When there's a will ...

You don't often see competition reform feature in the Budget, but we did last week.

"We are ... committed to boosting competition in the New Zealand’s grocery sector to ensure people pay fair prices for food and other basics", Grant Robertson said in the Budget speech. "Today, we are introducing legislation that will remove barriers to new retailers entering the market. Specifically, this will prohibit the restrictive covenants on land that major grocery retailers use to limit site availability for competitors. Such covenants will be prohibited immediately once the Bill comes into effect, and I anticipate that competitors can begin to consider new sites shortly thereafter".

The Commerce (Grocery Sector Covenants) Amendment Bill is here. It defines Foodstuffs North Island Limited, Foodstuffs South Island Limited, and Woolworths New Zealand Limited as 'designated grocery retailers', and creates a new s28A of the Commerce Act whereby "Certain grocery-related covenants are treated as prohibited and unenforceable" by deeming them as "having the purpose, or as having or being likely to have the effect, of substantially lessening competition in the relevant market", and so pinging them under the existing s27 and s28 of the Act. s27 we all know and love - contracts, arrangements and understandings substantially lessening competition - and s28 is its equivalent for anti-competitive covenants.

In its grocery market study (summary here, whole shebang here), the Commerce Commission had identified "more than 90 restrictive covenants entered into by the major grocery retailers, the majority of which are still active" (6.77) and "over 100 exclusivity covenants in leases entered into by the major grocery retailers, the majority of which are still active" (6.80). Clearly, this isn't a small issue, and it may be rather bigger than the Commission thought. On its helpfully proactive 'Market study reporting dashboard', Foodstuffs North Island says that it alone has removed restrictive covenants from 78 out of 135 affected properties (the outstanding ones are on land it doesn't own any more, and they are approaching the current owners to bop those off, too).

So it's good news that the government has moved quickly to implement the Commission's recommendations 2A, 'Prohibit restrictive covenants that relate to the development of retail grocery stores' (discussed at 9.68 - 9.72) and 2B, 'Prohibit exclusive covenants in leases that relate to the operation of retail grocery stores' (9.73 - 9.79). Their impact may be overstated - my guess is that planning laws restricting the supply of land available for supermarkets may be more important, as may planners' inclination to protect competitors rather than to protect the competitive process (hence the Commission's 'Recommendation 1F: Retail grocery store development should not be able to be declined on the basis of adverse retail distribution effects on existing commercial centres') - and the supermarkets look to have been dismantling them anyway, but it's progress. 

It's helpful that the political pressure to 'do something' about rising prices in the shops - a key focus of the Budget - helped bring about a quick competition policy response, and you'll excuse me if I snarkily add, 'for once', given the tortuous processes in getting s36 reformed, cartels criminalised, and indeed setting up the market study regime itself. When there's a will, there's a way, as they say. Moving this quickly, incidentally, means that you've only got a very brief window for submissions: Friday, in fact. The submission link is here.

But I hope that the "it's the supermarkets wot done it" line about inflation doesn't get taken much further. In April the Commerce Minister, Dr David Clark, commented on the 7.6% rise in New Zealand food prices over the year to March, and said that "The March increase is above general inflation figures and highlights the role the grocery sector is playing in driving up prices. Rising food prices is a global issue. Omicron, ongoing disruptions to global supply chains and Russia’s invasion of Ukraine is putting pressure on prices in every country, but that is exacerbated here by the lack of competition at the checkout".

Hmmm. In the US, annual food price inflation was 8.8% in March; in Canada it was 9.7%; in the UK it was 6.7% in April. Overwhelmingly, inflation is not a matter of grocery industry structure, but a result of those other global factors that the Minister mentioned: he might have thrown in monetary policy, here and overseas, being left too stimulatory for too long after the initial Covid hit. Blaming the supermarkets, if only in part, for current food price inflation may play well to the galleries, but it's not a strong argument. If, as he said at the time, he had "not ruled out going further than the options that the Commission tabled in its final report", fair enough: quite a few folks (but not me) reckon the Commission didn't go far enough. But I wouldn't take that step on the back of a not very convincing line of attack on inflation.

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.

How do supermarkets compete?

In the previous post I wrote up the results of the Electricity Authority's latest survey of competition in various industries: supermarkets came out tops in terms of people's assessment of whether they are getting a competitive deal from businesses they deal with. While it wasn't a full economy-wide survey, and maybe there are unsurveyed sectors that would have shown up better than the supermarkets, it was nonetheless very interesting that people feel they are getting a fair deal from supermarkets vying for their custom, and all the more so because there have been concerns about a potential duopolistic shakedown.

As it happens, I just came across another new survey which tells us in more detail what people value from supermarkets (it's Australian, but I'd suggest it's equally applicable here). It comes from Roy Morgan Research's 'Single Source' surveys, which are very large scale: this supermarket one had close to 16,000 respondents, all interviewed face to face. The press release is here (the full thing costs serious $, which is fair enough given the scale and value of the exercise).

Here's the core result, where we can see the various dimensions across which supermarkets compete, and which ones most press consumers' buttons.

Before seeing these results, I'd have guessed that some dimension of all-in-one convenience would have topped the list, supermarkets being (you'd think) the classic economies of scope/minimise transactions cost model, but I'd have been wrong. There are, to be sure, some convenience dimensions in the most valued characteristics of a supermarket. And there are some price/value dimensions, too, which you'd also expect to be high up the list. But the surprise packet - for me - was the very high ranking of quality, with 'high standards of food safety', 'hygienically prepared food', 'good quality' fruit and veg and 'clean and tidy' taking four of the top nine spots, including the top one itself.

Apart from its intrinsic interest, and the insight it gives into the real nature of the supermarkets' value proposition (and, I'd guess, a glimpse of their likely strategic thinking), it's a good reminder that competition is more than competition on price. Sure, most of us involved in thinking about competition have taken the idea on board, most of the time, and there's even an acronym SPQR (Service, Price, Quality, Range) that people sometimes deploy to make sure they've got all the potential bases of competitive rivalry covered. But it's nonetheless easy to lapse into using price as a proxy for everything. In some lines of business, and supermarkets are clearly one, that could lead you badly astray, and in several directions. You could easily assume there is less competition that there actually is. And, if rivalry diminished on one of those non-price dimensions, you could easily miss that, too.