#12546 - Industrial Economics Case Study - Industrial Economics: Market Structure

Industrial Economics I: Case Study - The supply of groceries in the UK market investigation

Q1: Describe the market that is being investigated in your competition case study (e.g. nature of good, number of players, geography, etc). Make sure to provide the facts and link to your economics terminology.

Oligopoly market (a few large and dominant firms with many small firms)

-Large grocery retailers that carry a full range of grocery products namely Asda, Morrisons, Sainsbury’s, CGL, M&S, Somerfield, Tesco and Waitrose

-4 largest grocery retailers: Asda, Morrisons, Sainsbury’s, Tesco

-The 4 largest grocery retailers account for just over 65% of total grocery sales in 2007

-There are other regional grocery retailers, symbol group retailers, convenience store operators, limited assortment discounters, frozen food retailers

-nature of product: homogeneous (groceries such as food, pet food, drinks, cleaning products, toiletries and household goods are similar in different stores)

-many consumers, none large relative to market

-High barriers to entry that constrain competition in grocery retailing by impeding growth of competitors

Ex. Cost advantages that large grocery retailers have over other grocery retailers and new entrants

Planning regime for grocery retailing

Control of land by large grocery retailers that may frustrate competitor entry into local markets

Q2: What are the competition concerns that the competition authority is investigating (i.e. what are the theories of harm)? Be specific to the case - for example, don't just say they are looking to see if merger has or may reduce competition. Be careful to talk about what they hypothesis the problems are/were at the start of the case rather than what conclusions they reached (more on that later).

(a) What is the competition issue?

90% of all larger grocery stores are operated by 8 large grocery retailers. There is a high concentration of market power between the 4 largest grocery retailers (Asda, Safeway, Sainsbury’s, Tesco in 1998). This results in prices of groceries higher in the UK than in comparable EU countries. Presence of market power can lead to the abuse of dominant position as the firms carry out exploitative and exclusionary behaviour

For instance there may be

• Predatory pricing with persistent selling of some products below cost distorted competition and damaged smaller grocery retailers and convenience stores, thereby adversely affecting elderly and less mobile customers, who tend to rely on smaller retailers (Predatory pricing is a form of strategic barrier to entry and it is an anti-competitive conduct)

• Practice of varying prices in different geographic locations where these locations seem to be not related to costs

• Behaviour of the five grocery retailers towards suppliers seem to be against public interest as well

• Land holdings of large grocery retailers and their use of restrictive covenants could be used to reinforce their existing market position (High barriers to entry determine the market structure directly according to SCP model and this will affect the conduct and performance of the firms, resulting in a restriction of effective competition. Barriers to entry are conditions that allow the established firms to earn abnormal profits without attracting entry. This is probably a structural barrier.)

• Buying power of major grocery retailers increased and this may harm consumer choice by undermining viability of alternative business models

Thus, there is a need to investigate if there are features of the market that are suspected of distorting or preventing competition.

(b) What economic analysis/tools/methods are used to investigate the issue?

The competition authorities used several measures of market concentration to determine whether there is a high concentration of market power. These include measuring the number of competitors in a market, the relative size of competitors as measured by sales shares (either by revenue or volume) and indices, such as concentration ratios or the Herfindahl-Hirschman Index, which reflect both the number of firms in a market and their relative size.

In addition, the competition authorities use the ACS model and look into

• Features of the all-grocery-stores product market

• Extent of concentration in local markets for grocery retailing and its impact on the retail offer

• Barriers to entry and expansion in grocery retailing due to cost advantages of large retailers

• Possible coordination between grocery retailers

• Possible sources of distortion of the competition such as

-‘waterbed effect’ whereby the lower prices that large grocery retailers extract from suppliers result in higher prices for other grocery retailers and wholesalers. Large grocery retailers have a cost advantage as they save on distribution and purchasing costs.

-a ‘tipping point’ in the financial viability of the grocery wholesaler sector

-the impact on convenience store operators, and specialist grocery retailers, of below-cost selling by large grocery retailers

-the impact on convenience store operators and other grocery retailers, of local vouchering by large grocery retailers

-recent expansion by Sainsbury’s and Tesco in convenience store retailing

(c) Does the methodology used correspond to models from industrial economics?

The methodology used by the competition authorities is similar to those we have seen in industrial economics. Since we have identified that the grocery retailing market is an oligopoly, we expect the few dominant firms to have some form of market power and P>MC. The competition authorities look into the features and extent of concentration of the market to verify that it is indeed an oligopoly market and how prices have been affected. They also look into whether the barriers to entry and expansion are permanent and prevent competition. Possible coordination between grocery retailers is also investigated as we learnt that any form of collusion or cartel can hurt consumer welfare.

(d) What data is used to analyse the issue and where does it come from?

The competition authorities used

• Submissions from grocery retailers, suppliers, consumers, local authorities. Conducted hearings with grocery retailers, site visits, round-table discussions with manufacturers and primary producers. Questionaires and surveys done by CC.

• Trends in convenience store numbers and revenues from ONS grocery store data (ONS grocery store data revealed that the number of convenience stores increased slightly since 2003 although number of independent convenience stores declined)

• Data published by IGD

• An analysis of the impact of entry by larger grocery stores and new convenience stores owned by large grocery retailers on the number of independent nonaffiliated convenience stores and specialist grocery stores in the locality of these new stores

• Data on detailed pricing, volume and cost data at the SKU level for a period of up to five years from 29 suppliers. These suppliers varied in terms of both size and the types of grocery products that they supplied. The sample covered 141 branded SKUs and represents approximately 1.8 billion of annual sales at wholesale prices, or at least 2 per cent of UK grocery retail sales.

• Experian Goad dataset, which contains details of retail stores in more than 1,000 high streets and retail parks across the UK

• Information provided by the ten grocery retailers (Aldi, Asda, CGL, Lidl, Morrisons, Netto, Sainsbury’s, Somerfield, Tesco and Waitrose) on which product groups they engage in below-cost selling and reasons why they do so

• Information provided by Asda, M&S, Morrisons, Sainsbury’s, Tesco’s and Waitrose on their local vouchering. In general, grocery retailers use vouchering to support a new store opening or the extension or refurbishment of an existing store. Tesco spent significantly more on local vouchering than any other UK grocery retailer.

(e) Is there anything else to add onhowthe competition issue is investigated?

Q3: Does the competition authority formally define the relevant market in the case? If they do, why do they do this? If they don't why not? [this can be your opinion or what they have said themselves but be clear on which it is] Describe the methodology used to define the relevant market in the case study? Make clear what methodology is used, whether product and geography are considered, and whether other issues are taken into account?

Market definition is needed for the purpose for competition analysis and the framework within which competition takes place. Authorities need to identify the grocery stores that impose a significant competitive constraint on each other. Key to identifying stores is assess the extent to which consumers regard different stores as effective substitutes of each other. Stores that should be included in the same market are those to which consumers will switch when the store at which they are currently shopping increases its price.

Methodology of market definition used is SSNIP: A market is defined as a product or a collection of products, the supply of which can hypothetically by monopolized profitably

The extent to which a profit-maximising hypothetical monopolist controlling grocery stores in a candidate market will be determined by demand and supply side substitution (take into account possible changes in price and non price factors since stores compete on price, product range, service and quality, store layout, cleanliness, opening hours and parking facilities too)

Found that supply side substitution not likely to take place since a retailer need to establish...