Coles and Woolworths – Super Market Power

I liked Coles and Woolworths. They seemed like convenient places to buy the things I eat. But sadly, sometimes you can’t trust the market to make sure convenient is fair.

I used to live right near an independent grocery store called Piedimonte’s. It was enormous, but every time you walked out, you had the strong feeling you’d paid too much. The word expensive just keeps popping up in its online reviews. I moved away and the ambiguous feeling of shopping there evaporated.

supermarket continental
This little place near me survives, somehow…

These days I get my groceries delivered mostly, and Coles is the go-to service. Spending 10 minutes making an order online takes half as long as going through the aisles, and it saves checkout, parking and travel time too. The delivery man will carry the items all the way in to the kitchen bench.

Coles and Woolworth also seemed good because they stock a lot of home brands. My enthusiasm for home brands should not be under-estimated. I love to be frugal and I hate compensating some crappy company for all their marketing.

This taste for the lower-price, equivalent quality good was only strengthened by some TERRIFIC recent research from NBER. It showed experts buy home brand: Chefs are more likely to buy generic flour, while pharmacists are far more likely to buy generic aspirin.

fresh bread
The local Foodworks, dubbed “expensiveworks”. Model is a curly-coated retriever named Susie.

Coles and Woolworths are supposed to be a duopoly. You’d expect them to sneakily raise prices and treat customers with disdain. Instead milk recently fell to $1 a litre. Competition reigns! So imagines the happy economist as he grabs bargains.

But The Big Two are wily. They don’t hurt the voting public, the shoppers. Instead, behind the scenes, where they think they can get away with it, the duopoly are flexing their muscles.

This terrific long article in the Monthly (unlocked and free at time of writing, although I recommend subscribing) was the first time I really engaged with the issue.

It turns out a major case is running in the Federal Court with the ACCC doggedly pursuing Coles.

I knew Coles and Woolworths were tough on their suppliers. But I didn’t realise how much they had in common with Don Fanucci at the start of the Godfather II.

In 2011, Coles demanded from its suppliers a “rebate” for “efficiency improvements”. The Monthly says they were very significant, at up to 1 per cent of total sales.

“At a meeting with Red Bull on 19 August 2011, Coles managers Simon Gillies and Philip Armstrong claimed that they had cut $400,000 from the energy drink company’s supply cost. In return, they sought a $200,000 rebate.

Red Bull’s representatives asked how Coles had arrived at those figures. Gillies and Armstrong did not provide substantiation. Red Bull refused to pay the rebate, having calculated that Red Bull’s total costs in serving Coles did not even come to $400,000.”

The weaker the company’s bargaining position, the bigger the rebate.

“[Coles] refined the supplier designation into three tiers. Tier 3 included 220 smaller suppliers for whom Coles constituted a “very significant” part – at least 30% – of their business. These had the weakest bargaining position. From them, Coles sought an across-the-board 1% rebate, to raise $16 million.

Category managers were trained in “ask” scripts. There would be no negotiation on the rebate amount. The suppliers would be asked to consent within days. There would be no substantiation of the nature of the savings Coles was claiming. Successful category managers would become eligible for “prizes”. If suppliers did not pay, the category managers were authorised to “escalate” the matter to their “business category manager”, who was likewise authorised to escalate it to the general managers Dymond and Pearson, even to Durkan himself. The scripts included “commercial consequences”: an end to supply contracts, a “range review” of current products, an end to data-sharing agreements, or all of the above.”

Here’s a quote from the man who runs the ACCC, Rod Sims.

“These were seriously large demands, put on these companies with threats. If these allegations are proven true, that is not the sort of behaviour you want in Australian business. It’s corrosive, we believe, of the effective working of a market economy.”

So what can you do? Shop at Aldi? They stock even fewer brands and their prices are even lower. I’m not exactly sure that will help.

Aussie Farmers Direct is probably the best choice if you care about suppliers – it seems to have good relationships with farmers. I used to get things delivered from them and the quality was pretty good – I stopped because at the time they only did fresh food.

Another option is to support the MPs who supported this Reducing Supermarket Dominance Bill [Wilkie, Xenophon, Katter]. Demanding the big supermarkets sell half their stores is an ambit claim, but perhaps something can be done. On this issue it should be possible to unite the Nationals in the Coalition and the Cross-benches, you’d hope.

I also learned from the Monthly that at their liquor outlets (Coles: Liquorland, Vintage Cellars and First Choice; Woolworths: Dan Murphy’s and BWS) the big two own a vast number of the brands on sale. Basically, they are fancied-up home brands! You can see the list here: http://whomakesmywine.com.au/thelist.html.

Confession: Just remembered. I own shares in Woolworths. Seems I may be arguing against my own financial interests here!

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thomasthethinkengine

Thomas the Think Engine is the blog of a trained economist. It comes to you from Melbourne Australia.

7 thoughts on “Coles and Woolworths – Super Market Power”

  1. Your blog posts are normally so informative, and well considered – this one is really below your normal standard!

    So, what exactly is the economic issue here? As you say, Coles and Woolworths are a claimed ‘duopoly’, but seem to exhibit none of the traditional characteristics of imperfect competition.

    Yes, they are hard on suppliers – maybe sometimes even ‘unfairly’ so (although this is an emotive claim, not an economic one).

    As far as I can tell, intense competition betwen Coles and Woolworths drives down prices for consumers, and forces them to innovate on their product offerings (offering generics, introducing online shopping, etc). The effects of this intense competition are forced through the supply chain, requiring suppliers to find efficiencies too. How is this a bad thing from an economy-wide perspective?

    You give the example of supplier rebates – aren’t these largely just transfers between the shareholders of one company (producers) and the shareholders of another (Coles/Woolworths)? And Red Bull is either imported or produced domestically under licence (therefore transfering licence fees overseas). Given Coles/Woolworths are largely Australian owned, I reckon it is probably welfare enhancing for Australian firms to force efficiencies on foreign firms (transfering rents in the process).

    So again I reiterate – what exactily is the issue? The vague idea of ‘dominance’ is silly, particularly if people make a firm ‘dominant’ through their purchasing choices.

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    1. Hi, thanks for the compliment, and for keeping me honest!

      I guess what I am saying, and could have spelled out more, is that they exhibit more of the characteristics of a monopsony than of monopoly – hurting suppliers not buyers.

      They aren’t a pure monopsony (duopsony?) but nothing ever is.

      Nevertheless, monopsony behaviour can cause deadweight loss and welfare effects.

      I will concede that every bit of lost welfare in the monopsony market leads to higher producer surplus or consumer surplus in the downstream market. But does it end up net positive?

      My first-year econ teacher, Stephen King, argues here it does not: http://economics.com.au/?p=4537

      I’m not saying that’s the final word on the topic, cause I have no particular love for farmers, etc. They get a great deal, politically. But I think there is a real market power issue in this market.

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      1. Yes, in theory duopoly behaviour can result in deadweight loses. This would occur if, after eliminating competition, the market participants raised prices and/or restricted supply to the market.

        Do we see that here? As you said, Coles and Woolworths are hardly ‘cosy’ and are ruthlessly competitive against each other (to the extent they are prepared to break enforceable undertakings from the ACCC over petrol discounts!).

        Yes, they might have reduced the shelf space for non-generic products, and some people might prefer those products. Yes, they might have made it unviable for an inefficient local supermarket (but one who knows all the locals’ names) to exist, and people don’t like that.

        But that is the effect of competition – some products require scale to exist at all, and grocery retailing looks to be one of them. Some people lose out, but given it is the result of voluntary trades made by the majority of the population, it is difficult to content that Coles/Woolworths’ behaviour is not net welfare enhancing.

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      2. “it is difficult to content that Coles/Woolworths’ behaviour is not net welfare enhancing.”

        It isn’t – and I would say the welfare of the general population has been badly served by the two major supermarkets – just check out how fat Australian’s have become as they have increased their market share. The way duopolies restrict competition is through barriers to entry. They already have prime locations of which are in limited supply. I personally detest shopping at either of the two majors because I know I’m getting ripped off and I also know that they are run by inward looking-profit driven bean counters who are cynical and exploitative. They are at least a decade behind the leading supermarkets in the world and still haven’t changed their practises much in the face of competition from ALDI. I still shop there sometimes simply because there isn’t any other alternative in some locations – but when I do my spending there is not a revealed preference – my preference would be to close them down.

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  2. Sure woolies and coles are hard on their suppliers but isn’t that capitalism. The blanket 1% rebate is just a lazy way of negotiating a new price. They have so many suppliers it’s easier to cut all prices 1% than go through each supplier product by product. Coles and woolies are big bureaucracies. Who else cuts all suppliers by a set percentage? The government’s efficiency dividend springs to mind. Rather than go through each spending program to see where savings can be made, cut everyone by 2%. If the political fallout is too hot you can always find some extra money.

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    1. I forgot to add that theory predicts additional suppliers will be drawn to an industry where duopolists are making super profits. We might have lost some small chains but Costco and Aldi have arrived and Lidl is talking about it. To me that indicates the market is pretty competitive. The fact that higher margin supermarkets like Carrefour and Tesco haven’t tried to establish here underlies how competitive it is. But Rod Simms is right. You can still break the Trade Practices Act in a competitive market.

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