The Australian Grocery Industry

According to Hubbard et. Al., (2010) perfect competitions takes place in markets where no businesses in an industry have market dominance as there are many sellers and buyers and there are no barriers to enter that particular market as a free flow of information exists.

According to the Australian Competitions and Consumer Council (ACCC) the Australian grocery industry is dominated by two key players, Coles and Woolworths, who together have around 80% market share. While there are other competitors in the market such as independent wholesalers and retailers including a variety of speciality retailers such as independent grocery associations (IGA) and Aldi; Coles and Woolworths have a major influence to control prices which in the long-run would see these smaller retailers either merge through acquisitions to compete or close their doors as they can’t compete. In the short term there are benefits to consumers with lower prices and better value for money. However if this dominance were to continue the Australian grocery industry may see the effects of a duopoly which could have some serious implications to consumers as there would be no other choices available in the market and the opportunity costs would be minimised.

Coles and Woolworths have more retailer shop fronts than their competitors (Bonn, 2004) they’re in more towns than their competitors and demonstrate better availability of grocery products in the Australian grocery industry. Hubbard et al (2010) addresses that in economic terms, a perfect market indicates many buyers and sellers, all products sold by all firms must be identical and there are no barriers to enter the market. Given Coles and Woolworths market dominance many competitors are unable to compete on price. While perfectly competitive markets are established by the relationship of demand and supply any competitor or consumer within this market would have no adverse effect on the market price as they would need to accept and acknowledge the market price. The current retail grocery market doesn’t indicate this type of behaviour as Coles and Woolworths do not accept the market price as they set their own price relative to not only competition but also to the trend of buying behaviour and to gain profits which in the long-term only these retailers would benefit from cost reductions hence the dominance in market share.

It should be noted that the more a product sells at a grocery outlet the cheaper that product will be at that particular outlet (Smith, 2006). As the costs associated in buying products from the wholesaler the more bargaining power they will have. This can be said for Coles and Woolworths as the market leaders more people will tend to buy products at these stores rather than competitors as the customers willingness to pay is driven by satisfaction for lower prices each time they buy resulting in a marginal benefit.

Smith (2004) indicates that Coles and Woolworths have used technology as a method to lure in potential consumers. Banking facilities can be found at all of these stores which give consumers convenience to conduct banking transactions before or after they conduct their shopping. Strategic alliances with certain banks give Coles and Woolworths the ability to purchase goods with their specific brand of credit card/s such as the Woolworths master card which gives consumers added benefits such as frequent flyer points. This can increase the amount of purchases as consumers may be influenced to purchase more to gain points at their stores as opposed to purchases made at other competitor locations. An additional rewards program card stores information so clients can get discounts when shopping at their other stores and gives these major players marketing data to analyse what products are popular at certain prices. This is evident in petrol consumption (Smith, 2004). Coles and Woolworths have affiliated themselves with Shell and Caltex, respectively, which allows buyers to save an amount of fuel if they shop at their stores. In economic theory a change in technology will either cause a supply curve to shift. These incentives can cause an increase of demand for goods which in turn would decrease the level of supply causing prices to increase. If the grocery industry is a perfectly competitive market these companies would not be able to affect the market price. (Hubbard, et. al., 2010)

The ACCC suggested that reducing barriers to new entrants for retail grocery stores could potentially improve the competitive landscape in Australia. In this regard some barriers can be identified. In a perfect market there are no barriers to entry (Hubbard, et. al, 2010). In the Australian retail grocery market barriers of entry are evident. For example the scarcity of land for new entrants into these markets is limited by the lack of appropriate sites as the top store sites are mostly all taken by these large players. Generally leases are signed for long periods of time and in order to cease these agreements high penalties are usually enforced causing competitors to have a poor market position (Smith, 2004). With reference to the Trade Practices Act 1974 (Smith, 2006)) these lease restrictions could highlight concerns of significantly lessening competition in a relevant geographic area. The ACCC suggests this will put a strain on independent retailers as these large supermarkets are given rights to continue to effectively as a monopolistic business. Perfect market conditions do not exist in this industry and barriers to entry are apparent.

In a perfect market, products can be compared equally (Hubbard, et. al., 2010). The retail grocery industry doesn’t allow this to be easy. Unit pricing can result in a gain for the retailer and a disadvantage for the consumer. For example when comparing a vegetable such as beans at different retailers they each may have unusual weights and usual pricing mechanism. According to Bowen (2009) unit pricing can minimise prices to a per gram or per litre relative value, depending on the suitable value for the good. Perfect market conditions reveal that a change in higher price will cause consumers to shop around for a cheaper alternative (opportunity cost). While in an imperfect market a change in higher price will not necessarily change the amount of quantity demanded. As there is no other alternative (i.e. competitors) consumers often pay for the price increase. However, the customer may have a choice to substitute this product with a cheaper alternative at the same store as opposed to a competitor which would limit competition and subsequently increase revenue at that particular retailer.

Imperatively, the ACCC suggested that the level of competition in grocery retailing has not been a substantial contributor to food price inflation in Australia (ACCC, 2008). While food prices were reported to have increased a range of other factors including high international demand, increased costs of production and adverse domestic weather conditions also participated to high price inflation.

Such findings are consistent with a ‘workably competitive’ industry (Smith, 2004). This means that there are several firms selling closely related products; the firms are not colluding; and incumbent firms do not face substantial long-run cost advantages. On the other hand, consumers are able and willing to switch between alternative suppliers. This is the type of competition that exists is most Australian industries. It is to be contrasted with the theoretical concept of ‘perfect competition’, where many producers sell homogeneous goods to many identical consumers. Such a concept can be a useful analytical tool, but it will rarely (if ever) match real world markets where firms are able to legitimately differentiate themselves and earn economic profits.

Smith (2004) refers to workable competition as a market situation where a high degree of monopolistic power exists and there is sufficient competition between near-monopolies to protect the buyers from monopolistic abuse. Furthermore, efficient production exists without achieving the strict standards of perfect competition. The concept of workable competition is often applied by governmental authorities in guiding regulatory policy for competition policy.

A recent study by the ACCC in 2008 revealed that supermarket retailing in Australia is ‘workably competitive’. The analysis makes mention that consumers are given a choice when they conduct their grocery shopping. Consumers are not limited to these larger retailers as there is a choice of other grocery stores, convenience stores and speciality retailers such as bakers, fruit and vegetable retailers and butchers etc.

An ACCC enquiry into the competitiveness of retail prices for standard groceries concluded that store switching is a reality for consumers as 85% of consumers visited more than one store in a monthly period. More so, over a third of these shoppers visited speciality fresh store outlets to buy fresh produce. This provides some evidence that consumers are making a choice when deciding what they will consume especially when it comes to fresh produce and that non-supermarket outlets show signs of strength when competing (ACCC, 2008). However, depending on the amount of people researched will indicate whether the analysis concludes a valuable argument.

Differentiated products and services that reflect innovation on the part of sellers in response to the preference of customers, and prices that reflect the efficient costs of those products and services are evident in the grocery market. Smith (2004) argues that the number of offers in any market will change from time to time depending upon the success of the offer. Coles and Woolworths regularly monitor their competitors pricing and respond to price matching. This may indicate signs of allocative efficiency (Hubbard, et. al., 2010). Resources such as price matching have been used to reflect demand by consumers. Competition therefore increases allocative efficiency because these retailers use certain resources (price matching) more efficiently influencing consumers away from their competitors by method of price. This demonstrates that the concept of workable competition exists, as this can provide consumers with a satisfactory level of competition (ACCC, 2008).

Specifically, workable competition can be measured by microeconomic indicators such as profits, revenues, quantities, qualities, information, property and rights (Batey and Friederich, 2000). For example where Coles and Woolworth retailers exists, especially in shopping malls, there is evidence that other grocery speciality stores surround them (ACCC, 2008). There is a demand for certain products as mention previously fresh produce. The average shelf life of some fruits can be stored for upwards of a year in these large retailers while speciality grocers pride themselves on delivering quality fruits recently obtain by the primary producers (Smith, 2006). However, a growing trend for organisations such as Coles and Woolworths indicates a method of vertical integration (Stiegert and Kim, 2009), as their display of dominance when negotiating prices from producers is pushing smaller businesses or new entrants away from the retail grocery industry which poses a threat to consumers.

Stiegert and Kim (2009) argue that vertical integration is a structure of some businesses which all stages of the production of a good, from the acquirement of raw materials to the retailing of the final product, are controlled by one company.

The Australian grocery industry indicates that Coles and Woolworths have a business model that displays a vertically integrated structure. This may cause a barrier for new entrants entering into the market. Given the large market dominance (Coles and Woolworths 80% market share) of these retailers their bargaining power can influence a decrease in procurement prices which would decrease costs incurred by primary producers. This positions the larger retailers to influence and dictate agreements to food manufactures who subsequently push these changes back to the primary producer level (Stiegert and Kim, 2009). Smaller players in the market would have to compete against lower procurement costs by inflicting higher prices to the consumer which can cause a lack of consumer’s interest in buying their products in comparison to a cheaper, identical product at the larger retailers.

While productive efficiency may occur in the retail grocery industry for certain products such as staple items like flour and sugar, where a number of goods/services is produced using the least amount of inputs possible for cost minimisation other products such as fruits/vegetables may have dire value for consumers in the long run. Usually fruits/vegetables are bought at low prices by Coles and Woolworths who then add a margin to sell to consumers. These items may take upwards of a year to hit the consumers once they have been picked by the farmers so the quality of the goods is usually not as good as those bought by competitors at local fruit/vegetable markets. So in the long run while consumers may get a better price the opportunity cost is an inferior product. This not only poses a threat to the quality of fresh foods but also indicates that the retail buying power of these large retailers manipulates members of the supply chain i.e. primary producers and consumers (Hubbard, et. al., 2010) to benefit, mostly their own interests.

The Australian grocery market is indeed a challenging industry to get into given the market dominance of Coles and Woolworths and, at a smaller scale, IGA’s. However, new entrants into the market, such as ALDI in 2001, indicated that this can be done. ALDI identified a gap in this industry and developed a niche market need to consumers who wanted to save money by purchasing items without the accumulation of in store advertising or the use of plastic bags, less check-outs etc. This strategy was developed to reduce procurement costs and give value to potential consumers (Bonn, 2001).

For a new entrant to be successful there would be a need to carefully examine the specific market they wanted to cater for i.e. the ability to understand what level of demographics that are present in that area to determine buying behaviour of potential consumers. Apart from the need to develop a sound marketing plan new entrants would need to consider an economic perspective to understand the market. At a microeconomics level firms and individuals are motivated by cost and benefit considerations. Costs can be either in terms of financial costs such as average fixed costs and total variable costs or they can be in terms of opportunity costs, which consider alternatives foregone (Hubbard, et. al., 2010).

A new entrant may consider that there is a need for a fresh produce store in a market dominated by Woolworths where a niche opportunity would be present. Suppose these large retailers obtain information that a new entrant will be opening their doors in next to Woolworths. A strategy for the existing retailers may be to incorporate a price war by offering a price match for fresh produce. The counter argument is that the new entrant may advertise that there is no substitute for quality and that their products are of superior quality when comparing to Woolworths. The new entrants opening specials advertises that if customers spend over $30 they will receive 10% discount. Woolworths have advertised that for every $30 customers spend they’ll receive 10% off indicating a price match. The payoff matrix illustrates strategy A: where both businesses give a discount while strategy B: shows that both businesses do nothing. At the opening weekend of the new store consumers have a choice where to shop, many are enticed by the discounts of both retailers, some may choose to continue to conduct there shopping through Woolworths while other believe the quality at the new place will be better than Woolworths.

The new entrant and Woolworths have a choice, and can choose to offer the discount or not. For example, with a payoff matrix 100 equals Woolworths and 0 equals the new entrant. The following is a payoff matrix to illustrate the strategy created by the new entrant in comparison to the large retailers Woolworths.

In this case there are two strategies where both choose to offer the discount or not offer any discounts. If we admit mixed strategies (where a pure strategy is chosen at random, subject to some fixed probability), then there are three strategies. The first two indicate two where the probabilities are (0%, 100%) for new entrant, (0%, 100%) for Woolworths; and (100%, 0%) new entrant, (100%, 0%) for Woolworths, respectively. Another strategy is the probability for each participant is (50%, 50%).

While the ACCC has investigated staggering price increases with reference to Coles and Woolworths the findings indicated that there was no influence on price rises due to lack of competition and that a workable environment is present. The evidence in this paper suggest otherwise. While some aspects of workable competition are present the buying power of Coles and Woolworths is influencing price within the marketplace. Smaller competitors cannot compete adequately enough with these businesses. The scarcity of land presents a barrier for new entrants into the market place. The use of new technologies are being bought by Coles and Woolworths are pushing smaller players aside as consumers time values are important so a quicker, more efficient processing store is more attractive. As Coles and Woolworths are in direct competition with each other it is more beneficial for each of these competitors to increase their prices in sync as a price war will only deter consumers to smaller players (as price war indicates workable competition to value consumers). In the long run these methods would cause higher prices for products ultimately at the consumer’s expense.