Coles and Woolworths code useful, but beware disputes

A new grocery code of conduct provides new rules for a sector subject to price wars, but will not solve all market problems. Lukas Coch/AAP

Coles, Woolworths and the Food and Grocery Council have released a draft industry code of conduct to help govern their relationships with suppliers.

The code will be “voluntary” under section 51AE of the Competition and Consumer Act. But this doesn’t mean it is toothless.

It comes after a push by farmers for a mandatory code of conduct as they sought protection from price gouging in the light of the ongoing supermarket price wars.

Given that Coles and Woolworths will be signatories, most of the supermarket industry will be on board from day one.

Once prescribed in regulations, the code will be enforceable by the Australian Competition and Consumer Commission (ACCC) and the courts. The law in section 51AD of the Act is very clear:

“A corporation must not, in trade or commerce, contravene an applicable industry code.”

If a corporation does breach the code, the courts can fix the breach, for example by voiding or varying contracts.

So what is the grocery industry signing up to?

First, the code is in addition to current laws. Coles and Woolworths are still bound by all of our competition and consumer laws.

The code will make clear the grocery supply agreements between retailers and suppliers. The code requires agreements up-front and in writing. Unsophisticated suppliers, who may have acted on ambiguous verbal “understandings”, will benefit from this formality. It will avoid nasty surprises – so long as the suppliers carefully read and understand their agreement!

Agreements cannot include behaviour that, arguably, would be unconscionable and illegal anyway. For example, unilateral, retrospective variations are ruled out. This benefits suppliers by avoiding uncertain legal proceedings. As the recent Monash Business Policy Forum paper noted, the law on unconscionable conduct has been difficult to interpret. In contrast, the code clearly rules certain behaviour out-of-bounds.

The code establishes rules for own-label products and for suppliers’ intellectual property and “innovation” rights. This will help suppliers have frank discussions with supermarkets about potential new products, and should benefit both suppliers and retailers.

The weakness of the code, however, is the dispute resolution procedures.

The first point-of-call for a complaint is the retailer-appointed “Code Compliance Manager”. It is reasonable that the retailer is given a chance to resolve a complaint internally before external intervention. However, if this route fails, the next stage is internal dispute resolution then external mediation and arbitration. These fall back options will be time consuming and costly, particularly for a small supplier. So I suspect that, in many situations, the decision of the Code Compliance Manager will be final. And this Manager is not arms-length from the retailer.

Of course, the supplier can always call in the ACCC if the Act has been breached. But they can do this without the code.

A better approach would be to have an independent Code Compliance Manager to deal with disputes up-front. The manager could be funded jointly by the retailers but appointed by both the retailers and suppliers. The decisions of such an independent umpire will have more weight.

Claims of abuse of suppliers by supermarkets are not new or unique to Australia. Chapter 9 of the UK Commerce Commission’s 2008 inquiry into supermarkets looked at supermarket “buyer power”. The main concern was retailers making “retrospective adjustments to the terms of supply”. The draft code should fix this problem in Australia.

The 2008 ACCC grocery inquiry also looked at buyer power. It concluded that the major supermarket chains have buyer power in that they “generally buy products on better trading terms than other buyers”. But that is not undesirable or anti-competitive by itself. The inquiry received many complaints, but little hard evidence, about unconscionable and anti-competitive conduct by the supermarkets against suppliers. And five years later, we are still waiting for any court cases. The code will help fix this problem by making it clear what conduct is disallowed.

But the code will not solve all market problems. Recent economic research highlights how buyer power may indirectly harm suppliers. Buyer power may lead to a waterbed effect, where suppliers lower prices to the major supermarkets but then have to raise prices to other retailers in order to cover their costs.

Unpublished research by David Haines at Monash University shows how buyer power may create incentives for the retailer to undermine the “general” terms it offers suppliers in order to improve its bargaining position with specific suppliers. The ACCC grocery inquiry was often told that “the only thing worse than having a supply contract with a major supermarket chain, is not having a supply contract with a major supermarket chain”. The Monash research shows this may be due to the undermining of “outsiders” rather than benefiting chosen suppliers.

The code will not deal with these broader industry effects. And nor should it. A risk with industry codes is that they are used as collusive devices to undermine competition. Taking the code further would prevent real competition and harm consumers. It will not solve all supplier problems, but it will provide clarity and make it clear that the worst abuses of buyer power are illegal.