Tuesday 22 March 2022

Are you underwhelmed? I'm not

It would be fair to say that the Commerce Commission's recent market study into the supermarkets left the commentariat distinctly underwhelmed: Bryce Edwards' Political Roundup had a useful summary of the immediate reactions and its title - 'Supermarkets win in the end' - captured the general drift (there are some follow-up reactions in his next few days' Roundups, here and here). 

That's partly the Commission's own doing. Its draft report had canvassed some radical proposals - potentially extending to "the structural separation of the major grocery retailers’ wholesale and retail businesses" (at 9.35.2) and "the facilitation of entry by an independent grocery wholesaler" (at 9.35.3), maybe even a government-owned or government-supported one (at 9.68). These were always unlikely to survive as final recommendations: the Commission had said (of structural separation) that it (and, I'd suggest, the other radical options) "would only be considered if other options were not feasible, had proved ineffective, or did not appear likely to improve competition within the desired timeframe" (at 9.64). 

But despite the implausibility of a KiwiShop anytime soon, in the meantime some people's hopes had got raised, and as a process issue the Commission might usefully have a think about giving a clearer steer in its draft reports on where it is thinking of landing along the final recommendation spectrum. It does no good to get a reputation for Crying Wolf.

All that said, I don't go along with the apparently prevalent perception that the Commission's recommendations were not proportionate to the issues involved. They correctly seized on the main point: the first best solution to inadequate competition is new entry - think 2Degrees shaking up Telecom (as was) and Vodafone, or Jetstar giving Air New Zealand the hurry-up -  and they identified a range of obstacles (planning laws, restrictive covenants, the overseas investment regime, the alcohol licensing regime) that could and should be cleared to make entry feasible. Good faith wholesaling to a new entrant is a useful starting point (I'd expected a bit more on access to a wholesale market, after seeing where the petrol market study had landed), and a code of conduct was always a certainty, following Australia's lead, to help address duopsony market power against suppliers. 

That package, and the threat of something heavier duty at a three year review if the shape of competition isn't looking better, looked to me to be an adequate policy combo. And I don't share the general pearl-clutching about its supposed timidity, for two reasons.

One is that I'm not convinced that there was such an enormous problem to start with. For all the jumping up and down about extortionate profits by the New Zealand supermarkets, the rate of return on the average level of capital employed in the New Zealand supermarket trade is not that different to the rate of return on the capital employed in the overseas supermarket game, as Figure 3.4 (below) of the market study showed. To explain this away, you either have to say an average is meaningless (no it isn't), or that all the overseas supermarket markets are rorts, too (no they aren't).


Return on capital employed is the best measure of potentially ineffective competition, but for what it's worth other measures of profitability (canvassed on pp60-64 of the report) showed the same thing: "Our analysis shows that profit margins for New Zealand’s major grocery retailers are broadly consistent with the sample of overseas grocery retailers" (p60).

The international price comparisons paint a darker picture, but even then it is not as black as the comparisons with the rest of the OECD would suggest. I like the general approach of benchmark comparators - countries that in some rough and ready way are 'like us' - and when the Commission did that exercise, it found (in Figure 3.13, shown below) that we still looked a bit on the expensive side, but not as obviously out of step as the whole-of-the-OECD comparison showed.


So my general reaction is that the scale of the proposed recommendations needs to be measured against the size of the competition problem, and it is too easy to get carried away about the size of the problem.

My second thought about the proportionality of the Commission's response is that they stayed on the correctly conservative side of respecting the incumbents' rights to earn a return on their investments. Some of the commentariat, on the other hand, would have happily embarked on extensive structural surgery, even though, as the Commission rightly said (on p404), "The lack of any essential facility or natural monopoly characteristic means that grocery wholesaling is not the type of industry ordinarily
regarded as potentially amenable to such intervention".

The reality is that the two supermarket chains rolled out national chains of stores, organised the suppliers, built the loyalty card schemes, and in general successfully managed to establish large, logistically complex, wholesale and retail businesses. We may dislike it that at least for now we are on the receiving end of a duopoly, as we were pre 2Degrees, for example, but let's face facts. The incumbents did the initial hard yards. It's in the nature of commercial affairs that, for a time, the first people to roll out the infrastructure will reap the gains: indeed, in some industries it's the prospect of early-mover superprofits that propels the investment in the first place, à la Schumpeter.

The best answer to this sort of situation is to help third and fourth players get into the game, especially when the first two have the advantage of Stiglerian barriers to entry: obstacles that new entrants have to surmount that the incumbents didn't (notably the limited availability of land zoned for supermarkets once the incumbents had got their share, and the restrictive and exclusive covenants inhibiting further grocery store development). Dismantle those, and then let's see what a Costco or an ALDI can do.

1 comment:

  1. I agree Donal. We saw during Covid that vertically integrated suppliers can be very good for consumers. Both chains continued to supply the country with groceries under serious constraints due to lockdowns. One thing I would have liked the Commission to do is paint a vivid picture of what a workably competitive grocery market in New Zealand today looks like. I doubt that is is exactly like what we have now. But is would be good to tell consumer what they should be expecting from competition, before going to say why they aren't getting it and what needs to happen for them to get it.

    ReplyDelete

Hi - sorry about the Captcha step for real people like yourself commenting, it's to baffle the bots