Competitive balance

MMR, Sept 8, 2008 by Sue Mitchell

SYDNEY -- Australian grocery retailers are facing a raft of new measures aimed at improving price transparency and reducing barriers to entry for new players following a six month inquiry by the competition regulator.

The Australian Competition and Consumer Commission's (ACCC) 642-page report into the $70 billion ($61 billion U.S.) grocery trade found the industry "workably competitive," and uncovered no evidence of price gouging of consumers or exploitation of suppliers.

But the commission found that competition was not as vigorous as it could be, due mainly to such structural impediments as outdated planning and zoning laws that limit access to new sites, restrictive covenants in retail lease agreements and a near monopoly in the supply of groceries to independent supermarkets.

ACCC chairman Graeme Samuel also said the major chains--Woolworths Ltd. and Coles Group--and wholesaler Metcash had "little incentive to destroy the current balance with vigorous price competition."

The commission recommended measures, including the mandatory introduction of a nationally consistent unit-pricing regime, changes to laws controlling "creeping" acquisitions by major chains and an overhaul of state and local planning and zoning laws to facilitate the entry of new players. Restrictive covenants, which are used by existing tenants to prevent the entry of competitors into shopping centers, will be further investigated.

The horticultural code of conduct, which governs transactions between farmers and buyers, may also be toughened and extended to include the major retailers.

Australia's Labor Government, which initiated the grocery inquiry in January as part of a 2007 election promise to tackle fast-rising grocery prices, has backed the recommendations.

It has also ordered the commission to establish a grocery price-monitoring web site, Grocery-Choice, to help consumers find the cheapest basket of groceries in their neighborhoods.

The average Australian family spends 12% to 14% of its after-tax income on groceries and over the last 10 years food prices have risen faster than overall inflation.

The commission found that grocery prices had risen 21% since 2003, but only one twentieth of that was directly due to expanding profit margins at the major supermarket chains. Most of the increase was due to adverse weather, including drought and cyclones, and the global commodity price boom, which had not only pushed up the price of wheat, rice and dairy products but had sent farm inputs soaring.

The recommendations were welcomed by the major grocers, but fell short of the expectations of smaller players like Aldi Australia, Pick 'n' Pays Franklins chain, independents, and consumer and farmer groups. Analysts said the recommendations would impose additional costs on retailers and could possibly curtail expansion if creeping acquisitions were blocked and new entrants competed for space. The measures could also increase pressure on margins as consumers trade down to cheaper groceries.

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For example, Citigroup believes unit pricing could cost the industry $810 million in forgone revenues and slice between 4% and 6% from Coles' and Woolworths' packaged grocery earnings.

However, the renewed consumer focus on price could also boost sales of private label groceries, to the benefit of both retailers.

Analysts said the overall financial impact on the major retailers was likely to be immaterial. "There do not appear to be any fundamental changes to the industry structure/returns for the listed players in the near term," said J.B. Were, an analyst with the Goldman Sachs Group.

One exception is wholesaler Metcash, which supplies 2,500 independent grocers, most of which trade under the IGA and Foodworks banners. Metcash faces further scrutiny after being accused of extracting "monopoly profits." The commission said excessive wholesale pricing prevented independent retailers from competing effectively against the major chains on price alone.

While the commission conceded that it would be difficult for a second major wholesaler to enter the Australian market and made no recommendations against Metcash, it may be willing to authorize collective bargaining to give independents more negotiating power.

Metcash and other critics had previously argued for measures to cap the market share of Woolworths and Coles, claiming the major chains accounted for close to 80% of packaged groceries, making Australia one of the most concentrated markets in the world.

The commission found that Woolworths and Coles accounted for 70% of packaged grocery sales, about 50% of fruit and vegetables sales and between 50% and 60% of dairy and delicatessen sales.

The majors also clearly dominate the large-format supermarket scene, holding 87% of supermarkets encompassing more than 20,000 square feet and 96% of those larger than 30,000 square feet.

But the commission found that Coles and Woolworths' earnings were "reasonable" compared with their international peers.

It ruled out a market share cap on any single retailer or separating the wholesale and retail operations of Coles or Woolworths, saying such measures would adversely affect efficiency and could potentially raise grocery prices.