Competition policy in the food industry

1
Competition policy in the food industry

• Lectures 33 and 34.
• Economics of Food Markets
• Alan Matthews

2
Market power in the food chain
Input suppliers
Farmers
Price squeeze
Processors
Retailers
Consumers
3
Lecture objectives

• How can market power in the food industry be
  addressed?
• Countervailing power
• Government regulation
• Competition policy

4
Reading

• UK Competition Commission Report 2000
• Emerging Thinking 2006
• Groceries Order reports

5
Countervailing power

• Farmers can attempt to countervail through
  collective action and cooperative marketing
• Cooperative action designed to improve farmers
  share of value added through
• vertical integration (dairy coops, horticultural
  producer groups)
• Improved bargaining position (liquid milk
  suppliers) Concept due to Galbraith (1968)
• Requires special exemption in the US from
  anti-trust action under the Capper-Volstead Act
• More extreme voices see collective action as a
  way of enforcing supply control
• Vertical integration as an individual farmer
  strategy

6
Government regulation

• Many European countries have regulations designed
  to try to protect small retailers from
  competition from large multiples (loi Galland in
  France, Groceries Order in Ireland until
  end-2005)
• We examine the Groceries Order debate

7
Competition policy

• Curtailing restrictive practices (collusive and
  cartel and price-fixing behaviour)
• Preventing abuse of a dominant position (Irish
  Sugar)
• Merger control preventing a dominant position
  from arising
• State aids (Enterprise Ireland proposal to reduce
  number of beef processors)
• Encouragement to new entrants and reducing
  barriers to entry (planning)

8
UK Competition Commission report into food
retailing 2000

• Perception that grocery prices in the UK tended
  to be higher than comparable EU countries
• Apparent disparity between farmgate and retail
  prices
• Continuing concern that out of town supermarkets
  were contributing to the decay of the high street
  in many towns.
• Barriers to entry limiting competition
• The level of supermarket operators profitability
• Concerns about the intensity of competition
  between supermarket operators
• Relationship between supermarket operators and
  their suppliers

9
UK Competition Commission report into food
retailing 2000

• UK food prices declined in real terms from 1989
  to 1998
• but international comparison of grocery prices,
  allowing for quality and tax differences, showed
  that in late 1999 UK prices were on average 12 to
  16 per cent higher than those in France, Germany
  and the Netherlands.
• However, comparison was very influenced by value
  of sterling which could distort the comparison by
  between 7 and 17 per cent.
• Overall profitability of the industry could not
  be considered excessive over period 1996 to 1999.

10
UK supermarkets profitability
Higher gross margins reflect higher share of
own-label products where various costs usually
borne by food manufacturer are borne by the
retailer The very similar operating margin
despite higher gross margin indicates that cost
base of UK supermarkets is higher (higher land
and building costs) Overall Commission concluded
that profitability of UK retailing was not
excessive Source Competition Commission 2000
11
Potential anti-competitive practices identified
by the Commission

• a) adopting pricing structures and regimes that,
  by focusing competition on a relatively small
  number of frequently purchased product lines,
  restrict active competition on the majority of
  product lines
• (b) selling, on a persistent basis, certain
  frequently purchased products either below cost
  (ie at a negative gross margin) or at retail
  prices that do not cover all direct costs
• (c) setting retail prices across different stores
  in different geographical areas in the light of
  local competitive conditions, such variation not
  being related to costs
• (d) setting the prices of some own-brand products
  in relation to their branded equivalents rather
  than to their underlying costs and
• (e) making changes to retail prices for some
  products that do not sufficiently rapidly reflect
  changes in their corresponding wholesale prices.

12
UK Competition Commission findings on limited
price competition

• Issue is whether supermarkets just compete on a
  limited number of KVIs, thus allowing them to
  charge higher (excessive?) margins on other
  products (price focusing)
• Consumer surveys highlight the importance of
  prices on limited number of frequently bought
  products price focusing exacerbated by
  promotional activity
• Evidence that margins vary greatly (20-50)
  across products. Supermarkets price in relation
  to demand rather than cost
• Supermarkets claim they regularly monitor prices
  on wide range (gt1,000 products)
• Commission found that price focusing does distort
  competition but, in view of overall low
  profitability of supermarkets, does not act
  against the public interest

13
UK Competition Commission findings on below
cost selling

• Found that all the main supermarkets (with
  exception of MS and Lidl) engaged in below-cost
  selling.
• Commission held that, despite its benefits to low
  income consumers, it damaged smaller supermarkets
  and independent outlets, and when practiced by
  supermarkets with market power was against the
  public interest.
• Did not find evidence that below cost selling was
  motivated by predatory concerns.
• Noted administrative difficulties in defining
  below cost selling and legitimate exceptions (end
  of stock products, close to sell by date)

14
UK Competition Commission findings on below
cost selling

• Quoted the 1991 Irish Fair Trade Commission
  report that the ban on below cost selling had
  resulted in higher prices overall, a decrease in
  price competition and an increase in margins
• Considered a rule requiring below cost sellers to
  sell without quantity limits to anyone who wished
  to buy
• Argued that remedies would be disproportionately
  costly in relation to the adverse effects
  involved.

15
UK Competition Commission report into food
retailing 2000

• They found that prices varied in different
  geographical locations in the light of local
  competitive conditions (price flexing). when
  practiced by supermarkets with market power was
  against the public interest.
• They found that competition focused on KVIs and
  that this distorted competition in the retail
  supply of groceries because not all products are
  fully exposed to competitive pressure. However,
  concluded that practice did not contribute to
  excessive profits or lead to consumers paying
  higher prices overall.
• They dismissed claim that own label products were
  priced in relation to branded products (umbrella
  pricing) rather than cost and were thus
  excessively profitable.

16
Groceries Order

• Long history of regulating competition in the
  retail grocery trade. Selective dates
• 1956 Order prohibited resale price maintenance,
  collective price fixing by suppliers and
  wholesalers, withholding supplies from a retailer
• 1973 advertising price of goods below cost was
  prohibited
• 1987 Order represented a fundamental shift by
  introducing a ban on below invoice price selling

17
Groceries Order

• Ink was no sooner dry than Order was reviewed
• 1991 Fair Trade Commission recommended by 2-1
  majority to abolish the Order
• 2000 Competition and Mergers Review Group
• 2004 National Competitiveness Council
• 2005 Department of Enterprise Trade and
  Employment Public Consultation Process
• 2005 Joint Oireachtas Committee on Enterprise and
  Small Business
• 2005 Consumer Strategy Group

18
Groceries Order

• Key questions
• What was impact of the Order on competition?
• What was impact of the Order on slowing
  structural change and defending position of the
  independent retailer?
• What was impact of the Order on prices?

19
Groceries Order effect on competition

• Order intended to prevent below-cost selling seen
  as a predatory device which would ultimately
  limit competition
• Order makes it illegal to sell particular grocery
  products below the net invoice price
• Predatory pricing anyway illegal and very
  unlikely in the retail trade

20
Groceries Order effect on competition

• Predatory pricing should be distinguished from
  practice of loss leading
• Loss leading not necessarily welfare-reducing
  (Walsh and Whelan)
• But GO did not prevent below cost selling, it
  prevented selling below net invoice price
• Effectively reintroduced resale price maintenance
  by allowing manufacturers to set retail price
• Off invoice discounts could not be passed on to
  consumers

21
Groceries Order effect on retail structure

• Ireland has more concentrated retail structure
  than UK which does not have GO
• Supermarkets not competing directly with the
  independent sector which is now concentrating on
  convenience
• Retail development can be partly controlled
  through planning guidelines

22
Groceries Order effect on prices

• Hard to disentangle effect of GO from other
  influences on food prices
• Food prices have risen less than general
  inflation
• .. But GO prices have risen faster than non-GO
  prices
• .. And Irish prices higher than elsewhere
• Collins and Oustapssidis (CO) show impact of
  Order econometrically

23
Groceries Order effect on prices

• CO hypothesis was that the GO increased retailer
  gross margins in the affected product categories
• Tested hypothesis in the processed and preserved
  fruit and vegetables sector
• Average weighted retail prices for 13 items were
  compared to wholesale price index for NACE 414
  sector to construct a processor-retail price
  spread

24
Groceries Order effect on prices

• Model to be estimated
• Retmar ConstCr4Advgval88
• GDPCPSterlLegis Dum414
• Retmar retail margin
• Cr4 concentration measure
• Advgval measure of retailer advertising
  intensity the more advertising, the smaller the
  margin
• GDPCP control for changing demand conditions
• Sterl dummy for exit of sterling from EMS
• Legis dummy for period when GO was in effect

25
Groceries Order effect on prices

• Model was estimated using quarterly data from
  1984 to 1994
• Positive sign on LEGIS variable suggesting that
  the GO increased retailer margins by 4.6
  percentage points

26
Impact of repeal of the Groceries Order
Source Bord Bia, Export Review and Outlook
2006/07