USING THE KINKED-DEMAND CURVE TO UNDERSTAND OLIGOPOLY
Joan Robinson hypothesised in 1936 that demand curves might be other than the traditional downward sloping curves that we have encountered so far. Specifically she thought there might be a demand curve with a ‘kink’ in it. Theories to explain these ‘imaginary curves’ were developed in a rare instance of simultaneous discovery by Paul Sweezy at Harvard and by R. L. Hall and C. J. Hitch in Oxford in 1939. Both publications produced versions of a kinked demand curve. Hall and Hitch questioned the owners of 38 firms and found that rather than profit maximising by producing where marginal cost is equal to marginal revenue, the majority in fact used cost-plus pricing. The entrepreneurs added up their costs of production and then added what they thought was a fair profit margin. A few took into account what the market price was but none was able to calculate marginal costs and revenues.
In Figure 2, the current price is therefore determined by cost-plus pricing. Above this price, an individual firm is afraid of putting up prices. A price increase would, he assumes, not be matched by his competitors, hence the demand curve above Pi is elastic. It will be remembered that if demand is elastic and price rises, revenue falls.
Similarly a price fall has the same effect on revenue. This time the firm imagines that dropping its own price leads to others dropping theirs. Overall, quantity demand increases as the demand curve slopes down, but the increase is less than proportionate. That is the demand curve below price Pi is inelastic. The implication here is that the prices in oligopoly tend to be more stable than in the other theories of the firm. Further insight can be gained by examining the marginal revenue curve. The marginal revenue recall, falls at twice the rate of the average revenue (demand) curve. The kinked demand curve can be thought of as two demand curves. The marginal revenue curve MRa is related to demand curve Da and MRb is related to demand curve Db. (See Figure 3)
The dotted sections of Da and Db are irrelevant as consumers are always going to choose any given quantity at the lower price, so the relevant sections of the marginal revenue curves are as in Figure 4.
In figure 5, the two parts of the marginal revenue curve are joined with a vertical section to help show where the MC and MR curves intersect. In this diagram when costs rise, from an increase in sales taxes for example, the marginal cost curve MCi moves upward to MCii. The profit maximising oligopolist still equates MC with MR in order to determine the level of output. But because the MC curves cut MR where it is discontinuous and vertical the output remains at Qi, and hence the price Pi remains constant too. The firm can keep their price stable by reducing the overall level of profit earned, and if they can sustain this stability in the long run it implies that a measure of abnormal profit was being earned before the cost increases.
For prices to change, costs would need to rise above that part of the MR curve which is discontinuous, say to MCiii (Figure 6, right) If demand increased, this too might not lead to an increase in price unless the demand curve moved far enough to the right to make the MC curve cut MR above the discontinuity of MR.
The main problem with the kinked demand curve model is that it fails to explain oligopolist’ behaviour consistently. It does help to explain price rigidity and why entrepreneurs are wary of price cutting as a business tactic or ‘spoiling the market.’ Today a more common term is price-war. And that brings us to ‘The Game Theory.’
THE GAME THEORY
Above, I mentioned that a common behavioural tendency that is exhibited by oligopolistic firms is interdependence. The games theory is a theory often used to analyse interdependence among oligopolistic firms. A game occurs when there are two or more interacting decision-takers (players) and each decision or combination of decisions involves a particular outcome (pay-off.) The fate (or the pay-off) of a player in a game depends not only on the actions of that player but also on the other players.
The game theory is mainly concerned with predicting the outcome of games of strategy in which the participants (for example two or more businesses competing in a market) have incomplete information about the others' intentions. The classic example of game theory is the Prisoners’ Dilemma, a situation where two prisoners are being questioned over their guilt or innocence of a crime. They have a simple choice, either to confess to the crime (thereby implicating their partner in crime) and accept the consequences, or to deny all involvement and hope that their partner does likewise.
The “pay-off” is measured in terms of years in prison arising from each of their choices and this is summarised in the table below. No communication is permitted between the two suspects – in other words, each must make an independent decision, but clearly they will take into account the likely behaviour of the other when under interrogation.
An optimal strategy for each prisoner must be reached (Figure 7 right). Equilibrium occurs when each player takes decisions which maximise the outcome for them given the actions of the other player in the game. In our example of the Prisoners’ Dilemma, the dominant strategy for each player is to confess since this is a course of action likely to minimise the average number of years they might expect to remain in prison. But if both prisoners choose to confess, their “pay-off” is higher than if they both choose to deny any involvement in the crime.
The equilibrium in the Prisoners’ Dilemma occurs when each player takes the best possible action for themselves given the action of the other player. The dominant strategy is each prisoner’s unique best strategy regardless of the other players’ action. The prisoners could do better by both denying, but once collusion kicks in, each prisoner has an incentive to cheat.
Game theory analysis in the real world has direct relevance to our study of the behaviour of businesses in oligopolistic markets, such as Tesco. For example, the decisions that firms must take over pricing of products, and also how much money to invest in research and development spending. Costly research projects represent a risk for any business, but if one firm invests in research and development, can another rival firm decide not to follow? They might lose the competitive edge in the market and suffer a long term decline in market share and profitability.
The prevailing strategy for both firms is probably to go ahead with research and development spending. If they do not and the other firm does, then their profits fall and they will lose market share. However, there are only a limited number of rights available to be won and if all of the leading firms in a market spend on research and development; this may ultimately bring a lower rate of return. The big question is why don’t the firms collude and agree together what to do with their money, instead of worrying about what the other firm might do? The simple answer is because, as I mentioned above, colluding is illegal, because it would be unfair on other competing firms.
A BACKGROUND TO TESCO PLC
Tesco now controls just over 30% of the grocery market in the UK, approximate to the combined market share of its closest rivals, Asda, Sainsbury's, Morrisons and other grocery markets. Originally specialising in food, it has diversified into areas such as discount clothes, consumer electronics, consumer financial services, selling and renting DVDs, compact discs and music downloads, Internet service, consumer telecoms, consumer health insurance, consumer dental plans and budget software. They are now entering into the housing market, with a self advertising website called Tesco Property Market.
As of its 2006 year end Tesco was the fourth largest retailer in the world behind Wal-Mart, Carrefour and Home Depot. Tesco moved ahead of Home Depot during 2007, following the sale of Home Depot's professional supply division and a decline in the value of the U.S. dollar against the British Pound. METRO was only just behind and might move ahead again if the euro strengthens against the pound, but METRO's sales include many billions of wholesale turnover, and its retail turnover is much less than Tesco's. At 24 February 2007 Tesco operated 1,988 stores in the UK, and 1,275 outside the UK. The company has a total market value of about £36,761.71m (April 2007) and is the largest private sector employer in the UK and second to the NHS overall.
During the 1990s Tesco expanded into Central Europe, Ireland and East Asia. Tesco bought into the USA market through internet shopping when it obtained a 35% stake in GroceryWorks. October 2003 meant the launch of a UK telecom division, comprising of mobile phone and home phone services, to complement its existing internet service providing which was launch in August 2004.
Figure 8 (above) illustrates the percentage that each firm holds in the market. Tesco has the holding share of the market with just over 30%, while Morrisons has the lowest with only 11%. Tesco is definitely a suitable example to model oligopoly, since it is competing with a small number of other large firms, selling similar products with significant barriers to entry mainly due to brand name, and large land acquisitions.
The source of the information in figure 8 is sourced directly from Tesco’s website. It is quite possible then, that the information above is not fully truthful and precise. I have still deemed it sufficiently trustworthy to use, because of
TESCO’S OPERATION
Tesco operates upon a robust four-pronged strategy:
Core United Kingdom Business: Grocery retailing in its home market. It has been innovative and energetic in finding ways to expand, such as making a large-scale move into the convenience-store sector, which the major supermarket chains have traditionally avoided.
Non-food Business: Many United Kingdom supermarket chains have attempted to diversify in other areas, but Tesco has been exceptionally successful. By late 2004, it was widely regarded as a major competitive threat to traditional high street chains in many sectors, from clothing to consumer electronics to health and beauty to media products. Tesco sells an expanding range of own-brand non-food products. It has also done rather well in non-food sales in Ireland. CDs are one of the best examples, with Tesco Ireland promising to sell all chart CDs for €15(£10.71). This can be seen in comparison to HMV selling the same CD for around €20(£14.20)
Retailing Services: Tesco has taken the lead in its sector in expanding into areas like personal finance, telecom, and utilities. It usually enters into joint schemes with major players in these sectors, contributing its customer base and brand strength to the partnership. Other supermarkets in the United Kingdom have done some of the same things, but Tesco has generally implemented them more effectively, and as a result, have made most profit.
International Expansion: Tesco began to expand internationally in 1994, and in the year ending February 2005, its international operations accounted for just over 20% of sales (about £7 billion.) It has focused mainly on developing markets with weak incumbent retailers in Central Europe and the Far East, rather than on mature markets such as Western Europe and the United States. The medium term aim is to have half of group sales outside the United Kingdom. Tesco rolls out successful UK initiatives in other countries. For example, Tesco Financial Services and Tesco Express convenience stores both operate in several international markets.
TESCO’S FINANCIAL PERFORMANCE
Tesco’s financial performance can be analysed using a ‘lines-on-two-axes’ graph, which is a classic combination chart, used frequently to analyse two related entities. This graph can be seen below, Figure 9.
The entire data are for Tesco's financial years, which run for 52 or 53 week periods to late February. Up to the 27 February 2007 period end, the numbers include non-UK and Ireland results for the calendar year ended on 31 December 2006 in the accounting year. The figures in the chart include 52 weeks/12 months of turnover for both sides of the business as this provides the best comparative. Including 60 weeks of non-UK and Ireland sales the figures to 24 February 2007 were:
- Revenue: £46,600 million
- Profit for year: £2,478 million
- Basic earnings per share: 22.36
As seen from figure 9, Tesco’s turnover and net profit have been increasing steadily since 1998, without exception. The most significant change during the analysed period occurs in 2005 and 2007. The highest percentage growth in turnover occurred in 2007 with a 21.67% increase, from £38,300m to £46,600m, a colossal increase of £8300 million. The highest net profit observed over the 9 year period, occurs in 2005 with a 24.18% increase in net profits. In actual figure, the increase was from £1100m to £1366m, again a huge profit of £266 million.
The EPS, or earnings per share, are the earnings returned on the initial investment amount, and are also important when testing for financial performance. Earnings per share are calculated by using the following formula:
The earnings per share have increased steadily since 1998. As seen from figure 10, in 1998 the earnings per share were 8.12 pence and have risen steadily to a share price of 22.36 pence, making a 64% increase in share prices over the 9 year period.
This data is also released from Tesco’s own website, so it may appear that the data is slightly biased. However, this thought can be quickly dismissed as Tesco are unlikely to release false data due to the fact that they are being monitored by the London Stock Exchange.
THE CAUSE OF TESCO’S GROWTH
Tesco’s growth over the last two or three decades has involved a transformation of its strategy and image. Jack Cohen, the founder led it to its initial success on the approach of ‘Pile it high, sell it cheap.’ The only disadvantage of this was that the stores adopted a poor image with middle-class customers. Earlier last year, it was the largest retailer in the United Kingdom, with a 29% share of the grocery market according to retail analysts, compared to the 16.8% share of Wal-Mart owned ASDA and 15.6% share of third-placed Sainsbury’s, which had been the market leader until 1995, when Tesco overtook. There are three reasons why this may have happened:
Tesco’s use of its own-brand products, including the upmarket ‘Finest’ and low price ‘value’ ranges. The company has taken the lead in overcoming customer reluctance to purchasing own brands, which are generally considered to be more profitable for a supermarket as it retains a higher portion of the overall profit than it does for branded products.
Appealing to customers of all income ranges is also a main reason to the leap in growth. An ‘inclusive offer’ is a phrased used by Tesco to describe its aspiration to appeal to all customers of all income range, in the same stores. According David McCarthy, a retail analyst, Tesco have ‘pulled off a trick that no other retailer has achieved; that is, of course, appealing to all segments of the market.’ In contrast, ASDA’s marketing strategy is heavily focused on value for money, which can undermine its appeal to upmarket customers even though it sells a wide range of upmarket products. By taking on this marketing strategy, ASDA have seemingly lost interest from upmarket customers, that Tesco benefit from, as well as the customers looking for good value.
The third point is simply, economies of scale. Economies of scale characterize a production process in which an increase in the scale of the firm causes a decrease in the long run average cost of each unit.
Economies of scale can be enjoyed by any size firm expanding its scale of operation. The common ones are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), and marketing (spreading the cost of advertising over a greater range of output in media markets). Each of these factors reduces the long run average costs of production.
During its long term dominance of the supermarket sector, Sainsbury’s retained an image as a high-priced middle class supermarket which considered itself to have such a wide lead on quality that it did not need to compete on price, and was indifferent to attracting lower-income customers. This strategy has been abandoned since losing its ‘Number One’ spot to Tesco. The reasons for Tesco’s success evidently revolve a lot around ‘non-pricing competition.’ Overall, the success of Tesco is probably based mainly on getting the basics of retailing correct, and getting it right slightly more often than its competitors.
TESCO’S UTILISATION OF TECHNOLOGY TO ATTRACT CONSUMERS
Like any large firm, Tesco are bound to invest money in research and development, and through this Tesco has made significant advances in technology, mainly through use of the internet. Tesco has operated on the internet in the United Kingdom since 1994 and was the first retailer in the entire world to offer a robust home shopping service in 1996.
Grocery Sales are available within delivery range of selected stores, goods being hand-picked within each branch. Tesco has also upgraded its software through ‘Business Systems UK Ltd.’ Whilst the upgrades were being performed, The Times made investigations and wrote in the paper: ‘Tesco, the UK’s largest supermarket retail organisation, has chosen Nice university quality management software and the NiceLog digital voice recording and screen capture platform which automates and optimises its approach to customer service and employee development through consultancy and implementation of a recording and quality management solution all promoting a more advanced Tesco.’
Tesco has also moved into Internet Service Providing (ISP) and its own mobile phone and home phone sector. These services are available to UK residential consumers and marketed via and through Tesco stores.
ECONOMIC SURPLUS; PRODUCER AND CONSUMER SURPLUS
The term surplus is used in economics for several related quantities. The consumer surplus is the amount that consumers benefit by being able to purchase a product for a price that is less than they would be willing to pay. The graph (right) illustrates this: consumer surplus is red, and producer surplus is blue. The producer surplus is the amount that producers benefit by selling at a market price that is higher than they would be willing to sell for.
Note that producer surplus flows through to the owners of the factors of production, unlike economic profit which is zero under perfect competition. If the markets for factors are perfectly competitive as well, producer surplus ultimately ends up as economic rent to the owners of scarce inputs such as land.
On a standard supply and demand (S&D) diagram, consumer surplus (CS) is the triangular area above the price and below the demand curve, since intramarginal consumers are paying less for the item than the maximum that they would pay. In contrary, producer surplus (PS) is the triangular area below the price and above the supply curve, since that is the minimum quantity a producer can produce.
It’s important to relate the above graph to Tesco. Just earlier on, we analysed Tesco’s growth and noticed that Tesco appeals to customers of all income ranges. Also, we analysed that Tesco can drive prices down as a benefit of economies of scale. With these two facts, coupled together, its inevitable that a customer of a high income range, may go to Tesco willing to pay a higher price for a product than it is selling for. This is therefore tied into the above concept of consumer and producer surplus, because they are making a loss due to selling products for cheaper than the customer is willing to pay.
If the government intervenes by implementing, for example, a tax or a subsidy, then the graph of supply and demand becomes more complicated and will also include an area that represents government surplus.
Combined, the consumer surplus, the producer surplus, and the government surplus (if present) make up the social surplus or the total surplus. Total surplus is the primary measure used in welfare economics to evaluate the efficiency of a proposed policy.
A basic technique of bargaining for both parties is to pretend that their surplus is less than it really is: sellers may argue that the price they ask hardly leaves them any profit, while customers may play down how eager they are to have the article. In national accounts, operating surplus is roughly equal to distributed and undistributed pre-tax profit income, net of depreciation.
POSITIVES AND NEGATIVE ASPECTS OF OLIGOPOLY WITHIN THE RETAIL/GROCERY MARKET
Inefficiency was the first negative aspect regarding an oligopoly, with the main point focusing on the high prices. As seen from figure 11, prices have decreased from 100 RPI in 2002, to 92 RPI in 2006.This is described as an ‘8 point drop.’
Tesco’s claims that between 2000 and 2006 Tesco prices fell by 17%. Tesco’s belief is that customers deserve the best value for money and that is why they work hard to find ways of keeping their prices down. On Tesco’s website they confidently write ‘Every week we check over 10,000 prices in Asda, Sainsbury’s and Morrisons stores to guarantee you low prices every day.’
Tesco also wrote on their site that whilst lower prices benefit all consumers they are especially important to families on a budget and have made a significant contribution to making healthy food accessible to all. Tesco believe that they do more by running promotions on fresh fruit and vegetables; they now sell 95 fresh fruit and vegetable Value lines and are also working with the Pre-School Learning Alliance to help parents and children in some of the UK’s most deprived areas to make healthier choices.
The retail food prices is a source obtained from The Office of Fair Trading website, and therefore there is no suspect to bias on this source, since The Office of Fair Trading have no reason to alter figures to support Tesco.
The Office of Fair Trading found that real prices for food had fallen 7.3% between 2000 and 2005, as seen in the above source. In an article in The Financial Times Richard Hyman, chairman of Verdict Research, said ‘intervening in the grocery sector could have a counterproductive effect if redrawing the competitive playing-field had a material effect on supermarkets' ability to deliver low prices.’ From the above sources, it is easy to show that a retail/grocery oligopoly such as Tesco does not raise prices but decreases prices.
This is stated in The Office of Fair Trading website; ‘Supermarkets, entry into the convenience store sector pushes prices down. Customers benefit from strong competition and falling prices in the sector. The Office of Fair Trading also mentioned ‘price cuts’ as a concern: ‘aggressive pricing by supermarkets may be distorting competition.’
Andrew Simms, an economist working for The New Economist Foundation, an independent firm, agrees with this concern: ‘The paradox is that if the government hand supermarkets freedom to deliver lower prices to consumers, what do they do if they kill the competition and create a position of long term price increase?’ David Rae, head of convenience stores, said that ‘Supermarkets sold lines at a loss to attract customers.’ This appears to convey that lower prices are really just a ‘disguise’ and prices are bound to rise in the long run, once enough customers have been attracted.
This point however, must be evaluated; Can Tesco endure a loss in the short run, hoping it will attract customers? And will consumers fall into the trap, and then later on pay the price? The answer to the first question is logical; Tesco will balance the loss with profits made on other product lines
is it tolerable for a supermarket such as Tesco to sell as a loss for an extended period of time, just to attract customers? The answer is that they must be balancing the loss with profits made on other product lines, or they have a cash reserve which they can rely on as collateral, until the profits start picking up later on.
THE INCREASE IN CONCENTRATION OF WEALTH AND INCOME INCURRED BY TESCO, AND ITS IMPACT ON CONVENIENCE STORES AND OTHER PEOPLE
After analysing Tesco and its financial status, I think it is important to analyse a negative aspect that I discussed earlier and incorporate with the ideas derived from information about Tesco. A negative effect of oligopolies in general, is the increase in the concentration of wealth and income. This is where a company increases its share in the market through internal growth and taking over other firms. Tesco definitely falls into this category as can be seen from figure 12 (left.) This means that Tesco could wield market power and weaken competition. One of the outcomes, of increases in the concentration of wealth and income, is the closure of independent local stores as stated on The Office of Fair Trading website, where it says that Supermarkets’ entry into the convenience store sector may force local stores to close.
Figure 13 below, illustrates the percentage point change in market share of store sales (2005-2007,) and it can be seen that convenience specialists and independent stores sales have decreased 6 points, while Grocery multiple sales have increased 7 points. Again, the source of the data is The Office of Fair Trading, and is not subject to any suspicion of bias. The data surely confirms that there is an increase in concentration of wealth as can be deduced from the taking over of stores and the increase in market share of store sales. The Times have even described this behaviour as ‘bulling and said that the bankruptcy of fruit and vegetable growers can be blamed on the bullish behaviour of retailers.
In addition ‘barriers to entry’ increase concentration of wealth at the supermarket level. ‘Barriers to entry’ was stated as the first of the four concerns listed by The Office of Fair Trading. It said in the entry that ‘new supermarkets may face barriers to entering the market because of the planning system.’ Planning laws make it difficult for new entrants to open stores. The current land bank of 319 sites across the big four retailers-Tesco, ASDA, Sainsbury’s, and Morrisons, could obstruct new competition and perhaps harm consumers. At current, a supermarket can develop a site it already owns without approval from the competition authorities. However, a supermarket must get approval every time it tries to incorporate a store from a competitor. Tesco has been investing in its stores pipeline since mid 1990’s. Tesco’s land bank stood at 46% of the total market in 2000 and had reached 58% by 2005. Lower choice is the outcome of these planning laws.
EVALUATION OF TESCO’S EFFECT ON THE PRODUCER
Farmers have to bear the burden of unfair trading practices imposed by supermarkets, especially Tesco, which is a name that comes up time and time again, during farmers’ complaints. The only point farmers have to make is that if they are to have a future as farmers and sustainable agriculture then supermarket power, must be heavily controlled.
In 2001, Tony Blair claimed that British supermarkets had farmers in an 'armlock'. Supermarkets control nearly 80% of the British grocery market and as the most powerful players along most food supply chains are able to dictate terms, conditions and prices to suppliers. If suppliers complain, supermarkets can simply move their business elsewhere, and their dominance of the food retail sector is such that there may simply be no one else for farmers to sell their produce to.
In 2000, the UK Competition Commission reported on many of the supermarkets' unfair practices which were considered anti-competitive. It found 52 kinds of abusive trading practices. The response by the Office of Fair Trading (OFT) was to introduce a voluntary code of practice, to be entered into by the large four supermarkets. Many of the 12 original provisions recommended by the Competition Commission were weakened. A later review by the OFT revealed that many practices identified in 2000 were still occurring, and a survey of farmers conducted by Friends of the Earth in 2003 showed that many farmers were 'being asked to pay a rebate on an agreed price, waiting over 30 days for an invoice to be paid, incurring additional transport or packaging costs due to changes in supermarket specifications and meeting the costs of unsold or wasted products where quality of the product was not an issue'.
Tesco and other supermarkets fail to pay farmers a fair share of retail prices too. Thousands of farmers and workers are forced to leave the industry each year because of the low prices they receive for their produce. Farmers' organisations believe that a major contributory factor to this crisis in British farming is the increasing buying power of supermarkets and their ability to squeeze suppliers. According to the 2000 Competition Commission Report the buying power of the major supermarkets actually means that 'the burden of cost increases in the supply chain has fallen disproportionately heavily on small suppliers such as farmers'.
Supermarket buying power means that a supermarket like Tesco can obtain more favourable terms than other buyers. For example, the Competition Commission investigation revealed that Tesco consistently paid suppliers nearly 4% below the average price paid by other retailers. However when a supermarket squeezes its supplier, it merely reallocates profit margin from supplier to retailer and there should be no assumption that the retailer's saving will be shared with consumers.
Dairy farmers are also recently speaking out; Friends of the Earth research in 2007 highlighted how dairy farmers are struggling to break even and are unable to invest in greener farming, despite increased consumer demand for more environmentally friendly produce. This coincided with the Office of Fair Trading allegations of dairy price fixing demonstrating just how supermarkets profit while producers and even the environment suffer.
EVALUATION OF TESCO’S EFFECT ON THE CONSUMER
Diet-related ill health is costing the NHS increasing amounts through illnesses such as cancer, diabetes, obesity and coronary heart disease. However, this is not just a question of personal choices, but of social circumstances, with low-income communities far more likely to suffer from diet-related illnesses, and an estimated four million people in the UK are unable to obtain access to a healthy diet.
Despite their complain of providing affordable food, supermarkets play a large part in this problem. The development of superstores on outskirts of town centres and out-of-town sites, and the closure of many local independent shops as a result, has created ‘food deserts’ – areas where it is almost impossible to buy affordable healthy food, especially fresh fruit and vegetables, without private transport.
More recently, and encouraged by government initiatives, supermarket chains have begun to set up stores in deprived areas, but this is not necessarily good news.
New supermarket developments could result in the loss of even more independent shops. It is often the most socially excluded and poorest groups who are most in need of the social and economic bedrock offered by independent neighbourhood shops and markets. In 2000 the Department of Health actually recommended that local authorities should discourage the provision of new supermarkets over 1000 square metres outside existing town centres in recognition of the value of local shops to low income households.
The value offered by supermarkets offers much less to the lowest income groups. They offer best value for car-based bulk buying through offers such as ‘two for one.’ Not only are these special offers mainly for processed food, but lower income groups without access to private transport, and in particularly elderly and less mobile people, are less able to advantage of them. NCH the Children’s Charity found that travel costs to go food shopping added 23% to the shopping budget of low income families.
Supermarkets are best value for unhealthy and heavily processed foods. A study by the National Consumer Council released in December 2006 showed that some supermarkets were undermining efforts to tackle health inequality, and that many economy lines were high in salt, fat and sugar. In 2005, a National Consumer Council study showed that retailers’ practices are contributing to, or aggravating, the inequalities that exist between the diet and health of more affluent and less affluent customers.
At the same time, research has shown that supermarkets are not always the cheapest sources of healthy food. A survey by Sustain in 2005 showed that a basket of fruit and vegetables at a supermarket in Walthamstow cost £2.50 more than the equivalent at a market. Research by the New Economics Foundation for the London Development Agency in 2006 showed that fresh produce in street markets was on average 30% cheaper than at supermarkets.
The UK's biggest supermarkets are grappling for ever greater market share. Small independent stores and suppliers, and ultimately consumers, are paying a direct price in the face of unfair competition. In the five years to 2002, 50 specialist stores including butchers, bakers, fishmongers and newsagents closed every week. In May 2005 the IGD revealed the loss of 2,157 unaffiliated independent convenience retailers, compared to only 1,079 the year before.(see earlier for further analysis into independent convenience stores.)
The All-Party Parliamentary Small Shops Group investigated the future of small shops in the UK. Its report "High Street Britain: 2015", released in January 2006, predicted a bleak future for independent shops. The report predicted that independent convenience stores were unlikely to survive by 2015 and independent newsagents were very unlikely to survive. The report argued that the social and economic benefits of diverse forms of retail should be protected. Likewise, a report by the New Economics Foundation (NEF) from 2005, Clone Town Britain, found that chain retailers are damaging to the local economy, social inclusion and local identity.
Small shops are vital for people to access healthy food, in particular disadvantaged groups, and people without cars or with limited mobility. The closure of many small shops has left some neighbourhoods with limited access to healthy food. Please see the food poverty page and Sustain's Food Access Network for more information on this. There are concerns that the closure of small shops is a one-way street. Once small independent stores shut, there are often insurmountable barriers to getting back into the High Street. It is very difficult for new businesses to start up. And there are concerns that a tipping point could be reached.
Once a certain amount of independent retailers shut, the wholesale industry may no longer be sustainable, and could collapse. The knock on effect of this will be further damage to the independent retail sector. For more information on this, please see the submission from the Federation of Wholesale Distributors to the Competition Commission, as well as the High Street Britain report and the Association of Convenience Stores submission to the Competition Commission.
There are concerns about the way supermarket chains gain an advantage over small shops on the High Street. Their market share gives them a level of flexibility between store formats and over product pricing, and control of supply chains. Smaller shops do not have this flexibility and control.
Tesco are abusing seller power, through practices such as price flexing and below-cost selling. According to the Competition Commission's report on the grocery market from 2000, the big four chains were persistently selling products at below market price. This could damage independents and smaller chains, and in turn damage consumers. This report also found that some of the chains were engaging in price-flexing. In geographical areas with no major competitors, they were selling products at higher products than in areas where they faced stronger competition. The submission by the Association of Convenience Stores to the Competition Commission grocery market inquiry in 2006 found that such practices were continuing.
It also appears the Tesco are abusing buyer power and the planning system. In particular Tesco is squeezing suppliers on prices. The larger chains can extract more favourable conditions from suppliers than other types of retailer can. They are able to do this because of their market shares and integrated supply chains. See the Code of Practice page for more information on these issues. The result of these practices is when suppliers raise prices for other buyers (including independent shops) as a knock-on effect.
Larger firms such as Tesco tend to buy in larger quantities of inputs and so are in a stronger position to negotiate discounts. However, the stronger the position of Tesco and other grocery retailers, could lead to the closure of suppliers, as The Times stated about vegetable and fruit growers going bankrupt, because of the ‘aggressive’ behaviour of larger retailers. Larger firms are also able to borrow money at cheaper rates, because they have more assets and so it is less risky to lend to them, and feel more secure to lend to them. By diversifying into several regions or countries, the firm is likely to have more stable demand patterns. Sudden falls in demand for the product in one area is likely to be offset by an increase in demand, elsewhere. As a result, demand is more predictable and the firm does not need to hold as much stock, which in turn, reduces stock holding costs.
CONCLUSION ON HOW TESCO AFFECTS BOTH CONSUMERS AND PRODUCERS
Many regard Tesco as a great British success story built on a fearsome determination to win in a competitive market, to the great benefit of consumers. Others regard it as a threat with excessive market share, which takes over entire towns and convenience stores.
Economists have described it as ‘Jekyll and Hyde Tesco.’ Using this phrase, we can ask whether the Competition Commission has seen the Jekyll Tesco or Hyde Tesco over the 17 month investigation of groceries markets which continued until 30th October 2007. The answer is, it probably regards Jekyll Tesco as the dominant personality but that the preliminary findings (not yet released) will be seen as curbing some of Tesco’s allegedly noxious habits.
That said, Tesco will not be singled out for special treatment by the commission. The recommendations will apply to all the big supermarket chains, but because of the way that Tesco has acquired very large market shares in many towns and districts, inevitably it will be most affected by proposed reforms. The debate that may spark is whether we actually want more supermarkets, whether the benefits of greater competition outweigh what many see as the negative impact on communities and landscape of superstore proliferation. The commission believes that Tesco’s large national market share is not a particular problem, even if it does take one in every three pounds we spend in supermarkets.
More relevant is that about a third of consumers have three superstores within relatively easy reach of them. Some consumers will see that as a blessing, but for proponents of competition, that’s a sign of inadequate competitive tension in some parts of the country.
Some technical proposals from the commission that could have far-reaching consequences, are expected to rectify this problem, and it is likely that supermarket groups will be prohibited from buying land near to an existing store and then sitting on the land with intent of preventing a competitor from muscling in. Supermarket groups may be forced to sell off those chunks of their so-called land banks that are competition-spoilers. It is also likely that there’ll be a ban on the groups’ use of restrictive covenants whose point is to prevent any parcel of land being developed by a competitor. As the biggest holder of land, Tesco is bound to be seen as the most at risk here.
Looking back at Tesco’s success, there are 3 main points that can be evaluated upon:
1. Tesco’s use of its own brand products
2. The inclusive offer, Tesco’s aspiration to appeal to upper, medium and low income customers in the same stores.
3. Customer focus, to create value for customers to earn their lifetime loyalty.
Although Tesco has been criticised for acquiring too much of the market, by forms of ‘hostile’ behaviour, and causing companies to be forced to close, it is easy to clearly see the benefits that consumers are benefiting from Tesco’s oligopoly. To state the obvious, when suppliers provide supermarkets with more items at a cheaper price, that is in theory good news for shoppers, and they are also offering good in-store service, and a comfortable shopping environment.
From the gathered data, I feel that the features of the original hypothesis have been suitably proved; however, it still remains unclear whether the future looks good for consumers and suppliers that deal with Tesco. Will Tesco start taking advantage of their power in the market, to drive other competitors out, and start forming the Tesco monopoly, at which point it will drive prices up, and consumers will have no power to change anything?
BILIOGRAPHY
Books used:
- Business Economics
- P.Maunder
- 1989
- Applied Economics
- A.Griffiths & S.Wall
- 2004
- Economic Growth
- R.A Barro
- 1995
- Heinemann Economics
- Susan Grant & Chris Vidler & Charles Smith
- 2003
Websites used:
Correspondence with: