.
- There are market and non-market barriers to entry. Non-market barriers to entry through regulation create the biggest obstacles to new competitors and existing competitors meeting market demand, including lowering prices.
- Market barriers in the supermarket sector are high because of infrastructure, stock and supply chain costs; but the expansion of ALDI's 300 stores in a decade shows they can be met.
- ACCC assumptions that they can regulate a more competitive market are based on assumptions of competition, not the reality of market competition.
- Non-market barriers, such as high wage costs and planning restrictions for new sites, carry heavy costs for the sector and are fractionalised across final sale prices for consumers.
- Seeking to regulate the drivers of supermarket business models will increase retail prices for consumers and would reduce the indicative 5 per cent competition and scale dividend.
2.0 ABBREVIATIONS
| ABS | Australian Bureau of Statistics |
| ACCC | Australian Competition and Consumer Commission |
| ACT | Australian Capital Territory |
| Alb | Albertsons (United States) |
| AUD | Australian dollar |
| Car | Carrefour |
| CML | Coles Myer Limited |
| COGS | Cost of goods sold |
| IGA | Independent Grocers of Australia |
| Kr | Kroger |
| MSC | Major supermarket chain |
| OECD | Organisation for Economic Cooperation and Development |
| PC | Productivity Commission |
| Wmart | Wal-mart (United States) |
| Wmart Intl | Wal-mart International operations outside the United States |
| WW | Woolworths |
3.0 INTRODUCTION
Politicians and regulators are increasingly focused on the competitiveness of the retail supermarket sector. Their concerns vacillate between perceptions of absent competition to concerns that there is excessive competition. In either case, there is a victim. In absent competition, prices rise and consumers are harmed. In excessive competition, prices fall and producers and suppliers are harmed, with a feedback loop that when producers and suppliers are harmed consumers are also harmed through lost future competition. Both provide excuses for government or regulatory action, without proper assessment of its unintended consequences.
The policy response is always to try and tax, regulate or legislate for competition equilibrium where producers make healthy profits and consumers pay lower prices. This equilibrium can exist, but as my earlier research work (2) found, it requires the market to decide outcomes, not government and regulators.
The stated objectives of politicians are often naked. Rural and regional politicians want to reign in the market power of major supermarket chains to increase negotiating power and the influence of producers. Every dollar negotiated down by the supermarkets is one less dollar in the pockets of their constituents. But they often conveniently ignore that lower prices for producers are often a consequence of the scale of purchasing and that, like in all industries, lower margins tend to be secured off higher volumes. They also ignore that all their constituents pay those higher prices.
Similarly, the objective of suburban-based politicians, and often government, is to maximise competition to decrease prices for consumers. They seek to do that by regulating perfect competition. But they often fail to understand that competition is built off the decentralised decision making of millions of consumers who vote with their wallet for the goods and services they seek every day. Trying to use the power of government to alter that balance invariably favours one market player over another, and any cost increase is paid for by the consumer.
In either case, politicians are exposed to the full political consequences of their actions and are held accountable. The same does not apply to regulators who seek to manage markets without responsibility for the consequences of their decisions.
The underlying attitude of the Australian Competition and Consumer Commission (ACCC) exemplifies absent responsibility for their decisions. Throughout this year the ACCC has outlined their concerns with the retail supermarket sector and the current state of competition, but concurrently the consumer appears to be missing in their decisions.
This research paper extends my earlier research work into retail supermarket competition — Consumer-first supermarket reform: The market, not government, knows how to best meet consumer demand. This research paper was released in January 2012 to inform public debate about the real consequences of excessive regulation has on consumers in comparison to the promised competition gains.
Since then, regulators have continued to further exercise their muscle on the sector, even as past regulations have been wound back by governments for failing to deliver their promised aims. This paper will extend my earlier work by looking at what is at stake, should greater restrictions by politicians and regulators influence the different business models of supermarkets that provide different product offerings.
The concern is that rather than regulating to provide an attractive environment for investment, the ACCC, with the support of politicians, is seeking to regulate the choices consumers have in the hope it will promote competition. By doing so the ACCC isn't just regulating people's choices, but also the underlying business models that operate in the sector to enable supermarkets to meet consumer demand, such as low prices and convenience.
The focus of this research paper is to analyse the underlying philosophy behind regulation on the retail supermarket sector and what the likely consequences will be. In particular it will assess the business models of supermarkets and how they influence their capacity to deliver for consumers based on the growing diversity of consumer expectations.
4.0 THE ROLE AND PHILOSOPHY OF THE ACCC
The Australian Competition and Consumer Commission is the major national regulator seeking to regulate in favour of competition and fair trading. It achieves this objective by acting as the enforcement agency of the Competition and Consumer Act 2010, whose primary objective is stated as:
"enhanc[ing] the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection". (3)
According to the ACCC it achieves this objective by promoting:
"competition and fair trade in markets to benefit consumers, businesses, and the community. We also regulate national infrastructure services". (4)
It seeks to achieve these objectives through four key goals:
- "Maintain and promote competition and remedy market failure.
- Protect the interests and safety of consumers and support fair trading in markets.
- Promote the economically efficient operations of, use of and investment in monopoly infrastructure.
- Increase our engagement with the broad range of groups affected by what we do".
(5)
Even within these four goals there are a multitude of contradictions and subjective tests that need to be applied by the ACCC and are likely reflected in the individual approach of its Commissioners.
Assessment of "market failure" is a deeply subjective test, considering the contemporary divide between "market failure" and an "undesirable market outcome" is increasingly blurred. Similarly the concept of "fair trading" can be directly at odds with the "interests" of mainstream consumers who are heavily motivated by price and will pay more should the regulator seek to manage market outcomes.
The attitude and influence of individual Commissioners, especially the Chair, will have a heavy influence on how these different objectives are weighted. Recent evidence shows the subjectiveness of that test is now being realised in the retail supermarket sector.
A recent decision by the ACCC to prohibit Woolworths from developing a new site in suburban Sydney on the grounds that it is located close to an already established Woolworths store is a case in point. The ACCC decided it was preferable for Glenmore Ridge consumers to have to potentially travel further to another store within the suburb of Glenmore Park to buy their groceries, rather than allow Woolworths to open another store. According to reports the decision was based on the ACCC deciding three players needed to be present in the market, where there is currently one dominant player with another intending to open a store in 2014. (6)
The decision is a classic example of the subjectiveness of assessing the balance between competition and consumer interest. First, there is no basis to the claim that three market players will deliver greater competition. The claim is essentially ambit. Second, competition cannot be planned and organic growth, with few barriers to entry, allows market players to identify opportunities.
The market responds to consumer interest by providing the goods and services they demand. Woolworths sought to open a new store because they thought consumers would shop there. More importantly, in meeting the demands of consumers they decided that splitting their customer base between two stores was still likely to be beneficial, even though there was a higher cost lay out on their part. If it did not, they incurred the cost of doing so.
The roll out of a new store did not limit the capacity for other competitors to enter the market. ALDI is already developing a new store in the area. Other retailers have the right to develop a new store if they see a market opportunity, including originally bidding for space at Glenmore Ridge.
Instead, the regulator has decided to limit the capacity of a chain to meet consumer demand. According to the ACCC:
"The ACCC concluded that the proposed acquisition would be likely to result in a substantial lessening of local supermarket competition ... [and] An alternative supermarket at the Glenmore Ridge site would stimulate local competition and provide greater choice to residents of the area. Woolworths buying the site would prevent that from occurring." (7)
By removing their right to acquire a site for a new store they've effectively reduced competition and will decrease the acquisition price for the site for a non-Woolworths and non-ALDI competition, leading to preferential treatment, in all likelihood, for Coles or Metcash.
Whether it will lead to greater competition remains unclear considering there are eleven different supermarkets across five major brands in the surrounding suburbs.
The decision is indicative of the subjectiveness of the ACCC's current approach to retail competition. This was outlined by the ACCC's head, Rod Sims, in a June 2012 speech to the Committee for Economic Development of Australia, (8) where he outlined that the ACCC is increasingly moving away from ensuring competition is vibrant for consumer choice, towards regulating the choices consumers have. According to Sims:
"Looking at the ACCC's mergers register, it is true that there are a number of current reviews underway that involve 'small retail acquisitions' in the liquor, grocery and home improvement sectors. While these acquisitions may seem small relative to a global merger of, say, two mining companies, they are important at both the local and at the national level". (9)
According to Sims, the nature of the industry is changing as supermarkets are increasing their market power by purchasing existing retail outlets and bringing them into their brand family:
"This ownership trend benefits from substantial economies of scale and scope in, for example distribution logistics centre and advertising as well as brand promotion.
Barriers to entry for other chains or buying groups to replicate the strong market position of Wesfarmers and Woolworths, are becoming increasingly high. Added to this often are local barriers associated with, for example, access to sites.
When the major supermarket chains (MSC) acquire an independent player the remove an alternative from the market, with potentially a different product range and service offering. This reduces consumer choice as well as, for example, competition generally if the number of players in a local market were to reduce from, say, four to three much less three to two. That competition is unlikely to be replaced by either a chain or a new independent given local and/or national entry barriers". (10)
Sims' approach to retail competition is disappointing. While he acknowledges it may occur, he under-emphasises the role that the removal of a single market player creates for new market entrants, especially when that store meets the unique needs of consumers. His response is to be defeatist and argue that it is "unlikely to be replaced by either a chain or a new independent given local and/or national entry barriers". On the latter point he may be right, but surely, rather than focusing on regulating the choices consumers can have, the role of the ACCC is to find pathways to remove those barriers.
In this speech Sims highlighted five key assumptions that underlie his approach:
"We can be seen to be at a critical decision point" in the nature and structure of the supermarket sector and the role of market players.
[Coles] "and Woolworths already have significant market power in groceries, and may move to a similar position in liquor, home improvement and even petrol with frequent small acquisitions of existing outlets, or indeed, greenfield land sites". (11)
"The ACCC is already concerned about the market structures in the supermarket sector and the continued expansion of Coles and Woolworths relative to the other retailers. While it recognises that growth by the major supermarket chains has bought benefits to consumers as a result of their scale, there is a risk that with only two major national chains, competition between them to offer lower prices and better service will be 'softer' than it might otherwise be."
Barriers to entry for other chains or buying groups to replicate the strong market position of [Coles] and Woolworths, are becoming increasingly high. Added to this often are local barriers associated with, for example, access to sites".
With a number of markets at the state/national level already being quite concentrated the ACCC is concerned to ensure that further acquisitions in local markets do not ultimately lead to retail of indeed wholesale industry structures that may adversely affect the competitiveness of these markets and reduce choice for consumers".
But underlying each one of these arguments are assumptions about the nature and desirable structure of the market from a top-down perspective, particularly in the case of the third point where current competition is weighted against what "might otherwise be". (12)
Considering the weight that these assumptions have on the direction of regulation, these arguments deserve to be tested.
5.0 THE CURRENT STATE OF SUPERMARKET COMPETITION
As outlined in Consumer-first supermarket reform, the data clearly shows that supermarket retailers operate in a highly competitive market in the $81.8 billion sector. (13) However, the extent of that competition is largely dependent on how the beholder seeks to view it.
5.1 RETAIL SUPERMARKET PLAYERS
Common perceptions of retail supermarket competition are that the market is dominated by Coles and Woolworths with the scraps left for other players. There is no single, consistent measure for supermarket competition.
It's regularly argued that Coles and Woolworths control 70-80 per cent of market share. This narrow interpretation is also repeated by the regulator. ACCC Head Rod Sims, has been quoted arguing "with over 40 per cent of the supermarkets in the country in the case of Woolworths and over 30 per cent in the case of Coles — two players with over 70 per cent of the market — people can make their own view of whether it's a concentrated market". (14) Sims' position stands at odds with past inquiries by the ACCC. The ACCC's 2008 inquiry into groceries argued:
"Based on the information available to it, the ACCC's view is that the [major supermarket chains] account for between 55 per cent and 60 per cent of consumer expenditure on grocery items. Woolworths accounts for at least 30 per cent and Coles around 25 per cent. Although each of these shares of retail grocery sales are large for a single company, to say that the MSCs enjoy an 80 per cent share of grocery sales exaggerates the position of the retailers." (15)
Data that reinforces the ACCC's 2008 inquiry claims has been reported by Euromonitor International in 2011 (Table 1). This data shows the market share of Woolworths was 33.4 per cent, Wesfarmers Coles was 29 per cent and Metcash IGA was 14.2 per cent and ALDI was 2.6 per cent. (16) But even the share of smaller players, like ALDI, is arguably higher than reported.
Table 1 | Market share (by National brand owner) grocery retailers, 2011
Source: Euromonitor International
Similar retail trend data has been reported by the Australian Bureau of Statistics, as presented in Figure 1, which provides a guide for the relative market share for the two supermarket majors since 2000.
Figure 1 | Food and alcohol market share
Source: Australian Bureau of Statistics. Catalogue 8501.0
The difference between the position of the current head of the ACCC, and its past review and the data presented above, is driven by an assessment of the breadth of the market that supermarkets are measured against. Sims' position is dependent on assessing competition based on their primary market — grocery sales — the 2008 inquiry's position is dependent on a more holistic assessment of the business environment that supermarkets operate in.
The full breadth of competition is argued in Section 5.2. However, the current state of market share is not a new development. As argued by IBIS World "the industry has been subject to increasing concentration since the mid-1970s ... [however] the entry of ALDI into the Australian market in 2001 had a significant effect on the performance of operators such as Bi-Lo, which catered for the lower end of the market". (17) Similarly, "ALDI's expansion plans are on par with those of major players such as Coles and Woolworths". (18)
However, what is clear is that supermarket competition is intensifying, particularly in major retailers. Coles and Woolworths clearly dominate market share, but they don't dominate sites. Based on the data provided in Table 2 the share of physical stores isn't consistent with reported market share.
Supermarket majors have around 20 per cent of total physical sites each, and ALDI has nearly 10 per cent of physical sites despite only operating in Australia for a little over a decade.
Table 2 | Major retailers and the number of their physical stores
Notes:
a Includes Bi-Lo banded stores.
b Includes some convenience stores.
Source: Productivity Commission, Coles, Woolworths and ALDI.
Noting that the data does include some convenience stores, the largest physical player is Metcash supplied stores, with nearly half the physical market. The dominance of Metcash is largely because they operate smaller-scale stores and convenience stores that are much easier to roll out in both urban and rural and regional environments, in comparison to larger-format stores like ALDI, Coles and Woolworths. The key point of comparison between the number of physical stores is market share. While Coles and Woolworths have around 20 per cent of physical stores each, they manage to leverage their market share well above their physical presence. That increased market share in comparison to share of physical sites is a clear indication that they are attracting consumers based on their product offering.
The other significant development is the continued and clearly aggressive expansion of ALDI. Since my last research paper released earlier this year the number of confirmed ALDI stores has jumped from 260 to 300. That's roughly equivalent to the number of new stores intended to be rolled out by Coles and Woolworths by 2014. Considering they are operating off a lower market share, it demonstrates their roll out is on par, if not more aggressive, than Coles and Woolworths, especially as a share of existing physical sites.
ALDI's strategy is to compete with the supermarket majors by utilising their global supply chain to provide local and imported private labelled goods at competitive prices to supermarket majors. The influence of ALDI has been significant and has driven key components of supermarket competition, most notably the expansion of private labelling. (19) The growth of Costco has been much slower, but is largely indicative of its alternate format as a big-box store that opens large sites that attract customers looking to purchase well-known brands in bulk, not to compete on convenience. The chain is expecting to double its presence from three physical stores to six, (20) and bring with it "further pressure on industry retailers to ensure their products are competitively priced and offer value for money to budget conscious shoppers". (21)
5.2 THE STATE OF COMPETITION
Numerous industry reports conclude that competition is both high and increasing as supermarkets grow their existing brands to primarily compete on price, as well as diversifying to chase narrower market segments based on convenience and quality. (22) This follows years of complaint from politicians, regulators and the public that the market competition was stagnant. As argued by Justice Emmett in response to consideration of an ACCC complaint against Metcash's acquisition of Franklins that "the scale and intensity of retail competition is extreme and increasing". (23)
Discussion surrounding the state of competition in the supermarket sector is largely dominated by Coles and Woolworths and their combined market share, which is significant. But, as outlined in Section 5.1, any analysis is dependent on how their market share is assessed. Critics focus solely on pre-packaged groceries. That is a poor analysis. A contemporary supermarket offers:
- Pre-packaged groceries.
- Fresh fruits and vegetables.
- Meats and fish.
- Cakes and baked goods.
- Alcohol (depending on the individual store and chain).
- Specialist ranges, including organic foods.
- Non-food general merchandise and apparel.
While there is no single agreed formula for measuring relative market share of supermarkets based on assessing the full product offerings, it is assessed to be lower because supermarkets do not just compete against each other, they also compete against a variety of other stores. As industry research concludes, supermarkets "compete with other purveyors of food and grocery items such as convenience stores; fresh meat, fish and poultry retailers; fruit and vegetable retailers; bread and cake retailers; and takeaway food retailers". (24)
Chart 1 reflects the broad competitive reality that supermarkets face. The chart does not include all aspects of competition — some wholesale markets sell alcohol, such as the Swords brand of refillable wine bottles, and some pre-packaged groceries are available at specialty stores — but it does include their primary competitors. The great unknown is the increasing influence of internet competition in the supermarket retailing space. Companies, such as Aussie Farmers Direct, have sought to meet increasing market demand for delivered groceries, while supermarkets themselves are rolling out internet retail options, delivery options and new grocery collection centres. (25)
The competitive market is now broadening. Both Coles and Woolworths have offered ready-to-eat options for years, such as ready-cooked chickens, and Coles has expanded options such as their "Jewel of India" range. Woolworths recently announced that it will produce and sell ready-to-eat meals in direct competition with take-away food restaurants. (26)
Chart 1 | Competition for retail food and groceries
Table 3 outlines the true nature of competition in the retail market across supermarket product lines. Based on IBIS World data, the closest equivalent market share to pre-packaged groceries exists in fruit and vegetables with a 61 per cent market share. But it drops quickly in meat, fish & poultry when compared to other market players to only 38.1 per cent, and where more than half of the competition is from small or non-chain competitors.
While not identical, the Productivity Commission's 2011 inquiry into the retail sector drew similar comparisons. The PC concluded that the two majors enjoyed 70 per cent market share for pre-packaged groceries, 50-60 per cent for diary and deli, 50 per cent for fresh meat and fruit and vegetables. (27)
5.2.1 Liquor competition
With a competitive market environment for groceries, supermarkets have been seeking to extend their capacity to use their business model into allied sectors, notably liquor. Coles and Woolworths have an equivalent market share in liquor compared to pre-packaged groceries, but, in comparison to other product lines also has a clear and strong competitor in Independent Brands Australia (owned by Metcash) that holds a 17 per cent share.
As Chart 2 outlines, even within the two supermarket majors, unlike their supermarket businesses, liquor businesses are shared across multiple intra-brand competitors.
Chart 2 | Inter and Intra brand competition in the liquor sector
Note: Based on primary promotional points on each company's website
Coles owns Liquorland which competes on price and range, Vintage Cellars on quality, First Choice Liquor on price and Wine Drop on convenience. Woolworths owns Dan Murphy's which competes on price and range, BWS on range and convenience, Cellarmasters on convenience and Langtons on quality. Independent Brands has similar sub-brands with Cellabrations that competes on price and range, IGA plus liquor on convenience, The Bottle-O on price and The Bottle-O Neighbourhood on convenience.
But, as Table 3 outlines, outside of the market share of the majors, around a quarter of the market is still controlled by smaller players. Those smaller players include small chains as well as individual stores and bottle shops attached to existing hotels.
Table 3 | Market share by industry players, 2011
Source: IBIS World
5.2.2 Increasing harmonisation with fuel retailers & convenience stores
The integration of supermarkets with fuel retailers is increasingly linking the retail market, especially as they act as an outlet for convenience stores and redeem points for loyalty programs. In recent years it has taken the form of a co-branding alliance between Shell that supply petrol and Coles that operate the convenience stores, and Woolworths with Caltex. The high volume, low margin business model of supermarkets reinforces the business model of petrol stations which also operate on high volume and low margin on petrol. However, they operate on lower-volumes and higher margins on sales of consumables such as chocolates, ice cream and drinks.
Convenience stores are now seeking to achieve scale. The remaining independent retailers are increasingly consolidating to respond to the market environment and achieve the scale of larger retailers, especially those backed by the supermarket majors. (28) Though the key players remain 7-Eleven, whose market share has grown considerably, and Metcash backed stores — the supermarket majors do not have the market share to be considered dominant.
5.3 MAIN DRIVERS OF COMPETITION
A key misconception about competition is that retailers only compete on price. As has been highlighted in past reviews of the sector, price is the primary driver of competition between different market players, but it is not the sole determinant. Competition occurs based on a series of relevant factors based on consumer priorities including price, convenience, experience, location, quality, parking and product range. There are also other factors that play a smaller role.
Different supermarkets meet different market segments based on the motivating factors that influence consumer behaviour. These factors vary, for example, the primary shopper in an average Australian family may:
- Shop at a convenience store early in the morning when they have run out of orange juice. Their choice to shop at a convenience stores is primarily motivated by time constrains, not cost because their purchase is in a low volume.
- Shop at a fresh food market for their major weekly, or bi-weekly, fresh food shop, including fruit, vegetables, meat and fish. They shop at a market because their primary concern is cost because of the large volume purchased.
- Shop at a major supermarket for their major weekly, or bi-weekly shop of pre-packaged groceries, when their primary concern is cost because of the large volume purchased.
- Shop on a monthly or quarterly basis at CostCo for large-volume preservable goods, like rice, toilet paper or oils, when their primary concern is cost because of the large volume purchased.
- Shop at a speciality store for a gift or quality item when their primary motivation is taste, quality or appearance.
- Shop at a convenience store late at night for sweets, ice cream or milk when they are primarily motivated by time, and not cost.
Rather than being a hypothetical, this is part of the Australian supermarket experience.
While all supermarkets, to varying degrees, seek to meet all aspects of consumer demand, they cannot do so completely without compromising other aspects. For example, it is almost impossible for a supermarket to compete on price which requires low overheads, while also competing explicitly on convenience and range which requires high overheads including well-located sites, available parking and extended opening hours with associated staffing and energy costs. The data clearly shows the divergence in capacity.
For example, ALDI is the most aggressive competitor on price. It competes by leveraging its global supply chain to cut prices for consumers. ALDI also limits consumer options to streamline logistics and in-store requirements. As a result, ALDI only stocks around 600 product lines. By comparison Coles stocks nearly 30,000. Stocking a larger range from multiplier suppliers carries significant additional storage, transport, logistics and supply chain costs, as well as requiring larger-format stores. (29)
As data (Figure 2) from the ACCC's 2008 grocery inquiry found the major drivers are price, brands, convenience, experience, location, quality, parking and product range. The two most important "elements" rates as "very important" are price and food quality. Combined, they represent a mainstream assessment of consumer value.
Figure 2 | Elements of the retail offer respondents rated as "very important"
Source: Australian Competition and Consumer Commission. 2008. "Report of the ACCC inquiry into the competitiveness of retail prices for standard groceries, July 2008". Commonwealth of Australia.
Within the different desired elements there is significant competition to meet different consumer's expectations. Chart 3 outlines the comparative strengths of the different store options. There is both inter and intra brand competition based on consumer demand. The greatest diversity is arguably within the IGA family. IGA seeks to compete for convenience using IGA X-Press, quality through IGA Marketplace, a balance of convenience and location through standard IGA stores and low prices through Supa IGA. But they also compete against each of their alternatives.
Supermarkets clearly compete based on different value propositions, and consumers understand the different product options being offered. Table 4 provides data from the Martin Review into the ACT's supermarket competition landscape. While most stores achieve their highest ranks (highlighted in pink) in roughly the same categories, the outlying results for ALDI and IGA reflect their individual points of market differentiation through price and convenience.
Consumer identification with different brand strategies clearly influences the success of supermarkets.
Chart 3 | Predominant motivating factors from supermarkets meeting consumer demand
Note: Based on data from the 2009 Martin Review and 2008 ACCC Inquiry.
Coles has focused its energy on integrating its brand with convenience through smaller stores and stores located with petrol stations, such as Coles Express. Woolworths has acted in a similar fashion, but has expanded its range to cover the growing number of predominantly wealthier, inner-city consumers that are motivated by quality and experience, not price, through Thomas Dux.
IGA has the largest diversity of intra-brand competition offering supermarket options for consumers influenced by price, convenience, locality and quality. IGA's divergent brands may have made it difficult to associate directly with a key brand position. In the past their focus has been variances of being a convenient, local, community-connected retailer. Recent advertising is broadening IGA's market position as a store that stocks a consumer's favourite brands.
While ALDI and CostCo sit alone, they have introduced significant competition, particularly on price. ALDI has introduced competition through a large rollout of retail stores that directly compete on a day-to-day basis with the two supermarket majors. CostCo has a small number of stores that compete predominantly through preservable grocery items and large volume fresh produce targeting large families, businesses and community organisations. (30)
But despite the diversity of product offering, the key driver remains price.
Table 4 | Survey among store's own shoppers in the ACT, 2009
Source: Martin, J. 2009. "Review of ACT supermarket competition policy". Martin Stone Pty Ltd.
Figure 3 | Average household share of food toward household goods and services expenditure (%)
Source: Australian Bureau of Statistics, Household expenditure Survey, Summary of Results, 2009-10, catalogue no 6530.0.
ABS data provided in Figure 4 shows that since the mid-1980s the average household spent just under 20 per cent of their household income on food alone. But that has now declined to just over 16 per cent with a clear and progressive trend during the intermittent years.
However, that decline is disproportionately felt. As Figure 4 demonstrates, ABS data also shows food and non-alcoholic beverages are the second highest sources of expenditure for the average weekly household. Combined, food, alcoholic and non-alcoholic beverages are the largest single source of average weekly household expenditure, and exceeds housing costs.
Figure 4 | Average weekly household expenditure on goods and services
Source: Australian Bureau of Statistics, Household expenditure Survey, Summary of Results, 2009-10, catalogue no 6530.0.
Of greater importance, and impact considering its overall contribution to household expenditure, is the disparity of food and non-alcoholic beverages between higher and lower income households. Lower income households spend nearly 20 per cent of their weekly household income on food and non-alcoholic beverages. Higher incomes spend less than 15 per cent, ensuring that any price rises disproportionately impact the poor. Table 5 illustrates that the poorest Australians spend substantially more on food and non-alcoholic beverages than those with the highest incomes.
Table 5 | Percentage of household income spent on food and non-alcoholic beverages
Source: Australian Bureau of Statistics, Household expenditure Survey, 2009-10, number 6530.0.
The ABS data has been reinforced by poll data. A Galaxy survey commissioned in March 2012 found that 22 per cent of Australians were more concerned about food prices than all the other major household expenses. (31) The respondents most concerned about food prices were those in the lower income brackets: those who are unemployed, work part time, or self-describe as "blue collar" workers. Disturbingly, that poll followed declines in food prices since 2011, as outlined in Section 9.1.
Figure 5 | Good and services expenditure by the lowest and highest equivalised disposable household income quintiles
Source: Australian Bureau of Statistics, Household expenditure Survey, Summary of Results, 2009-10, catalogue no 6530.0.
Unsurprisingly, the importance of food prices is also reflected in different consumers' primary source of income. Figure 5 clearly shows that the share of household expenditure on food and non-alcoholic beverages for welfare and pensions recipients is even higher for almost all categories in comparison to the lowest quintile of income, with the highest share of expenditure amongst the large, and growing number, of fixed-income pensioners.
Table 6 | Percentage of households on government support spent on food and non-alcoholic beverages
Source: Australian Bureau of Statistics, Household expenditure Survey, 2009-10, number 6530.0
Consumer sensitivity to price variations is reinforced by consumer survey data. Data in Table 7 from the 2008 ACCC Inquiry shows that 59 per cent of consumers are "very likely" or "somewhat likely" to change supermarkets for a 5 per cent price decrease. For many consumers a 5 per cent price reduction is not likely to be significant. The fact that nearly 60 per cent of consumers will allow a modest price reduction to direct their shopping behaviour reinforces how important price is to consumer behaviour.
Table 7 | Customers likely to change supermarkets for a 5 per cent price decrease
Source: Australian Competition and Consumer Commission. 2008. "Report of the ACCC inquiry into the competitiveness of retail prices for standard groceries, July 2008". Commonwealth of Australia.
Considering the sensitivity of Australians to prices, industry data unsurprisingly concludes Australians are some of the least loyal supermarket customers in the world. (32) As the example above highlights, the prospect of customers attending multiple stores within a week is a practical reality. That reality is being experienced on a day-to-day basis by the major supermarket chains who are continuing to invest more in their supply chains to reduce prices, build customer loyalty programs and expand advertising of temporary and permanent price discounts.
5.4 COMPETITION DRIVING BUSINESS MODELS
Price-sensitivity has also driven innovation in the sector. The quick expansion of ALDI is largely in response to price and an increasing appetite for cheap, private-labelled goods. In fact ALDI is considered "virtually exclusively a private label retailer". (33) The influence of ALDI as a private label retailer has followed through to all retailers with private labelled goods growing from $9.96 billion in 2008 to $19.7 billion in 2012. (34) By 2018 private label goods are expected to account for a third of all supermarket sales and be valued at $31.8 billion annually. (35)
Table 8 | Private-label spending by Australians
Source: IBIS World. 2012. "Bypassing brands: Spending on private-label products is on the rise". Special Report.
Based on IBIS World data presented in Table 9, the strongest growth has been in private labelled liquor, bread and butter, although butter enjoys the highest market share of private labelled goods, closely followed by sugar. Only eggs have seen a decline in the same timeframe which has largely been assumed to result from market differentiation branding strategies by free range egg companies. According to the report "chocolate, confectionary, soft drinks, cosmetics and sanitary products appear to be poor performing segments" as a result of established, identifiable brands that attract consumer loyalty. (36)
Table 9 | Australian private-label spending by product category
Source: IBIS World. 2012. "Bypassing brands: Spending on private-label products is on the rise". Special Report.
Competition within the private-label sector is now considerable. Coles has rebranded with its primary advertising product offering focusing on the permanent reduction of prices pushing that prices are "down". Coles also launched an aggressive competition war by reducing the cost of key staples, notably private-labelled milk. Staples have clearly become the battle ground in the private label market because of the capacity for supermarkets to buy them in volume from producers or wholesalers and shave off margins.
Chart 4 | Private label brands
Source: Updated from Stuart Alexander. 2013. "Channels". Cited on 01/05/2013.
Woolworths responded to Coles' aggressive price reduction through cheap, private-labelled staples and reciprocated with similar reductions. The competition war between the two majors continues and has now prompted a backlash from suppliers concerned about the continued decline of retail prices and cost reductions being pushed down the supply chain.
In response both Coles and Woolworths are negotiating new supply arrangements with wholesalers, in the case of bread, or removing the middle-man processor and going straight to primary producers, in the case of milk. The intention of these arrangements are designed to achieve a reliable quality of supply, positive relationships and diminished perceived and actual risk to farmers. As was outlined by Business Spectator:
"Under the arrangements with Coles, Murray Goulburn will supply about 200 million litres of milk a year with a pricing mechanism that locks in a premium to the farm-gate price that will be protected regardless of fluctuations in the price". (37)
The drive to reduce costs down the supply chain is largely a reflection of the evolution of their business models. To varying degrees, Coles and Woolworths have made considerable investments in past decades improving their own logistical capacity to reduce their overheads, enabling them to limit flow-through costs to customers and make them more competitive. Considerable investment in logistics over the last few decades has extracted maximum value from their systems and limited the capacity of the supermarkets to further reduce unnecessary costs. (38) As was noted by The Australian's Blair Speedy:
"While the two supermarket giants are spending money on new stores and fittings, they have been cutting prices — down an average of 1.3 per cent over each of the past three financial years, or 2.3 per cent when excluding the more volatile fruit and vegetable segment. Not only are they saving consumers directly, they're also boosting household disposable income. It's arguable that without the influence of falling supermarket prices on inflation, the Reserve Bank may have stopped cutting interest rates a lot sooner". (39)
Faced with a new competition war against each other, and the relatively new and highly competitive ALDI that can leverage its global supply chain, supermarkets have had to push competitive pressure down supply chains and onto suppliers.
The increasing backlash from suppliers against supermarkets is an indication of how much competitive pressure is now starting to bite. Recent disputes between Coca Cola and Woolworths have resulted from expectations from supermarkets seeking to use the size of their purchasing arrangements to achieve price reductions from suppliers. (40) Similar disputes have emerged between retailers and alcohol suppliers, to the point that an alcohol company temporarily ceased supply to Coles and Woolworths subsidiaries in response to sustained discounting. (41)
Table 10 | International comparisons of gross margins, 2006
Source: Australian, Canadian and US data cited in Productivity Commission. 2011. "Economic Structure and Performance of the Australian Retail Industry". Commonwealth of Australia. n56.
Neither side is likely to relent easily, especially with suppliers unlikely to reduce their margins. The challenge for supermarkets already is the extent that they can use their market power to negotiate lower prices without disrupting suppliers. That isn't clear.
Figure 6 | Australian market share of select food processors
Source: Deloitte Access Economics. 2012. "Analysis of grocery industry".
The challenge for supplies will be justifying their existing cost structures. Productivity Commission data does suggest competitive pressure may be able to drive down wholesale margins. Table 10 outlines the comparative wholesale and retail margins in the retail sector. While it is broad, aggregate data, it does suggest that wholesale margins are more variable between Australia and retail margins in comparable countries. But, as the ACCC identified:
"It should be noted that while the percentage margins on sales are similar, the absolute dollar margin on sales in Australia in many cases may be larger. This would occur if the landed cost or cost of goods that Australian wholesalers and retailers source from overseas is high compared to other countries. This may arise from the transport costs incurred in shipping products to and within Australia, or because of international price discrimination practised by overseas manufacturers and suppliers". (42)
However, that does not discount that a key reason both wholesale and retail costs are higher results from significant cost drives including high wage and labour on-costs and occupancy and rental costs.
The response, so far, has been for suppliers to respond that supermarkets are abusing their market power. That appears to be a classic example of the pot calling the kettle black. As Figure 6 sourced from a Deloitte Access Economics report outlines, many suppliers have equivalent or higher market shares than the two supermarket majors share combined. (43)
But like with supermarkets, having a high market share is not a sign of absent competition. Suppliers have strong market share because they are meeting market demand. Both supermarkets and suppliers appear to be evenly matched in their ongoing battle.
6.0 SUPERMARKET BUSINESS MODELS
The business model of supermarkets is essentially a high-volume, low-margin industry. It's common to food retailing which "as a generalization ... in Australia may be described as a high volume, low margin business". (44)
The model is in stark contrast with traditional retail that operates as a low-volume, high-margin business model because consumers only buy one or two items per purchase, supermarkets sell millions of items daily and extract very small margins off each sale which cumulatively achieve profits from each basket or trolley from each consumer.
However, the nature of each business model is dynamic and continually evolving in response to market conditions. It was a point made by Justice Emmett in response to consideration of an ACCC complaint against Metcash's acquisition of Franklins:
"The grocery industry in Australia is a highly competitive industry characterised by high volumes and low margins. The operators of self-supplying supermarket chains are extremely disciplined and endeavour to standardise their offerings at any one time. Nevertheless, those offerings are not static, but shift as the chain operators explore market opportunities and develop new strategies. On the other hand, the products offered by independent retailers exhibit greater diversity than those of the chains in areas such as, for instance, size and location. Independent retailers may choose, or be forced, to rely upon factors other than price to attract customers". (45)
For many years Coles lost ground against Woolworths leading to its eventual sale from the Coles Group to Wesfarmers. A primary driver for Woolworths' growth was investment in their supply chain and logistics to reduce costs in transport and storage which can add significant costs to retail products because of Australia's expensive rents at both distribution points and retail stores, as well as high energy costs for refrigerated items, and high transport costs because of the long distances of moving goods.
Investment in reducing these costs provided big dividends which enabled Woolworths to reduce retail prices for consumers. Woolworths also identified that a key driver in consumer's purchasing behaviour was driven by perceptions of the quality and freshness of produce. The development of the "Fresh food people" as a recallable slogan for Woolworths ensured they built their market share from around 35 per cent in 2000 to 41 per cent in 2010. In comparison, Coles slipped. The influence of freshness to consumers is clearly outlined in Figure 2.
In recent years Coles have made equivalent investments and developed their own recallable slogan for their brand — "Down, Down" — that has ensured they have stabilised from earlier drops in market share from as high as 39 per cent in 2005 to 31 per cent in 2011.
The influence of improved efficiency and supply chains to improve business models to profitability was identified in the ACCC's 2008 review. The review explicitly concluded that only a small component of any price increases in the previous five years contributed to the rise in profitability of supermarkets. (46)
To compete against the increasing efficiency of the supermarket majors smaller, independent grocers have operated under the IGA brand since 1988. IGA was initially formed from ten independent stores. IGA now brings together thousands of stores nationwide under four major sub-brands: Supa IGA, IGA, IGA X-press and IGA Marketplace.
The driver behind stores working within the IGA brand surrounds the efficiency gains and negotiating power from cooperation with other stores and the power of Metcash.
Metcash now supplies around 60 per cent of independent retailers and 95 per cent of their grocery turnover. (47) By working together, IGA stores had broadly equivalent negotiating power to the two majors, enabling them to secure lower prices and efficiencies in logistics and supply chains to compete with Coles and Woolworths. (48)
But Coles and Woolworths have not vacated the market segment demanding convenience. Instead, they are using the value they can extract from scale to meet consumer demand based on convenience and price. As marketing firm, Stuart Alexander, identified:
"In the quest for earning growth in a mature market, both retails choice of store location is evolving. Traditionally, Woolworths and Coles stores are found in high rent, high capacity metropolitan shopping malls with large parking lots as anchor tenants whose pulling power brings customers to the other speciality shops. However, with growing consumer demand for convenience and one-stop shopping, both chains are now seen to be moving into non-traditional store locations using more compact 'express' convenience-style formats in high density residential and business areas". (49)
The nature and competitiveness of the supermarket sector is outlined in their profitability. Table 11 outlines the current state of profitability of supermarkets based on their revenue, earnings before interest and tax as well as market capitalisation.
The data is quite stark. Coles and Woolworths' annual revenue is both around $35 billion, but EBIT is relatively modest at 4 per cent for Coles and 8 per cent for Woolworths. The EBIT on revenue highlights a clearer image of the profitability of the business model. What's particularly noticeable from the data is that the profitability of Metcash as a share of market capitalisation is substantially higher than Coles and Woolworths and is likely a reflection of a business model that is less dependent on volume and seeks to extract higher margins from individual sales, even after factoring in the additional costs associated with a convenience-based business model.
Table 11 | Supermarket data, 2011-12
Source: Annual reports
Notably, Australian supermarket margins are smaller than retailers in comparable countries. While dated, a 2004 Department of Agriculture, Fisheries and Forestry report found that, at the time, Australian supermarket EBIT was low or significantly lower than comparable competitors. While profitability now varies from that time, the variance would still not put Australia's supermarkets in a substantially different position.
Figure 7 | Earnings before interest and tax, 2001-2004, % of sale
| Note: | CML | Coles Myer Limited (Ausralia) |
| | WW | Woolworths (Australia) |
| | Wmart | Wal-mart (United States) |
| | Wmart Int | Wal-mart International operations outside the United States |
| | Tesco | Tesco (United Kingdom) |
| | Car | Carrefour (French) |
| | Alb | Albertsons (United States) |
| | Kr | Kroger (United States) |
Source: Department of Agriculture, Fisheries and Forestry. 2004. "Price determination in the Australian Food Industry 2004". Commonwealth of Australia.
Historical data shows this is not a recent trend. Data from the Australian Bureau of Agriculture and Resource Economics from 2005, and provided in Table 12, shows margins have not changed significantly in the past decade.
Table 12 | Gross Margin comparison of the big four retailers in Australia, 2003-2004
Source: Delforce, R., Dickson, A. & Hogan, J. 2005. "Australia's Food Industry: recent changes and challenges". Australian Commodities.
As Table 11 and 12 indicate, supermarkets run on very small margins in comparison to their market capitalisation and revenue, and have had to find aggressive strategies to increase profits resulting in "significant structural and operational rationalization has occurred, focused on reducing costs along the entire food supply chain as a means of increasing profitability". (50)
The reason for low margins follows directly from the data provided in Section 5.3. Despite being the source of a declining share of average household income, food and alcoholic and non-alcoholic beverages represent around one-fifth of average household expenditure, and a higher share of low-income earners and welfare recipients, notably pensioners.
As a consequence, consumers are highly likely to change supermarkets for even modest discounts of expenditure that can take up a large share of their household income.
A recent report commissioned by Coles highlights, in practice, how little margin is extracted from individual sales. The Deloitte Access Economics report shows in the previous 18 months the volume of sales in Coles supermarkets increased by nearly 50 per cent, but the increase in income was only slightly half that increase at a time prices actually fell by 8 per cent.
Table 13 | Change in Key aggregate for "Down Down" products (Jan 2011—mid-2012)
Source: Deloitte Access Economics. 2012. "Analysis of grocery industry".
Such strong movements in prices in an otherwise struggling retail environment demonstrates the importance of volume necessary to achieve lower prices for consumers. When sales volumes are disaggregated for individual product lines the rise in volumes is even clearer.
Table 14 | Coles Volume of Selected Products, 2012
Source: Deloitte Access Economics. 2012. "Analysis of grocery industry".
As Table 14 outlines, sales volumes have increased considerably to continue to achieve profitability. Sales volume increases were clearly easiest to achieve amongst private labelled goods where reducing margins are more easily achieved than branded goods. However, the report increase in sales volumes includes both branded and private labelled goods. The stunning increase in sales of staples — milks, cereal and eggs — demonstrates their capacity to act as products that can successfully change consumer behaviour when discounted.
7.0 DRIVERS OF PRICES AND COMPETITION
Price movements are a determinant of multiple factors in the supermarket sector. As a high-volume, low-margin business model any increase in price movement leaves both the business and consumer exposed, as price movements are passed through especially in a highly competitive market. The alternative is that the business can take higher margins and protect consumers from fluctuations. Consumers may have greater certainty, but prices would be higher and profits from supermarkets are likely to be higher.
Cost break downs in the supermarket sector are predominantly driven by wholesale purchasing. Based on IBIS World data provided in Figure 8, purchases contribute 75 per cent to the total cost structure of supermarkets the capacity to reduce wholesale purchase costs to overall lower prices. The other main drivers are wages and profit.
Figure 8 | 2012 Supermarket cost breakdown
Source: IBIS World
The challenge with having high fixed costs passed on from suppliers is that supermarkets have to focus their capacity to reduce their expenses in a narrow area of specific overheads. Therefore any cost increase cannot be broadly fractionalised and reduced.
Increases in rents and property costs, utilities and energy and wage costs by market forces or government regulation will directly lead to increases in prices that are passed through, especially in a business environment with low profit margins.
7.1 RECENT PRICE MOVEMENTS
The consequence of a high-volume, low-margin business is that retail supermarket prices are heavily influenced by external factors. High price sensitivity ensures that retailers cannot easily absorb any price increases because the margins are too tight.
The clearest example of supermarket price sensitivity occurred in recent years. Figure 9 outlines food price movements across select OECD countries over the past decade. The data shows that during the prolonged drought throughout the middle of the 2000s food prices significantly rose in comparison to comparable countries, but has since declined as the drought ended.
Figure 9 | Moving food price averages in select OECD countries, 2005 = 100
Source: Organisation for Economic Cooperation and Development. 2012. Main Economic Indicators: Food Prices.
The Australian drought was not the sole influencer of price rises. International factors, including supply disruptions, quarantine restrictions and world commodity prices, also influenced price movements resulting in sharper price rises globally around 2008. But the unique impact of the Australian drought reflects the primary influence in the rise of prices in Australia and some correlation in New Zealand price rises.
Figure 10 | Moving Australian price averages, 2005 = 100
Source: Organisation for Economic Cooperation and Development. 2012. Main Economic Indicators: Food Prices.
The decline of food prices since the middle of 2011 has been a notable change in trend from comparative countries where it has continued to rise, with Australian food prices now sitting below the OECD average increase. The decline in prices is a partial reflection of the high degree of competition in the marketplace. By themselves price declines aren't necessarily an indication of competition, however it does reflect that any potential for decreases in prices are delivered to consumers because there is competitive pressure and a risk of lost market share to competitors if they are not.
The moving average is even more noticeable when it is compared to all movements for consumer items. Figure 10 outlines OECD data which shows the clear and rising influence of energy prices in the past few years and, despite earlier increases, food prices are increasingly aligned to average price rises.
7.2 REGULATORY COST DRIVERS
Local and international factors in food prices can only be hedged, they cannot be avoided. Another key driver to prices has been the rising cost of regulation which directly impacts on cover overheads of supermarkets that have to be passed onto consumers through the price of final goods.
The influence of regulatory cost drivers was recognised by ACCC Head, Rod Sims, in an interview earlier this year in the Australian Financial Review. In the interview Sims conceded that any additional regulation may lead to price increases. (51) An analysis by Deloitte Access Economics submitted to the Productivity Commission's Review into the retail sector, and funded by Woolworths, identified that additional regulation through trading hour restrictions that lead to high wage rates, and transportation restrictions lead to higher costs that are then passed onto consumers. (52)
They are not alone. Industry data analysing the competitive landscape of regulation has identified that planning regulations are adding considerable costs to the operation of supermarkets and creating a competitive environment, especially in the case of larger-format stores. Restricting the availability and use of land, as well as prolonged planning approval, increases cost structures for the establishment of new supermarkets. Similarly, when these sites are not owned by supermarkets the cost structures of new store development impacts on established stores because "rent expenses have risen due to demand for prime retail locations", (53) and the absence of competing sites that can be used to keep prices lower.
The real price impact of prolonged planning approvals was highlighted by the Productivity Commission which concluded that a three year delay to planning approval can add 52 per cent of the cost of the initial investment. (54) Sadly, these planning delays are increasingly common-place. The PC's review broke down the nature of these planning regulations and compliance costs, and included:
- "Procedural requirements such as preparing, submitting and providing impact assessments and other material to support an application.
- Meeting specified development controls such as location, operating hours, business format, density, amenity, environmental heritage and requirements.
- Fees and charges such as application or other administered fees.
- Charges to verify that developments accord with approved drawings.
- Holding costs associated with the time taken to obtain planning approval". (55)
Planning regulation is also being abused to choose competitors. As case study 1 outlines, the ACT government introduced an active policy to abuse planning regulations to limit the expansion of supermarkets within the Territory. The result was that consumers had less access to major supermarkets which may have driven up prices. Despite initial support for the policy, after three years it was abandoned as it clearly did not have the desired effect of reducing prices. The result is hardly surprising because the policy didn't promote competition or choice; it used regulation to decide what choices customers had.
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Case study 1 | The ACT government's abuse of planning that drove up prices
In practice regulation can directly influence prices. Following the 2009 Martin Review, the ACT government used planning regulations to restrict supermarkets entering into certain sites. As outlined in my 2010 paper, Forcing Prices Up, (56) the ACT Chief Minister Jon Stanhope commissioned consultant John Martin to complete a review of the ACT's supermarkets policy in June 2009. (57) Following the completion of the Martin Review the ACT government released its ACT Supermarket Competition Policy Implementation Plan.
According to the Implementation Plan, the ACT government developed a new framework to support supermarket competition. This included supporting new entrants and larger and independent full line supermarkets to operate, supporting more wholesale competition, flexibility in zoning provisions, no cap on the market share of participants, interdepartmental coordination on policy and regular industry consultation. Importantly the implementation plan included proposals for land release assessments for new supermarkets based on weighting criteria to support market outcomes. (58)
My earlier report outlined the specific issues that arose from imposing restrictions and favouring some market entrants against others, including that it would lead to:
- the price of groceries at these news supermarket sites to increase of between $6.52 and $13.45 more expensive than the cheapest ACT supermarket site.
- the price of the mean ACT basket of groceries to increase by $8.02 compared to the cheapest basket available in the ACT amounting to a mean price nearly ten per cent higher than necessary.
- the price of the mean basket of groceries to increase in the ACT by $1.05 or 1.18 per cent, adding an additional third increase on top of inflation.
The policy operated for nearly three years before the ACT government eventually aborted the policy after it was deemed to have been unsuccessful. Instead, the ACT government has decided to rely on the ACCC to ensure competition. (59)
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7.3 BARRIERS TO ENTRY
There are two key concerns about regulatory price drivers. First, they increase prices directly for consumers with debatable benefits. Second, they increase barriers to entry to continue promoting competition. There are barriers to entry for new market players. But there are essentially two types of barriers — market and non-market barriers. The nature of these barriers and broken down in Box 1. The ACCC should be focusing on non-market barriers to entry. Market barriers to entry can be overcome through investment and meeting consumer demand. Non-market barriers to entry increase costs and can make it impossible for new players to enter the market and established players to meet consumer demand.
| Box 1 | Barriers to entry |
| Market barriers to entry | Market-based barriers include significant upfront costs that make it prohibitive for new players to reasonably enter the market. Market barriers to entry can include the necessity of economies of scale to be competitive, ownership of scarce resources, high start-up costs and high research and development costs. In the case of supermarkets, major barriers to entry can include large-format sites suitable for supermarkets, capital to purchase stock and the logistics necessary to achieve scale to compete on price. |
| Non-market barriers to entry | Non-market barriers include primarily government-imposed restrictions and regulations that limit the establishment and operation of new players into the market. In the supermarket sector that can include regulations that prohibitively increase the costs of establishing a new supermarket, limit the number of supermarkets operating or other taxes and regulations that increase the cost of operations. The challenge with non-market barriers to entry is that all regulations have a cost profile that individually may have limited impact, but cumulatively contribute significantly to increasing the cost of a new market entrant and favour existing competitors who can spread the costs across their existing business operations. |
There's no dispute that the size of a supermarket operation creates barriers to entry because of the cost of being competitive with volume purchasing, supply chains and retail outlets. But they are not insurmountable.
Over a period of twelve and a half years, ALDI has succeeded in establishing 300 news stores across Australia competing against the establishment supermarket majors and driving major trends and behaviours in consumption. As stated, ALDI is expected to continue opening 30 new stores annually. (60) ALDI was in a unique position to compete and enter the market and immediately compete against the supermarket majors by having the necessary capital to acquire major large-format stores, the logistics and supply chain capacity to achieve scale and compete on price.
Importantly, ALDI's rapid growth disproved one of the major assumed barriers to entry of available sites to host supermarkets, especially in established and built-up suburbs. Almost all of ALDIs stores have been established in the capital cities of Brisbane, Canberra, Melbourne and Sydney. Even though ALDI's stores are around one-quarter the size of a Coles or Woolworths, they still require substantially more space than the average retail store. (61) But even without ALDI, those barriers do not have to have be prohibitive. Like all businesses, competitors can develop from smaller operations providing a different product offering to meet a market demand and grow their operations.
Market-based barriers to entry are problematic, but only addressable to the extent that government-imposed costs increase them, such as wage requirements that increase labour costs, shop trading hours that also increase labour costs and reduce the capacity for supermarkets to extract maximum value from their infrastructure, and planning restrictions that increase site purchases and rents.
7.4 INDICATIVE COMPETITION AND SCALE DIVIDEND
The diversity of factors that impact on supermarket competition make it difficult to assess what individual factors impact supermarket prices. However, based on OECD data provided in Figure 11 we have a broad guide of the movement of Australian food prices over the past decade.
Figure 11 | Moving Australian food prices versus average, 2005 = 100
Source: Organisation for Economic Cooperation and Development. 2012. Main Economic Indicators: Food Prices & Calculations.
In the past few years, there has been a decline in food prices against the average, predominantly based on increased competition and the benefits of scale achieved by supermarkets. However, the trend is likely to have been depressed as a result of the influence of scale and competition already. Used as an indicative measurement, based on current prices, and taken as a broad competition and scale dividend, these factors have led to a price reduction for food of at least 5.03 per cent against the trend.
While a 5 per cent reduction is not significant, as outlined in Section 7.3, up to 60 per cent of consumers have identified it would influence their supermarket choice. Based on ABS data of average weekly Australian earnings, a 5 per cent reduction results in food and non-alcoholic beverage prices delivers a $9.20 weekly discount or $478.62 annually.
8.0 CONCLUSIONS AND RECOMMENDATIONS
Despite the concerns around the state of competition, there is clearly a competitive landscape for retail supermarkets and their allied interests in convenience stores, liquor and fuel retailing.
Consumers are clearly motivated by price and quality as their value propositions. Each of the four major supermarket chains is attempting to segment the market to meet those demands while offering alternatives to compete on convenience and quality.
Supermarkets operate on a high-volume, low margin business model to achieve lower prices. They fractionalise their costs, including profit, across millions of products sold that accumulate in baskets and trollies.
Most of their costs come from wholesale products which accounts for 75 per cent of their costs. To deliver them cheaply they have sophisticated supply chain and logistics systems. These systems allow supermarkets to reduce the cost impost on every item from the remaining 25 per cent of their costs. Higher costs ultimately lead to high prices at the checkout.
While Coles and Woolworths achieve these efficiencies through their size, IGA has achieved it through partnerships with Metcash as a group wholesale purchaser. ALDI achieves it through its global supply chain which gives it both negotiating power and the capacity to parallel import cheap goods.
The more products that supermarkets sell the less each fractionalised cost has to be applied. Therefore scale matters. Smaller supermarkets have higher cost structures because disproportionately higher costs have to be spread across fewer items. Large supermarkets have lower cost structures because they have disproportionately lower costs spread across more items.
ALDI's entry into the Australian marketplace has significantly increased competition, especially for the custom of price-sensitive consumers. ALDI has successfully grown its market share by rolling out larger-format stores selling private labelled goods at cheap prices.
To be competitive, Coles, Woolworths, and to a lesser extent ALDI, has had to respond and increase their private label offerings. Because private labelling removes some costs, it can bring down prices, but for supermarkets that also compete on convenience, experience, parking and range the high cost structures of a large-format supermarket are still spread across private labelled goods.
Supermarkets are, in part, now using their scale to deliver lower prices to consumers while also meeting the rising demand for convenience. They are doing so by using the efficiencies of their supply to offer competitive prices in convenience stores partnered with petrol stations, and smaller-format stores in convenient locations.
Consumers are understandably price sensitive, despite recent declines, the general direction of retail prices over the past decade have been extremely high. Price sensitivity is particularly high amongst low-income earners and those on fixed incomes and welfare and pension schemes. Food and non-alcoholic beverages can account for more than 20 per cent of their household income.
Price-sensitivity is driving the business model of supermarkets to increase their scale, reduce prices and fractionalise their overheads further. As an indicative measure, the competition and scale dividend suggests prices are at least 5.03 per cent lower than they otherwise need be. While only a modest reduction, it's equivalent to the price reduction 60 per cent of Australians have identified they would change their choice of supermarket for.
As a regulator, the challenge for the ACCC is how to remove barriers to entry and structures that increase prices for consumers. Instead the ACCC appears to be adopting a strategy of regulating the choices consumers have in the hope that they can manufacture a competitive landscape more perfectly than the market.
Concerns by the regulator about the state of the market, market concentration and market power against suppliers and wholesalers, and market-based barriers to entry cannot be made out, particularly:
- The "critical decision point" in the sector is whether market players are allowed to meet consumer demand, or whether the regulator will interfere to achieve non-price objectives.
- Competition has increased following the entry of ALDI, and to a lesser extent, CostCo.
- No supermarket has a dominant share in the convenience or liquor market where competition is healthy.
- Consumers want competition to drive lower prices. Lower prices are being achieved through supermarket business models that harness scale.
- There's no evidence that organic evolution of supermarket chains and sites weaken competition.
- The ACCC's requirement that competition is achieved when there are three players in close vicinity is an essentially unsupportable, ambit claim.
- The entry of ALDI, and to a lesser extent, CostCo, show market barriers to entry are low.
By comparison, concerns by the regulator about the state of non-market barriers to entry can be made out. Taking into account the business models of supermarkets, if the ACCC wants to reduce prices for consumers in a competitive market they should:
- Focus on non-market barriers to entry that unnecessarily increase costs for established market players and raise hurdles for new market entrants.
- Assess the impact of high wage structures that increase costs to supermarkets that are passed onto consumers.
- Assess the impact of shop trading hours that can lead to higher wage costs and an under-fractionalisation of rent costs that are passed onto consumers.
- Assess the impact of planning regulations at both a local and State and Territory level that reduce the number of available sites to allow for supermarkets to be established, reduce the number of sites where supermarkets can compete and increase the costs of rents that are passed onto consumers.
9.0 REFERENCES
Australian Bureau of Statistics, Household expenditure Survey, Summary of Results, 2009-10, catalogue no 6530.0.
Australian Competition and Consumer Commission. 2013. "About us". Commonwealth of Australia. Cited on 01/06/2013.
Australian Competition and Consumer Commission. 2013. "About the ACCC". Commonwealth of Australia. Cited on 01/06/2013.
Australian Competition and Consumer Commission. 2013. "ACCC to oppose Woolworths' proposed acquisition of Glenmore Ridge site". Cited on 08/06/2013 at .
Australian Competition and Consumer Commission. 2008. "Report of the ACCC inquiry into the competitiveness of retail prices for standard groceries, July 2008". Commonwealth of Australia.
Australian Competition Law. 2011. "ACCC v Metcash Trading Limited". Cited on 01/05/2013.
Bartholomeusz, S. 2013. "A Coles coup to defuse milk intolerance". Business Spectator. 10/04/2013
Speedy, B. 2013. "Size matters to grocery shoppers". The Australian. 09/03/2013. Cited on 09/03/2013.
Speedy, B. 2013."Woolies in Fresh Food Fight". The Weekend Australian. Cited on 16/05/2013.
Chanticleer. 2013. "Face-off: Woolworth's O'Brien v Competition chief Sims". Australian Financial Review. 07/06/2013.
Commonwealth Treasury. 2011. "Australia's food processing sector: Submission by the Treasury to the Senate Select Committee on Australia's Food Processing Sector". Submission to the Senate Select Committee on Australia's Food Processing Sector. Parliament of Australia. 2012.
Delforce, R., Dickson, A. & Hogan, J. 2005. "Australia's Food Industry: recent changes and challenges". Australian Commodities.
Deloitte Access Economics. 2012. "Analysis of grocery industry".
Deloitte Access Economics. 2011. "The Structure and Performance of the Australian Retail Industry". 10 June 2011.
Department of Land and Property Sales, 2010, "ACT Supermarket Competition Policy Implementation Plan", ACT Government, Canberra, Australia.
Drummond, M. 2013. "Supermarket prices may be casualty of probe: Sims". 11/03/2013. Australian Financial Review.
Euromonitor International. 2012. "Grocery Retailers in Australia". March 2012.
Ferguson, A. 2013. "Grocery chains put heat on suppliers". The Age. 07/05/2013. Cited on 07/05/2013.
Fielding, Z. 2012. "Costco to expand its footprint". Australian Financial Review. 09/07/2012.
IBIS World. 2012. "Bypassing brands: Spending on private-label products is on the rise". Special Report.
IBIS World. 2013. "Supermarkets and other grocery stores in Australia: Competitive Landscape". G5111.
IBIS World. 2013. "Supermarkets and other grocery stores in Australia: Industry at a glance". G5111.
Independent Grocers of Australia. 2013. "About IGA". Cited on 25/05/2013.
Irish Food Board. 2009. "Australian grocery market dominated by 'big three'." Cited on 01/05/2013.
Lui, S. "Woolworths trials grocery collection service at Melbourne airport". ZDNet. Cited on 13/06/2013.
Martin, J. 2009. "Review of ACT supermarket competition policy". Martin Stone Pty Ltd.
Mitchell, S. 2012. "Private-label grocery share tipped to reach 33pc". Australian Financial Review. 19/07/2012.
Mitchell, S. 2012. "Woolies pushes its trolley too fast". Australian Financial Review. 12/12/2012.
Nicholson, L. 2013. "Supermarket policy fails says IGA man". Canberra Times. Cited on 09/05/2013.
Organisation for Economic Cooperation and Development. 2012. Main Economic Indicators: Food Prices.
Parliament of Australia. 2010. "Competition and Consumer Act 2010". Cited on 12/05/2013.
Productivity Commission. 2011. "Economic Structure and Performance of the Australian Retail Industry". Commonwealth of Australia. n56.
Speedy, B. 2013. "Size matters to grocery shoppers". The Australian. 09/03/2013. Cited on 09/03/2013.
Stuart Alexander. 2013. "Channels". Cited on 01/05/2013.
Wilson, T. 2012. "New poll: Households concerned about energy and food prices". Media Release. 20 March 2012.
Wood, R.J. 2013. "Consumer-first supermarket reform: The market, not government, knows how to best meet consumer demand".
Wood, R.J. 2010. "Forcing Prices Up: The impact of the ACT government's supermarkets policy and implementation". June.
Zappone, C. 2011. "Competition a casualty in beer wars: Xenophon". Sydney Morning Herald. 23/03/2011. Cited on 01/04/2013.
ENDNOTES
1. Wood, R.J. 2013. "Consumer-first supermarket reform: The market, not government, knows best how to meet consumer demand".
2. Wood, R.J. 2013. "Consumer-first supermarket reform: The market, not government, knows how to best meet consumer demand".
3. Parliament of Australia. 2010. "Competition and Consumer Act 2010". Cited on 12/05/2013.
4. Australian Competition and Consumer Commission. 2013. "About us". Commonwealth of Australia. Cited on 01/06/2013.
5. Australian Competition and Consumer Commission. 2013. "About the ACCC". Commonwealth of Australia. Cited on 01/06/2013.
6. Chanticleer. 2013. "Face-off: Woolworth's O'Brien v Competition chief Sims". Australian Financial Review. 07/06/2013.
7. Australian Competition and Consumer Commission. 2013. "ACCC to oppose Woolworths' proposed acquisition of Glenmore Ridge site". Cited on 08/06/2013.
8. Sims, R. 2012. "Better communicating the ACCC's role, its approach to reviewing mergers involving small retail acquisitions and the benefits of competition in electricity". Speech to CEDA. Australian Competition and Consumer Commission. Commonwealth of Australia. 14 June 2012.
9. Ibid.
10. Ibid.
11. Ibid.
12. Ibid.
13. IBIS World. 2013. "Supermarkets and other grocery stores in Australia: Industry at a glance". G5111.
14. Mitchell, S. 2012. "Woolies pushes its trolley too fast". Australian Financial Review. 12/12/2012.
15. Australian Competition and Consumer Commission. 2008. "Report of the ACCC inquiry into the competitiveness of retail prices for standard groceries, July 2008". Commonwealth of Australia.
16. Euromonitor International. 2012. "Grocery Retailers in Australia". March 2012.
17. IBIS World. 2013. "Supermarkets and other grocery stores in Australia: Competitive Landscape". G5111.
18. Ibid.
19. Commonwealth Treasury. 2011. "Australia's food processing sector: Submission by the Treasury to the Senate Select Committee on Australia's Food Processing Sector". Submission to the Senate Select Committee on Australia's Food Processing Sector. Parliament of Australia. 2012.
20. Fielding, Z. 2012. "Costco to expand its footprint". Australian Financial Review. 09/07/2012.
21. IBIS World. 2012. "Supermarkets and other grocery stores in Australia: Competitive Landscape". G5111.
22. Ibid. & Euromonitor International. 2012. "Grocery Retailers in Australia. March 2012.
23. Australian Competition Law. 2011. "ACCC v Metcash Trading Limited". Cited on 01/05/2013.
24. IBIS World. 2013. "Supermarkets and other grocery stores in Australia: Competitive landscape". G5111.
25. Lui, S. "Woolworths trials grocery collection service at Melbourne airport". ZDNet. Cited on 13/06/2013.
26. Speedy, B. 2013."Woolies in Fresh Food Fight". The Weekend Australian. Cited on 16/05/2013.
27. Productivity Commission. 2011. "Economic Structure and Performance of the Australian Retail Industry". Commonwealth of Australia. n56.
28. IBIS World. 2013. "Supermarkets and other grocery stores in Australia: Industry at a glance". G41112.
29. IBIS World. 2012. "Supermarkets and other grocery stores in Australia: Competitive Landscape". G5111
30. IBIS World. 2012. "Supermarkets and other grocery stores in Australia: Competitive Landscape". G5111
31. Wilson, T. 2012. "New poll: Households concerned about energy and food prices". Media Release. 20 March 2012.
32. IBIS World. 2012. "Supermarkets and other grocery stores in Australia: Competitive Landscape". G5111
33. Productivity Commission. 2011. "Economic Structure and Performance of the Australian Retail Industry". Commonwealth of Australia. n56.
34. Productivity Commission. 2011. "Economic structure and performance of the Australian retail industry". Productivity Commission Inquiry Report. V56. 04/11/0211.
35. Mitchell, S. 2012. "Private-label grocery share tipped to reach 33pc". Australian Financial Review. 19/07/2012
36. IBIS World. 2012. "Bypassing brands: Spending on private-label products is on the rise". Special Report.
37. Bartholomeusz, S. 2013. "A Coles coup to defuse milk intolerance". Business Spectator. 10/04/2013.
38. Speedy, B. 2013. "Size matters to grocery shoppers". The Australian. 09/03/2013. Cited on 09/03/2013.
39. Ibid.
40. Ferguson, A. 2013. "Grocery chains put heat on suppliers". The Age. 07/05/2013. Cited on 07/05/2013.
41. Zappone, C. 2011. "Competition a casualty in beer wars: Xenophon". Sydney Morning Herald. 23/03/2011. Cited on 01/04/2013.
42. Productivity Commission. 2011. "Economic Structure and Performance of the Australian Retail Industry". Commonwealth of Australia. n56.
43. Deloitte Access Economics. 2012. "Analysis of grocery industry".
44. Delforce, R., Dickson, A. & Hogan, J. 2005. "Australia's Food Industry: recent changes and challenges". Australian Commodities.
45. Australian Competition Law. 2011. "ACCC v Metcash Trading Limited". Cited on 01/05/2013.
46. Australian Competition and Consumer Commission. 2008. "Report of the ACCC inquiry into the competitiveness of retail prices for standard groceries, July 2008". Commonwealth of Australia.
47. Stuart Alexander. 2013. "Channels". Cited on 01/05/2013.
48. Independent Grocers of Australia. 2013. "About IGA". Cited on 25/05/2013.
49. Stuart Alexander. 2013. "Channels". Cited on 01/05/2013.
50. Delforce, R., Dickson, A. & Hogan, J. 2005. "Australia's Food Industry: recent changes and challenges". Australian Commodities.
51. Drummond, M. 2013. "Supermarket prices may be casualty of probe: Sims". 11/03/2013. Australian Financial Review.
52. Deloitte Access Economics. 2011. "The Structure and Performance of the Australian Retail Industry". 10 June 2011.
53. IBIS World. 2013. Supermarkets and other grocery stores in Australia: "Competitive Landscape". G5111.
54. Productivity Commission. 2011. "Economic structure and Performance of the Australian Retail Industry". Commonwealth of Australia.
55. Ibid.
56. Wood, R.J. 2010. "Forcing Prices Up: The impact of the ACT government's supermarkets policy and implementation". June.
57. Martin, J. 2009. "Review of ACT supermarket competition policy". Martin Stone Pty Ltd.
58. Department of Land and Property Sales, 2010, "ACT Supermarket Competition Policy Implementation Plan", ACT Government, Canberra.
59. Nicholson, L. 2013. "Supermarket policy fails says IGA man". Canberra Times. Cited on 09/05/2013.
60. Irish Food Board. 2009. "Australian grocery market dominated by 'big three'." Cited on 01/05/2013.
61. IBIS World. 2013. "Supermarkets and other grocery stores in Australia: Competitive Landscape". G5111.
