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January 25, 2007

Supermarkets take comfort from Commission investigation

With the Competition Commission’s investigation into the UK’s GBP1.24bn (US$2.46bn) grocery sector reaching its halfway stage, the governmental watchdog has announced little that will worry the country’s leading retailers. But as Katy Humphries heard, there was far less to cheer about from the suppliers’ side.

With the Competition Commission’s investigation into the UK’s GBP1.24bn (US$2.46bn) grocery sector reaching its halfway stage, the governmental watchdog has announced little that will worry the country’s leading retailers. But as Katy Humphries heard, there was far less to cheer about from the suppliers’ side.

The sigh of relief from the UK’s supermarket sector was audible on Monday (23 January) when the Competition Commission’s (CC) chairman Peter Freeman announced that his investigation into the grocery sector was not here to “punish success”. In that one line, Freeman would have allayed many of the jitters the sector had that it was being targeted for unfair treatment.

In fact, although the “emerging thinking” document that was released on Monday highlighted a number of issues that the CC plans to probe more thoroughly in the next six-months, a lack of evidence to support claims of mistreatment to suppliers means the document is being hailed as pro-supermarket.

According to figures released by the Competition Commission, supermarket sales have increased by 26% in real terms since 2000 and the number of stores operated by the big four – Tesco, Wal-Mart’s Asda, Sainsbury’s and Morrisons – have doubled. In comparison, specialist stores such as greengrocers and butchers have faired poorly over the past six-years, with sales rising by only 1% and the number of specialist stores decreasing by 7%.

The picture is clear: the UK is increasingly becoming a nation dominated by supermarkets.

But, in many respects this ‘survival of the fittest’ is a function of competition, not a consequence of anti-competitive policies. Supermarkets are thriving because consumers, lured by convenience, service and price, choose to shop at them.

There can be little doubt that consumers have benefited from the lower prices and improved services resulting from competition between supermarkets. However, anti-competitive practices could still result in a constriction of choice. Indeed, Freeman acknowledged that he was “concerned with whether Tesco, or any other supermarket, can get into such a strong position, either nationally or locally, that no other retailer can compete effectively.”

In order to determine whether this scenario is playing out in towns throughout the UK, the Commission has identified a number of key topics it intends to further scrutinize. It will concentrate on how grocery retailers operate at a local level to determine whether the strength of national supermarkets is being used to distort competition in local markets or influence store development through local pricing tactics and misuse of the planning regime.

“Our principal concern now is to focus on competition between retailers at the local level, where it most matters to consumers,” Freeman said. “We need to see what choices shoppers have in particular areas and how competition works between retailers of different sizes. We know about the extent of retailers’ land holdings, but it’s how these are used locally, and the related effect of the planning system, that matters.”

Turning to the supplier-retailer relationship, thus far the investigation has been unable to uncover evidence that the large multiples are using their buying power to exploit suppliers.

Few suppliers have come forward with proof of unfair treatment, a fact that can be interpreted in one of two ways: either suppliers are too afraid of the might of their largest buyers to speak out, or the relationship between the two groups is less exploitive than has been suggested.

Drawing to a close the initial stage of the Commission’s investigation, Freeman recognised that a ‘fear factor’ might be preventing suppliers from substantiating general claims of retailer misconduct. He urged food producers to come forward if they had been mistreated and offered reassurances that he could guarantee anonymity. 

“Many suppliers have been reluctant to provide us with details of specific instances to illustrate the general concerns that have been raised with us due to concerns of possible retaliation by grocery retailers. In the absence of more specific examples, we may find it difficult to come to any conclusion,” the report said.

Based on the evidence available to date, the Commission’s initial analysis has not indicated a systemic problem with the economic viability of food and drink manufacturers and processors.

“We have not identified an ongoing decline in margins or return on capital for this group of firms,” the CC said. “In our own survey of suppliers, less than 4% of suppliers indicated that it was either fairly unlikely or very unlikely that they would be in business in five years’ time.”

Indeed, when one looks at retailer-manufacturer margins a case can certainly be made that the retailers actually get the short end of the stick. With higher costs and operational overheads to contend with, retailer margins are generally lower than those of the major food companies. For example, in its most recent income statement, Tesco reported trading profit margins of 5.8%. Meanwhile, the world’s largest food manufacturer Nestlé posted margins for the first half of 2006 of 12.8%.

A number of unfair practices regarding retailers’ treatment of their suppliers have been brought to the Commission’s attention. These include unilateral changes to contractual provisions, payments by suppliers to retailers, the provision of category management and marketing support to retailers, exclusive purchasing agreements and the use of recommended retail prices.

“It is difficult to judge how widespread such behaviour is purely from the number of submissions,” the emerging thinking document concluded. “Suppliers have told us that they are not willing to come forward with evidence for fear of retaliation by their main customers.”

According to the Commission, a fear raised by food manufacturers has been that the misuse of retailer buying power and competition from own label sales have reduced incentives for branded food manufacturers to engage in product innovation.

This, the Commission concluded, appears to be unfounded. Food producers’ expenditure on research and development has increased since 1996 in order to mount effective competition, the CC discovered, with 80% of suppliers surveyed by the body claiming to have invested in product development over the past two-years. Forty-three percent of suppliers surveyed said they spend more on R&D now than they did five years ago and only 14% claim to spend less.

While processed and branded food manufacturers appear not to be suffering at the hands of the national supermarkets, the Commission did concede that particular parts of the grocery supply chain might be under greater pressure than suppliers as a whole. In this regard, the CC expressed concern about milk and pig-meat industries.

“Going forward, we will continue looking at supplier profitability both overall and in individual sectors, particularly in primary producing sectors where concerns are raised with us,” the Commission said.
This stance has been criticised by trade associations representing suppliers and smaller retailers. The Association of Convenience Stores’ chief executive, James Lowman said: “What is clear from the emerging thinking is that in some areas the Commission still needs to go out and find crucial information.  For example, their analysis of the relationship between retailers and their suppliers has not gone far enough. They must probe this issue much further in order to fully understand how buying power operates and how it ultimately damages competition and the consumer.”
On the other hand, the response of large supermarkets to the Commission’s initial findings has unsurprisingly been more positive.
Tesco boss, Sir Terry Leahy, said: “We are at the early stages of this inquiry but the Commission appears to have made some progress on dispelling the myths surrounding our industry, particularly in their early work on suppliers where they have found no problems with the economic viability of manufacturers, processors or wholesalers.”

The emerging thinking document, which has been widely hailed as pro-supermarket in its findings, many have done much to calm the jitters of the large multiples. Having identified specific areas of concern, as the investigation continues, its focus has narrowed to examine the relationship between retailers at a local level and specific links in the supply chain. The Competition Commission now expects to publish its final findings in June.

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