Is it possible to reorganise supermarkets to introduce genuine competition?
Economists have a precise definition of a competitive market. It is where no firm is a price setter. That requires many small firms in a market with ease of entry and exit. Economic theory shows that such markets are beneficial for consumers. They may be a bit rougher for the firms; as John Hicks remarked, the advantage of being a monopoly is the quiet life.
Such purely competitive markets are rare. At the other extreme is a market dominated by a single firm – a monopoly – which has considerable discretion over setting prices. Practically, a monopoly may not supply the whole market, just most of it. (It may even find it beneficial to allow smaller firms to operate, simplifying its management.)
In between, there are a host of market forms. Most common in New Zealand are oligopolies, where a few firms dominate the market. Examples include air travel, hardware stores, electricity, petrol, banks, supermarkets and telecommunications. (That’s a lot of consumer spending.)
Oligopolies will tell you they compete against one another – but this is not the competition that occurs in a purely competitive market. If there are only a few significant firms each firm can work out what its competitors will do so they have some control over the prices they set. There may be no need for a formal cartel – a collective conspiracy against the public – to get an outcome that an illegal cartel would generate. That is why governments intervene in highly concentrated markets.
The Coalition Government has focused its efforts on supermarkets which are ‘duopolies’ – where just two of them dominate the market. The effort has been led by the Minister of Finance. (She would normally be considered too busy with economic and fiscal management to be concerned with a sector which did not involve government funding.)
The government has not been very successful. It tried to induce up to 24 international supermarket chains to enter the market. Not surprisingly, they were not interested. The costs of entry – setting up a chain in New Zealand – would be high. Because of economies of scale an entrant would need significant market share. It would be expensive to exit if they failed. Whether the consumer would have benefited much, is a moot point. There would have still been only three significant competitors and implicit collective pricing would still be relatively easy.
After three years, the National Party’s election platform promises to start splitting one of the chains (Foodstuffs) into two separate entities (Pak'nSave would be one, New World and Four Square the other), while leaving Woolworths untouched. That would lead to three significant competitors. The NZF policy is similar. The Greens propose a third chain by nationalising 120 existing supermarkets into a publicly owned chain called ‘KiwiMart’. (It is not clear where it expects to find the funds to buy out existing owners.) One may be sceptical that the three significant supermarket chains will make much difference.
ACT opposes such interventions, instead favouring the reduction of planning and regulatory barriers to allow new competitors to enter the market. But such changes won’t get over the substantial costs of entry and exit. (You can bet your bottom dollar that the five (of the 24) international chains which seriously investigated entering the local market, discussed these barriers with the government and concluded that even if that those barriers could be reduced, the costs of entry and exit would still be too high. *) We can discount the ACT policies as having much effect.
From an economist’s perspective, the Labour Party’s proposal is the most interesting. It wants to force both Foodstuffs and Woolworths to separate their wholesale and retail operations, so they operate independently. Supermarket chains are oligopsonists (a rather clumsy term, analogous to monopsonist, in which the buyers control the demand for a product or service from many sellers). They exercise their market power to keep down supply prices. (Almost certainly some, but perhaps not all, the price reductions will be passed onto the oligopsonists’ buyers – household consumers.) Labour is arguing that the problem is ‘vertical integration’ of wholesalers and retailers – vertical integration is the business strategy where a company owns or controls multiple stages of its supply chain. Galbraith argued that duopsonists confronting duopolists resulted in countervailing power which benefited consumers. **
It is not clear what this proposal might mean. Would the retailers be allowed to go direct to suppliers, cutting out the wholesalers? Would the wholesalers be allowed to supply households direct, cutting out the retailers? (An increasingly feasible option, given that the rising significance of home delivery.) If the answer to both questions is ‘yes’, would not that mean the market would evolve to four suppliers with a continuing oligopolistic structure? Labour might argue that four significant suppliers would result in a more ‘competitive market’ than three. (Split Foodstuffs and there would be five.)
Some have drawn attention to the success of separating Telecom into Spark and Chorus. The analogy does not work. Telecom had a monopoly on supplying the cable connection to households and businesses (Chorus’ activities) which it used to benefit its value-added services (Spark’s). That the latter were overly profitable was demonstrated by the Telecom share price falling substantially when the separation was announced. Shareholders judged that losing the connection monopoly would undermine the profitably of the value-added services. They were right; today Spark is a very ordinary firm compared to high-flying Telecom.
The pricing of Chorus, which is still a monopolist, is restricted by a revenue cap and price-quality regulation set by the Commerce Commission. I do not think price controls would be an effective means of restraining the supermarkets. Typically, they have more than 30,000 different items (stock units) for sale – a price controller’s nightmare.
In summary, it seems unlikely that a third or fourth significant supermarket chain would undermine the oligopolistic nature of the market – a fifth might. It is not obvious that relaxing barriers to entry or price controls would have much effect either. However, I am intrigued by the possibility of measures to reduce the power the supermarkets have over their suppliers. But it would probably increase prices to consumers.
Sometimes there are no easy solutions to economic problems despite what the politicians promise.
* Almost certainly at least one of the five would have been a ‘low-cost supermarket’ chain with a different business model based on fewer items (5000 instead of 30,000) and fewer staff.
** John Kenneth Galbraith (1952) American Capitalism: The Concept of Countervailing Power.