Economies of bullying

The government has belatedly reacted to the long-running scandal of the supermarkets’ treatment of their suppliers by announcing that it will establish an ombudsman to enforce a new code of practice.  Unfortunately, it misses the point, is the wrong solution and won’t work.   The Lib Dem plan is little better.

Something certainly needs to be done; the market may perhaps have been competitive 20 years ago but it’s evolved into a very unhealthy oligopoly where a tiny group of companies sit astride the route to market for a significant fraction of the nation’s primary output.  As the supermarkets diversify this increasingly includes manufactured goods, not just food products.   Like medieval robber barons they are making a good living off their control of vital trade routes.  

What they say goes and they have become notorious for their high-handed treatment of suppliers; they long-since moved from the economies of scale to the economies of bullying.   The supermarkets justify their behaviour by saying that they merely aim to get the best price to pass on to their customers.  Like hell they do!   If you think you benefit just look at how, for instance, milk margins have changed over recent years.  

 

(If the details are hard to read click here for a link to the original.  Blue is farmgate price, red is processor gross margin and green is retail gross margin.  The timeline runs from Jan 1994 to Jan 2009)

Retail prices have risen by around 50% over the last 15 years and this is almost entirely due to a massive increase in retailers’ gross margins – the difference between their buying price and their selling price.  Over the same timespan farmers have done a splendid job keeping prices roughly level despite high cost inflation; the only substantial uptick in farmgate prices in over ten years was in 2007 as a result of soaring fuel prices.  The only winners in this business are the supermarkets; consumers are emphatically not winners.

This has come about because in the ‘markets are God’, ‘deregulated’ world we have lived in since Reagan/Thatcher, size is hugely important in retailing.  Of course, size isn’t the only thing that matters (and the big retailers are pretty smart and well-managed companies by any standards) but, other things being equal, if you are bigger than your rivals you can screw your suppliers for better prices leading to higher gross margins.   It may be only a few percentage points advantage, but in retailing that is a LOT; if maintained over several years it amounts to an unbeatable advantage and before long the bigger players are in a position to squelch and/or buy out some of their competitors and tighten the noose on the rest.  In simple terms that is why the two biggest firms, Tesco and Asda, have captured so much of the growth in the market.  The others struggle to keep up.

Moreover, the established players face little threat of competition from innovative new entrants or rivals with a different proposition – for instance higher quality or local produce or pack sizes tailored for one person households etc.  (There is a partial exception to this; foreign firms like Aldi and Lidl that are already powerful players in their home markets can make some inroads but I would like to see home grown competitors given the same opportunity).

So at one and the same time we have a market that is highly competitive in some ways and highly uncompetitive in other ways.   The big firms constantly push against each other – but only within limits; one firm might win customers by slashing the price of, say, milk, but they know that their rivals, with similar cost structures, would simply retaliate.  The end result of any such plan would be to shoot oneself in the foot so it rarely happens.   Instead what we get is a follow-my-leader situation where the biggest player, the one with the most buying power (Asda by virtue of its Wal Mart link), sets prices just a fraction lower than its rivals to keep the high ground while simultaneously maximizing gross margins.  The other players match prices where they can but commonly resort to confusion marketing – deals designed to obscure the actual price.  Hence Asda advertising tends to emphasis ‘everyday low prices’, the others tend to advertise ‘offers’ and ‘deals’.

For suppliers the impact is life-defining, often life-threatening, so they have been the source of most complaints.  Customers are less aware; retail spending is only a part of their total spend, confusion marketing is a powerful weapon and supermarkets constantly advertise what good value they give while discreetly endorsing the notion that the alternative (and hence the benchmark) is the corner shop even though this is patently nonsense.  The debate is framed as suppliers (and small shops) wanting to push prices up while the (virtuous) supermarkets struggle to keep prices down.   

Progressives have made a huge error in not challenging this framing head on.   It has allowed the supermarkets to inflate their margins at the expense of both suppliers and the public.  They are protected from real change as long as the public believes that they are a ‘Good Thing’ because in a world of focus group-driven politics what masquerades as political leadership is actually just following public opinion. 

How much might the public benefit if the competition was working properly?  Aldi and Lidl claim to be around a third cheaper which is co-incidentally (or perhaps not!) exactly the same saving that customers would make on milk if gross margins returned to their former level.  The biggest winners of a more competitive market would be those on low and fixed incomes  because food is a bigger percentage of their disposable income.  These are the very people we should help most.  (A rhetorical question:  are trends in retailing part of the reason that inequality has increased so much over the last 30 years?)

Despite the failure to push back against the oligarchs’ clever framing, a background of mounting complaints has at last forced some action.  There have been several investigations since 2000 leading eventually to a referral to the Competition Commission and a report by them in 2008 recommending the establishment of an ombudsman to resolve disputes between supermarkets and their suppliers.   Just months before an election the Conservatives, followed by Labour have come out in support of an ombudsman, a move Tim Farron correctly dismisses as a “fig leaf solution”.  

Indeed it is.  It completely misses the point about retail margins and selling prices and there is no reason to think it will be an effective mechanism even on the supply side; the farming community is distinctly underwhelmed.   

Regulators, whose task it is to intervene in the market, are a poor tool at best especially when confronted by powerful and politically-connected regulees.   They are at perennial risk of regulatory capture and/or being neutered by a nod and a wink from government that itself has been captured by vested interests and only wants only ‘light touch’ regulation (despite what it may say for public consumption).   We have seen just how badly this can all go wrong with the financial meltdown; why would this case be any different?

The BBC reports (via the first link in this post) that the ombudsman is to have a budget of just £1.3 million per annum, only enough for a staff of perhaps 15 or so plus a modest amount of consultancy.   While I do not believe that size equals efficiency (often it’s the opposite in fact), this is simply not credible as a team to monitor thousands of suppliers and tens of thousands of products.   Moreover, even if suppliers’ complaints are initially anonymous, the ombudsman cannot investigate far without it becoming obvious who the complainant is and so risking retaliation by the supermarkets.  

The most we can expect is a handful of high-profile cases to ‘prove’ the ombudsman is effective while real change is deferred for another ten years.

Unfortunately, Tim Farron’s proposal is little better; his call for an ‘Independent Food Market Regulator’ is just a toothier version of the ombudsman and would suffer all the same drawbacks except that its very existence would imply a government more committed to action. 

Does that mean that the situation is hopeless?  Not as all; only that it requires a different approach but unfortunately this post is already too long so it will have to wait for another day.  (Hint: the root of the problem is that size is an important determinant of competitiveness – the large get larger and the small get smaller – until the market degenerates into an oligopoly that it no longer serves the public interest).

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4 responses to this post.

  1. Posted by David Boyle on 6 January 2012 at 12:54 pm

    I absolutely agree. Why are Labour and Conservative so forgiving of monopoly power?

    Reply

  2. […] Liberal Eye blog makes a convincing case that the result has been ‘efficient’ only in the sense that it has been efficient at extracting […]

    Reply

  3. […] the top of the food chain have the power to dictate terms so forming an effective oligopsony as described in an earlier post.   This has enabled them to pump up gross margins year by year; they rip off consumers while […]

    Reply

  4. […] to faith that competition reliably delivers in sectors other than energy.   However, here too evidence is piling up that not all is well with the received wisdom although, inevitably, the picture is complicated so no simple statement suffices.  I see at least […]

    Reply

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