The all-consuming market for markets

Adele Ferguson
July 28, 2012
The Age

The Australian retail landscape is drowning under a Coles and Woolworths deluge, say industry observers. But can governments or regulators stem the flow?

IN THE business world there is big, there is very big, and then there are Coles and Woolworths. Out of every $10 that Australians spend on groceries, up to $8 goes into the tills of the two chains, and the wallet widens when hardware, pokies, electronic goods, petrol, clothes and alcohol are thrown in. Indeed, the two behemoths have become so all-imposing in many towns and suburbs that local wags wonder whether their localities would more appropriately be called Colestown or Woolworthsville.

In Toowoomba, Queensland, the territorial fight between the two so-called ugly sisters is at a flashpoint, with the independents – and local suppliers – caught in the crossfire.
Debbie Smith, who runs a couple of independent Foodworks stores in Toowoomba, says the town of 100,000 is drowning in Coles and Woolworths supermarkets, pubs, hardware stores, petrol stations, convenience stores, liquor stores and discount outlets including Kmart. She says they hold the equivalent of almost 90 per cent market share.

”There are five Woolworths supermarkets and five Coles supermarkets after a Super IGA was sold to Coles this year and another IGA closed,” she said.

”Now they want to build another two big complexes with more Coles and Woolworths outlets. They have warped the value of hotels by bidding such high prices and now they are putting the squeeze on independents and suppliers.”

While some may think Smith’s complaint smacks of vested self-interest, hers is far from a lone voice. The South Australian town of Mount Gambier, famous for its natural surroundings, including a volcano, caves and a lake that changes colour dramatically each year, is about to get a grand new landmark, and some of the locals are none too pleased. Next month on the town’s doorstep Woolworths will open an $80 million shopping centre that some fear could rip the guts out of the town’s local commerce.

In the past year, Woolworths opened a record number of supermarkets across Australia and now has floor space of 2.3 million square metres, compared with Coles, with 1.6 million square metres, which translates to hundreds of shops or, put another way, enough space for a car park holding 500,000 cars.

The Mount Gambier centre, named Mount Gambier Market Place, speaks not only of Woolworths’ might, but its readiness to spread its wings by moving into areas divorced from the humdrum, but very profitable, business of selling groceries. Market Place is just like a mini-Westfield and is anchored with Woolworths-owned stores, including a Masters hardware store, a Woolworths supermarket, a Woolworths petrol outlet, a Big W discount department store, a Dan Murphy’s liquor outlet and a Dick Smiths electronics outlet. The other 30-plus stores have been sub-let to companies including Michael Hill Jeweller, Muffin Break, Payless Shoes, Angus & Coote and Priceline Pharmacy.

All of that comes about as a result of Woolworths’ activities as it wears another hat, that of property developer. The in-house retail property development division houses 60 retail-based developments valued at more than $1.5 billion. Since the global financial crisis, when property developers found it hard to raise money for shopping centres, Woolworths decided to ramp up its internal division and build its own. Last year it opened a $90 million shopping complex in another South Australian town, Murray Bridge, with 45 speciality shops.

But far from displaying any discomfort about their pre-eminent position in Australian life, the default stance for Wesfarmers – which owns Coles, Kmart, Target, Officeworks, Bunnings, Liquorland and Vintage Cellars, and Woolworths, which owns Dick Smith, Big W, Safeway, Dan Murphys and Masters hardware – when they are criticised is frustration.

Richard Goyder, chief executive of Wesfarmers, says the criticism is unjust, and he disputes the claim that Coles and Woolworths are a duopoly or are misusing their powers.

”Consumers are getting a much better deal,” he said. ”Prices are falling and for the past 4½ years we have pushed back on a number of suppliers to get better prices by asking them to be more efficient and perform better. We had to let some suppliers go and when we do, there is bound to be some noise.”

Goyder said Coles sourced 95 per cent of its own brands in Australia and it was selling more Australian made and supplied products than ever.

”It is a more competitive market with more players in the market and more stores,” he said. ”Since 2008 Metcash has added more than 100 stores, Aldi has grown from 167 to 280 stores and Costco has gone to three stores. Being big doesn’t mean it is bad. Wesfarmers started life as a small business and grew bigger. Is that bad?”

This week, BusinessDay revealed that Metcash, which operates the IGA supermarket chain, plans to copy Coles and Woolworths and break into the hotels, pubs and poker machine market. Metcash yesterday clarified its position on buying hotels following a number of misleading media and consumer group reports.

Metcash boss Andrew Reitzer said in a statement: ”The joint ventures will provide competition to the major grocery chains that dominate and are seeking to further expand their dominance of the hotel industry. They will allow customers of Metcash, being independent retailers, to grow their liquor businesses, and will protect independent hoteliers from the creeping acquisitions by the large supermarket chains,” he said.

If that is the kind of news to set alarm bells ringing, it may be that those bells are ringing a trifle too late. The former competition tsar Allan Fels says: ”There have been a lot of inquiries into the power of the supermarkets and more lately politicians have taken an interest, but their power is irreversible. You can’t break up [or] slow their spread in non grocery areas. The governments and the ACCC play a role at the edges, occasionally curtailing anti-competitive behaviour with fines, but it is tinkering around the edges.”

But since the milk and bread wars flared last year, the power of the supermarkets, who together generate more than $100 billion a year from their ever-expanding retail activities, has spilled into the political and regulatory arenas. More recently the use or misuse of shop-a-dockets, petrol prices and private label brands selling foreign produce has added to their concerns.

A Senate Select Committee on Australia’s Food Processing Sector led by Richard Colbeck is due to report in mid-August, the National Food Plan green paper is expected to advocate a forum for stakeholders to talk to government about the market power of the retailers, the Coalition has committed to a root and branch review of the supermarket system if elected, and the LNP in Queensland, driven by Senator Barnaby Joyce, recently passed a motion in favour of divestiture powers.

The Australian Competition & Consumer Commission has joined the debate with new chairman Rod Sims launching a number of investigations into the supermarket giants to ensure they are not misusing their power. Privately, competition law experts believe Sims wants to test the boundaries of his powers, expects to fail and is hoping the recent pub acquisitions by Woolworths will establish a test case, potentially proving the limitations of the current powers and providing the foundation of an argument to government to review ACCC powers.

Sims told BusinessDay: ”I think they have a lot of market power which is why we take seriously these issues.” Sims said the investigation into the relationship with suppliers had resulted in a lot of complaints.

Australia has the most highly concentrated market in the world and competition is a function of many things, says John Cummings, the head of the National Association of Retail Grocers of Australia.

”Concentrated markets have negative effects on manufacturers and growers,” he said. ”Innovation, new products, new ideas fall when there is too much consolidated buying power. In the short term, the battle between Coles and Woolworths might deliver lower prices, but it won’t deliver choice, and when the manufacturers are gone, what then? Lower prices won’t continue forever and so the government needs to do something to stop the inevitable happening.”

Another concern is the effect an overhaul of their supply chain management is having on suppliers and the transport sector. Most suppliers refuse to go on record for fear of upsetting their masters. If they criticise either Coles or Woolworths, they fear they will be cut off and lose an important customer. Over the past few years, many inquiries have been conducted into how powerful the chains are becoming, but all have come to nought.

But the cries of protests are getting louder, with anecdotes of ”cliffing” where suppliers are asked to stand at the edge of a cliff and agree to certain discounts and if they don’t, they are told to look over the cliff and see if they like that better. Another said cliffing was a choice between quick suicide or death by a thousand cuts.

A report released in March by Merrill Lynch analyst, David Errington, warns the big three retailers, Coles, Woolworths and Metcash, will need to boost their earnings by $1.3 billion in the next three years if they are to make an acceptable return on the billions of dollars of acquisitions and capital expenditure. This is on a total earnings before interest and tax (EBIT) pool of $4 billion for the retailers.

In the past year, the profit growth of the entire sector has shrunk. Errington’s report says, in the first half of this financial year, the three food retailers delivered a combined $150 million EBIT growth, a far cry from the $400 million-a-year earnings growth required to make an acceptable return. It will be interesting to see what the full-year earnings will be when the sector reports in the next few weeks.

If Coles, Woolworths and Metcash fail to generate suitable returns on capital in the next couple of years, investors’ patience will run out and they will suffer a significant de-rating. It goes a long way to explaining the intensifying price war between the supermarket giants as each tries to snatch market share to justify its investment.

The dilemma is price wars are good for consumers, who benefit from cheaper products. Indeed, in a submission to the Senate last year, Coles made the bold claim that its competitive activity was saving customers more than $1 billion a year, and had turned an inflationary food situation into 2 per cent food deflation per annum.

But there is a dark side to the discounting. If enough suppliers and smaller competitors are driven out of business, it will reduce consumer choice and eventually drive prices up.

Allan Fels says the push by the dominant supermarket operators into ever more sectors of the economy will end in higher prices, less diversity of products and less innovation.

”If the entry of Coles and Woolworths into the petrol market is any guide to what will happen in hardware and other areas, close scrutiny will be needed,” he said. Fels believes there are signs that the chains’ shop-a-docket petrol discounting schemes are a smokescreen for higher prices: ”Economically and politically there must be a high concern about the spread of the dominant players into so many areas.”

In little more than a decade, Coles and Woolworths have spread their tentacles – and power – across the retail spectrum. They run a near-duopoly in the $84 billion grocery industry, with market share above 70 per cent. They are among the biggest players in petrol retailing, with a combined share of more than 45 per cent. They hold at least 60 per cent of the liquor, clubs and hotels industry and 60.5 per cent of department stores through Big W, Kmart and Target. In hardware, Bunnings already controls 16 per cent of the highly fragmented industry and more than 56 per cent of hardware retailing.

They have moved into the beer market, with Woolworths buying a 25 per cent stake in Western Australian brewer Gage Road, and private label beer brands, including Platinum Blonde. Coles is selling Tasman Bitter Hammer ‘n’ Tongs as its own brand and Woolworths has bought Cellarmasters, which gives it a one-stop-shop for wine, including wineries, distributing wine, a wine club and an online business.

They have also moved into financial services, including a credit card and insurance, and both are keen on the pharmaceutical industry if and when it is ever opened up.

The activities, coupled with the various loyalty programs being revamped by Coles and Woolworths, are designed to further capture the consumer wallet and make it difficult to escape.

This power and reach is unprecedented globally and means that they are able to pay suppliers less than prevailing market prices. The move to offer $1 a litre for milk is having a disastrous impact on farmers, milk distributors and smaller milk retailers.

Post the milk price war, discounting has squeezed the margins by lifting private label milk’s share of the market.

According to AC Nielsen, in the last quarter before Coles’ Australia Day discounting in 2010, branded milk was 36.17 per cent and private label was 63.8 per cent. In the most recent quarter, branded was 32.59 per cent and private label was 67.4 per cent.

While cheap milk is good for consumers, the long-term impact on farmers, distributors and non-supermarket customers doesn’t look so flash. Two years ago in Britain, the big four grocery chains reduced the price of house brand milk. The impact was catastrophic with herds declining and milk imports rising.

Nationals Senator John Williams said he was concerned at what was happening to the food industry. ”They have stitched up butchers, bakers, fruit and veg, pubs and pokies, petrol, and if they could they would move into pharmaceutical.” He said an ombudsman with powers and country of origin labelling was needed to support the local industry.

Frank Zumbo, associate professor at the University of New South Wales, says Australia still has one of the highest food inflation rates in the OECD group of developed countries over 20 years, 10 years, five years and lower. He also believes petrol prices are higher than they should be due to the presence of Coles and Woolworths in the industry.

The ACCC’s grocery inquiry of a few years ago found that there was ”comfortable competition” and that once barriers to entry, such as restrictive covenants in shopping centre leases that restrict competition in grocery retailing, were removed, it would become vigorous.

It is a tough and complicated debate with no clear-cut answer. Lower prices for consumers and the convenience of a one-stop shop versus the spectre of clone towns.

As one industry expert said: ”Either way, regulators and the federal government need to very carefully consider what the two ugly sisters are up to. Killing off local suppliers and substituting them with low-cost overseas suppliers isn’t good for the country. They give the car industry big subsidies on one hand, while standing on the sidelines on this one.”

Read more: