The ABC’s Four Corners story on supermarket concentration highlighted a range of trade practices used in relation to suppliers and customers.  Aside from the knee-jerk reactions from politicians, why should we be concerned about supermarket concentration?  In Australia, Woolworths and Coles hold 65%+ of the supermarket trade. Roger Montgomery’s article in the Weekend Australian (Feb 24-25,p30) suggests that EBITDA margins earned by Woolworths and Coles in 2022 are substantially higher than for comparable UK supermarkets.  Rod Sims, former ACCC chair is more direct: “When you get this much concentration you are going to get higher prices.  Its just a straight causal relationship, proved everywhere.”

In 2023, the OECD Competition Policy Roundtable released a Background Note titled ‘Competition and Innovation, A Theoretical Perspective’ which summarised current learning about the link between market concentration and innovation.  This Note makes clear that more competitive markets are typically also more innovative.  In these markets, firms innovate to differentiate their products and services and escape competition. But they will invest in innovating only if they think they can capture higher revenues, profits and/or market share to justify that investment.  Competitive markets are typically characterised by low barriers to entry, where the capital cost to enter a market and the cost to access customers is low.  These markets are typically also price competitive. Examples include markets for primary produce and all supermarket products.

Supermarket concentration matters because supermarkets provide the logistics infrastructure for suppliers to access large numbers of customers cost effectively. Cost-effective access to large number of customers is essential for most suppliers to generate and take advantage of economies of scale in production.  This gives Woolworths and Coles the market power to determine what products they want to sell, from whom, when and at what price to meet their own profit and margin targets and create value for their shareholders. For both chains the calculus is simply to get the best price from suppliers and charge the best price to consumers to optimise profits. If suppliers in any product category do not, or cannot accept the price offered, they are effectively denied access to a large proportion of Australian consumers.

Following the OECD logic, any market-imposed constraint that limits the opportunity to capture a financial reward to compensate for investment in innovation reduces the incentive to innovate. In the case of supermarkets, a trade-off likely exists between the benefits of efficient large scale logistics infrastructure and the dampening impact this may have on upstream product market innovation from suppliers, and the choice offered to consumers.

When products cannot get on the shelf or are removed from shelves because the chain and its supplier cannot agree a price, this limits the opportunity for innovators to capture a margin and risk premium they can live with.  Some may say it is up to the supplier to find a different route to market, however those routes are costly and/or may not be able to offload the volumes necessary to generate scale unit costs.  If the big chains decide to destock a higher quality product that is selling well and stock a lower quality lower cost product or an imported product at the same price to increase their product margin, what is the cost to innovation?  What is the cost if the big chains replace higher quality products with lower quality ‘home’ brands?  (The big chains do not export their home brands or pretend that these products could compete in any other market except the markets they influence.)  Our big chains do not bear this cost.

How Woolworths and Coles manage the range of intrusive public inquiries and media scrutiny going forward will be interesting.  The last Financial Services Inquiry show how industry should not respond. Our big supermarkets have a range of capabilities they could harness to survive scrutiny and build their social license. Lets see how they respond.

 

 

 

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