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Coles and Woolworths duopoly hard to swallow

Woolworths chief Michael Luscombe is leaving, but our retail problems remain. AAP

This week’s change of leadership at Woolworths has managed to temporarily deflect the vitriolic criticism being heaped on Australia’s two grocery retailers as they engage in their so-called ‘milk’ wars.

But some crucial questions remain. While Woolies and Coles have been justifiably criticised for their market dominance, there has been insufficient scrutiny of the legislative, regulatory and political failures that allowed this supermarket duopoly to emerge.

Coles set the ball rolling towards a duopoly in the 1980s when scooping up myriad grocery retailers following the emasculation of the merger provision of the Trade Practices Act in 1978.

Progress was stalled in 1994 when the Trade Practices Commission – the precursor to the Australian Competition and Consumer Commission (ACCC) – under Allan Fels prevented Coles and New Zealander Graeme Hart from taking over Franklins’ Australasian assets.

However, the ACCC has since welcomed retail consolidation into what is now an overbearing duopoly. Apart from swallowing many minnows in ‘creeping acquisitions’, Woolworths was permitted to acquire one third of Franklins’ 200 retail stores in 2001 and 21 prime stores and sites in Western Australia from Foodland in 2005.

The toleration of Woolworth’s acquisition of Dan Murphy’s in 1998 and of ALH hotel group in 2004 facilitated a quantum leap into the future domination of liquor retailing.

Price power

Woolworths and Wesfarmers’ Coles and Bunnings exploit their market power to the fullest. Previously, retailers were required to report ‘rebates and discounts’ obtained from suppliers – a requirement that unfortunately lapsed with new accounting standards.

The last figures publically available show Coles in 2001-02 reporting a net operating profit of $345m and rebates and discounts of $651m. In the 2004-05 financial year, Woolworths reported a profit of $792m and rebates and discounts of $601m.

The big retailers, and especially Woolworths, generate efficiencies through logistic applications, but their modus operandi depends essentially on profiting from extractions from suppliers.

The extractions from packaged liquor suppliers are well hidden and diabolical. Beer and wine suppliers sell at invoiced prices that are equal for all purchasers. Then comes the ‘trading terms’ – discounts demanded of suppliers for retailer warehousing costs, quantity purchased, favoured shelf position, product range allowance, and allowance for breakages.

Estimates of discounts totaling 11% to 12% are considered not unrealistic at the big two. Other undocumented ‘discounts’ exist – for example, supply of 15 or 16 bottles to the dozen.

Meanwhile, suppliers are forced to accept ‘rebates’ – discounts expected after the sale, often linked to quantity of stock sold but disposal at the retailer’s discretion. The quantum of the discounts and rebates leads to retailer periodical payment bearing no relation to the formal invoice terms.

An internal mid-2005 estimate at Foster’s Group, divulged indirectly to me, reported that 70% of liquor was being derived from independents and while 30% was coming from Woolworths and Coles. These appear to be incongruous figures, given that the big two’s market share of packaged liquor sales was then about 45%.

This massive discounting for the big players is said to have resulted in the bizzarre situation where independent bottle shops find themselves buying Victoria Bitter at Dan Murphy’s because the latter’s retail price is lower than what the independents pay wholesale. Competition it clearly isn’t.

Competition confusion

In the old days, competition meant the more sellers the merrier, and this vision (at its crudest) remains in the core tertiary economics syllabus.

But after the Second World War, the United States came up with the Chicago School vision, in which the large corporation, being efficient, is all we need. This was coupled with Contestability theory, in which two firms – or even just one – will do, as long as there’s a threat of market entry.

These radical stances have not encouraged endless market consolidation but have served to legitimise it, and simultaneously inhibit understanding of what constitutes a functional competitive process.

Worse, the economics syllabus at universities is resolutely devoted to denying the existence of economic power – as opposed to market neutrality – and thus incapable of providing insight into its character.

The academic economics syllabus has thus effectively vacated the field on this core issue of how markets work. Consequently, many ‘economists’ who staff the regulatory agencies bring minimal understanding to their professional responsibilities.

Departing ACCC Chairman Graeme Samuel may have trouble understanding power asymmetries, but it is also possible that he does not want to understand them.

Prior to his current position he presided over the National Competition Council, an inquisitorial body which oversaw comprehensive dismantling of structures erected during the last century precisely to offset such asymmetries.

In a speech in November 2004 before MBA students, Samuel claimed that competition “benefits those businesses that are able and motivated to take advantage of the powerful forces driving their particular market. The corollary, of course, is that businesses that are unable or unwilling to respond to the, often daunting, challenge of competition, will languish and may ultimately fail. But this is the essence of an open market economy.”

Everything, according to Samuel, is in perfect working order.

The plot thickens, however. In 2001, the Senate instructed the ACCC to investigate supplier-retailer relations. The 2002 report claimed no evidence of retailer monopsonistic power although its inquiry was partial and flawed.

Subsequently, a 2004 report by Whitehall Associates for the federal Agriculture Department claimed that retailer monopsonistic power was non-existent by assuming the claim a priori, meanwhile citing the flawed 2002 ACCC report in support. Samuel subsequently cited the Whitehall report in support of the ACCC’s position.

We are thus witness to a peculiar phenomenon in which reports blessed with authoritative status are interpreted as denying the existence of large retailer market power – even though they avoided an examination of the issue.

The reputed absence of retailer market power has thus acquired definitive status, although the grounds of its declaration are hollow. Repeated assertion has been converted into tangible reality.

Legal shortfall?

Many commentators have suggested that our laws do not give regulators enough power to discourage anticompetitive behaviour.

Actually, the laws do give regulators such power – they are merely being neglected. The problem is that it’s easier for regulators to prevent takeovers than it is to stop subsequent anticompetitive behavior.

In the commercial field, the legal profession condones the law of the jungle. In his ruling in the case ACCC v Berbatis (2003), the High Court’s Gleeson CJ asserted that: “parties to commercial negotiations frequently use their bargaining power to ‘extract’ concessions from other parties. That is the stuff of ordinary commercial dealing.”

Thus, both economic and legal cultures defend and reinforce the survival of the most powerful, as opposed to the survival of the fittest.

Gleeson CJ also presided over the further emasculation of Section 46 of the Trade Practices Act, which details abuse of market power, in Boral v ACCC (2003) – an execrable judgement.

In principle, a functioning Section 46 is the appropriate vehicle to deal with Coles’ current predatory pricing strategy.

The section, along with the unconscionable conduct provisions (Section 51) and misleading representation provisions (Section 52) are the key sections of the act that give small business formal protection against corporate predation.

But the combination of regulatory passivity and judicial conservatism have rendered them weak reeds.

Political inaction

Few in politics care for small business or the family farmer, save for Independent Senator Nick Xenophon and some powerless backbenchers. The two major parties have recently gone wholly over to big business. The National Party, save for the hot-and-cold Barnaby Joyce, has gone to water on its constituency.

The odd parliamentary inquiry or report has highlighted corporate predation against small business. However, positive recommendations are ignored by the reigning government.

Rarely, some recommendations are enacted, but then face the regulatory passivity or judicial antagonism, with governments on a bipartisan basis ignoring the impasse.

In short, the entire system is stacked in favour of Coles’ current pricing strategy. The hard-headed Coles management will enjoy its handsome performance bonuses, leaving carnage amongst suppliers.

The process is not sustainable and will damage Australia’s food production industries, but who cares? Following the Australian supplier cleanout, Asia beckons.

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