In describing Australia as an “inhospitable” market, Heinz expressed what many suppliers feel but fear to say. But it’s an awkward truth, Ben Cooper writes. The last thing the Australian food industry wants is international investors viewing it as a hostile market.
The suggestion by Heinz that Australia is an “inhospitable” environment for grocery manufacturers caused quite a stir a few weeks ago though the company was arguably expressing sentiments shared by most suppliers and industry observers.
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“Those comments certainly resonated with a lot of suppliers,” says Paul McMillan, industry analyst at business information group IBISWorld.
Kate Carnell, chief executive of the Australian Food and Grocery Council (AFGC), agrees. “Heinz said it as they saw it and I have to say they wouldn’t be unique in their views of the Australian market,” she says.
Australia has an extremely concentrated food retail sector, with Coles and Woolworths Ltd controlling around 80% of the market, compared with 35% back in 1975. The acquisition in 2007 of Coles by the Wesfarmers group has resulted in the latter significantly raising its game in a bid to take on its larger rival.
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With even more intense price competition between the two and both seeking to boost private-label penetration, suppliers have been squeezed. For instance, private-label growth and discounting has driven down supplier margins in the dairy sector to such an extent that industry representatives recently told a Senate inquiry that competition between Coles and Woolworths had had a “catastrophic impact” on the sector.
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By GlobalDataPrivate label has risen from around 15% of the market in 2003 to around 25% in 2010, and the major retailers envisage pushing this closer to 40% in the foreseeable future.
“Deep discounting and a resurgence of private-label products” were recently cited as factors behind a 17% drop in annual net profits at Goodman Fielder, while Associated British Foods said last week that its George Weston Foods business had encountered “difficult trading conditions”. It said baking margins were reduced by increased consumer promotion and a switch to lower-margin, private-label products. While Campbell Soup Company said earlier this month it was “bullish” about Australia, CEO Denise Morrison warned that the market was “starting to become more under pressure”.
Of course, it is not just retail concentration that has created this pressure. New industrial relations and environmental legislation has led to above-inflation cost increases, while high oil prices mean freight costs – key in such a large country – have never been higher. But the concentration of retail power appears to represent the primary challenge for food and grocery suppliers.
Coles and Woolworths are “profitable, big and dominant operations” that are “having a large fight”, says Carnell. “What that’s meant to manufacturers is that they are pushing it back down the supply chain, so they’re being much more aggressive in their relationship with their suppliers than we’ve seen before in Australia.”
It is perhaps no surprise that it was a very powerful, multinational branded company that made such a public and unequivocal statement about Australia. The suggestion is that, with only two major supermarket chains, many local suppliers would simply have too much to lose by stating so vehemently how tough a trading environment Australia has become.
“When you’ve got true market failure it’s extraordinarily difficult for any company to put up their hand and say there’s a problem, which I suppose is the reason the Heinz comments have been out of the blue a little bit, because they were made internationally, not here in Australia. On the whole, manufacturers here won’t put their hand up.”
The term “market failure” hints at the regulatory issues behind the retail concentration issue. The power of Coles and Woolworths was the subject of an inquiry by the Australian Competition and Consumer Commission (ACCC) in 2008, which concluded that there was functioning competition between the two retailers.
However, Carnell asserts that the ACCC looks too narrowly at the issue of competition and fairness and has not considered how suppliers are affected by extreme market concentration. In fact, she says the ACCC has “done nothing” to protect suppliers from the negative effects of over-concentration. The AFGC is lobbying for the creation of some form of co-regulatory code of practice and possibly a supermarket ombudsman, though Carnell concedes this is “a forlorn hope, probably”.
Indeed, the ACCC blocked the acquisition of the Franklins retail chain by wholesale group Metcash on the grounds that it would affect competition in the wholesaler space. Carnell says this is another case of the regulator looking at the issue of fairness and competition too narrowly.
The ACCC judgment was thrown out by a Federal Court, which resulted in the regulator lodging an appeal. The Franklins case could prove to be an interesting – and extremely public – examination of how the ACCC approaches the food retail sector.
IBISWorld believes the Australian retail sector represents an attractive opportunity for international retailers. However, McMillan qualifies this by stating that in the supermarket space “existing market share concentration is certainly a barrier for new entrants”.
While food retailing has seen increased diversity in recent years with the arrival of Aldi and Costco, critically these are not full-range supermarkets, and do not represent the kind of competition to Coles and Woolworths that would make a substantial difference to food suppliers.
Moreover, both have found it difficult to find appropriate sites, which Carnell believes underlines again how little the regulatory system has done to curb the power of the dominant retailers. “It’s only very recently that there was any legislation there to stop Coles and Woolworths having leases with shopping centre owners that actually excluded other operators,” Carnell states.
However, Carnell is reluctant to brand Australia as an inhospitable market for inward investment. “We certainly don’t want to see Australia as a bad place to invest because it’s actually not a bad place to invest,” she says, citing among other factors the country’s stable and strong economy, the fact that it produces “great primary produce at pretty reasonable prices” and is close to the Asian market.
This may all be true. But Carnell also concedes that the Australian food manufacturing sector has been slow to innovate and modernise. There is possibly something of a Catch 22 here. Australian manufacturers must modernise and innovate to cope with the tough conditions created by private-label growth and high retail concentration but these conditions ensure it must do so while margins are pared to the minimum.
This appears to place even greater onus on inward investment and it is little wonder that Carnell was reluctant to welcome the Heinz remarks, even if they were publicly attesting to what her members feel about Coles and Woolworths.
According to Tourism Australia’s current slogan, “there’s nothing like Australia”. With regard to food retailing, this is quite possibly the case: very few countries have two large chains accounting for such a dominant share of the market. The AFGC’s challenge is to persuade global food companies that it is also true in other more appealing ways. In doing so, it arguably needs some help from its prime business regulator and the government.
