The price increase of commodities, especially of basic necessities such as groceries is a matter of concern for members of the public. In recent years, sustained criticisms have been leveled against the Australian retail grocery sector because of rising prices of goods.
Various reasons have been advanced to explain the reason why the sector has been experiencing the problem over the past couple of years. Questions have been raised about the role that competition plays in determining prices in the Australian grocery market.
A study commissioned by the Australian competition and consumer commission, (A.C.C.C) estimated that two stores; Coles and Woolworths accounted for about 70% of package grocery sales and nearly half of all the fresh food products that were sold in Australia. To comprehensively analyze the groceries market in Australia, it would be useful to apply microeconomic principles.
The Concept of Perfect Competition
In understanding the concept of Competition in the Australian market for groceries, a critical factor to consider is whether the market is perfectly competitive. A perfectly or purely competitive market is a phrase that is used in reference to a condition or situation where consumers and producers are too many and too small to have the ability to significantly alter the price of goods or services (Machovec, 1995 p3).
Essentially it is a state wherein, the buyers or sellers cannot initiate any measure of individual control in determining the prices of goods and services. (Dewar, 2010 p.71-72).
A perfectly competitive market is further characterized by having large numbers of producers and consumers who are free to enter and leave the market at will and who all have equal awareness and access to information about the prices, volume, availability and quality of goods and services that are being traded (Baumol & Blinder, 2007 p.201).
Moreover, the perfectly competitive market is distinguished by the fact that the goods or services being traded are homogeneous in nature and thus, it is possible to substitute one product or service for another.
The situation is also characterized by the presence of a complete mobility for the resources that are used in production. It is important to note that the perfectly or purely competitive market exists only as a theoretical framework or model and is impossible for it to be applied in reality (Goldberg, 2000, p.84-87).
This description of the perfectly competitive market model makes it abundantly clear that the Australian retail grocery market is not a perfectly competitive market (justfood.com, 2009). This is because; although there is homogeneity in terms of the products being traded and a large consumer base, the market does not conform to the determining characteristics of the perfect competition model.
An integral hallmark of the perfectly competitive market model is the fact that it is made up of a large number of buyers and sellers who do not have the individual ability to initiate any measure of control over the prices of commodities and services (Dewar, 2010 p.108).
This is not the case in the Australian retail grocery market sector. In an inquiry commissioned by the Australian competition and consumer commission, (A.C.C.C) to determine the competitiveness of the retail grocery prices, it was revealed that the market was dominated by two retail grocery stores; Coles and Woolworths.
The statistics indicate that these two stores had a substantial share of the retail grocery market, amounting to about 50% of the fresh food products and nearly 70% of the packaged food sales that were sold in the country. (accc.gov.au, 2008).
This implies that these two stores have virtually cornered the retail grocery market and consequently are in a prime position to determine the retail grocery prices. This is a fundamental deviation from the perfect competition model that is characterized by the fact that no individual buyers or sellers have the capacity to individually affect the prices of goods and services.
The Australian retail grocery sector is not a perfectly competitive market because Woolworths and Coles, the largest players in the market have an advantage in terms of getting advance information and awareness about the prices, quality and availability of goods from their suppliers (wotnews.com, 2007). The two organizations enjoy this advantage because they are the largest market for the suppliers.
This is an advantage that is not enjoyed by other smaller players in the industry. This is in direct contrast to the characteristics of a perfectly competitive market that, according to Goldberg (2000), is characterized by equal awareness to information about the prices, volume, availability and quality of goods and services that are being traded.
The fact that the Australian grocery market is not a perfectly competitive market has significant implications for the consumer. In recent years, consumers in Australia have been suffering from the adverse effects of rising grocery prices.
This problem has been attributed to the fact that the market has been dominated by Woolworths and Coles, both of which have been criticized for setting high commodity prices and systematically increasing those already high prices. This situation has negative implications on the consumers and urgent intervention is required.
Workable Competition
Economic theorists have reached the consensus that the concept of perfect competition has numerous shortcomings and limitations in the determination of public policy. In reaction to this, the alternative theory of workable competition was formulated.
The workable competition, also known as the effective competition model was proposed in 1940 by J.M. Clark, a prominent economic theorist.
The model is used in reference to a state of affairs that is characterized by the existence of a monopolistic power that exerts a significantly high measure of control over the market; however, the effects of this control are mitigated by the existence of adequate competition that is provided by near-monopolies. This has the effect of protecting the consumers from the effects of a monopolistic system. (Ferguson, 2008 p.78-80).
The application of the workable competition model would be more relevant to the Australian retail grocery market because the perfect competition model has been shown to be ineffective in the market. The workable or effective competition model is geared towards protecting the consumers from the effects of monopolistic practices. (Masters, 1955 p.37).
The domination of the grocery market by Coles and Woolworths implies that these two stores are enjoying what has been described as a duopoly of the market. In recognition of this fact, the workable model that is characterized by the presence of near monopolies that are meant to protect the interests of the consumers would be highly relevant (Ferguson, 2008 p.87).
A comprehensive assessment of the Australian retail grocery market reveals that effective or workable competition does not exists in the sector. To justify this contention, it would be useful to examine the presence or absence of several indicators.
According to Barthwal (2000) any given industry is said to be workably competitive if it has a number of companies that are selling or providing similar or closely related goods and services and that these companies are not in collusion with each other. Critical examination of the pricing trends adopted by both Woolworths and Coles reveals a level of complicity, especially in price increases.
Barthwal further contends that a workably competitive industry is characterized by the fact that the average cost-curve that will be applied to a new investor in the sector will not be significantly higher than that applied to an established company.
The situation in the Australian retail grocery market is such that, new investors in the sector have a considerably higher average cost curve than that of established companies, notably, Woolworths and Coles This is because, the two companies have sufficient scale to leverage the costs of supplies.
These factors serve to comprehensively justify the contention that the Australian retail grocery market does not conform to the workable competition model.
Vertical Integration
Retail stores are an integral component of the economy of any given country. Retail stores have the essential function of acting as the link between the manufactures and the consumers of products. The retail stores also have the important functions of adding value to products before they are sold to the public and offering the producers a means of selling their products directly and effectively to the public.
Research indicates that a majority of profitable retail stores are vertically integrated. Vertical Integration is a micro-economic principle that is used in reference to a situation whereby all the supply chains, production processes, marketing initiatives and all other processes that are involved in the functioning of a company and organization are controlled by a single management or administrative body.
Vertical integration stands for procedures in which all steps involved in the contraption and distribution of goods fall under the control of a single firm in order to increase dominance of its market area (Parker, 2007 p.18-20).
Vertical integration can be further distinguished into forward and backward integration. Backward integration occurs when a company establishes control or ownership of the suppliers of its products (Vincent, Grantham,1997 p. 315).
On the other hand, forward integration is where a company establishes control over the distribution of its products.(Ibid 317) These measures are instituted in an attempt to minimize dependency on distributors and suppliers and also to minimize expenses.
Vertical integration is the management style that is the direct opposite of horizontal integration. Horizontal integration is the management principle that is distinguished by the fact that the various processes that are applied in the functioning of a business, company, organization or any other entity are controlled by a multiplicity of functionaries. (Hill & Jones, 2010, p.228).
Horizontal management also focuses on the expansion of a business at a similar position in the supply chan. In reference to the retail grocery business, the horizontally integrated retail store may sell groceries in addition to a wide selection of non-food items in an attempt to increase profitability. (Miler, 2010 p.12-17)
Vertical integration is widely applied in the retail sector because it has several advantages. Vertical integration has the benefit of reducing logistical costs and fostering efficiency in the supply chain. (Grant 2005, p.393) The principle also has the advantage of restricting or limiting the entry of potential competitors into the market by means of having the sole access to a supplier.
Vertical integration also ensures efficient supply and distribution of goods. However, the biggest advantage of vertical integration is increases in the profit margin. However, the principle is also associated with a number of disadvantages. Among these is the fact that vertical integration implies the lack of supplier competition and consequently higher costs.
Another drawback that is associated with the principle is lack of flexibility and decreased capacity to increase the diversity of products on offer. Furthermore, the fact that vertical integration requires the acquisition of new departments for supply and distribution may lead to increases in the bureaucratic costs. (Parker, 2007 p.27-30)
Vertical integration has adverse effects on the competitors in the grocer retail market. This is because, vertical integration enables an established company in the market to limit or restrict the entry of competitors into the market. This is because; the established vertically integrated company may have the sole access to a particular supplier. This is especially problematic in the case of scarce commodities. (Parker, 2007 p.33).
To illustrate this fact, the supply of groceries such as gourmet food products for example truffles and caviar is practically impossible for new entrants into the grocery retail market in Australia. The supply problems eventually led some retail grocery stores to be forced out of business.
The vertical integration also extended to the fact that Woolworths and Coles had a clause in their lease that restricted the smaller stores from being set up in the same shopping mall (theage.com.au, 2009). However, eventually, this practice was discontinued. In summation, vertical integration has negative impact on competitors.
That being said, the most successful strategy for an entrant into the grocery retail business in Australia is the adoption of horizontal integration. Despite the fact that most retail businesses have adopted the vertical integration model, this model would not be well suited for a new entrant into the market, it is best applied by the established companies like Coles and Woolworths.
The business should focus on diversification. Offering groceries for sale can be accompanied by venturing into non-food items such as magazines and cosmetics. This is the best strategy to compete in a market that is virtually a duopoly.
Payoff Matrix
To illustrate the contention that horizontal integration would be the orientation that would be best suited for a new entrant in the Australian grocery retail market, it would be useful to construct a payoff matrix.
The payoff matrix reveals that both vertical and horizontal integration have advantages and disadvantages. However, the horizontal integration orientation would be the best option that would enable a new entrant in the Australian grocery retail sector to be successful
References
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