UK Supermarket Analysis: Oligopoly

Economists have long back understood that an individual recognizes the structure of an industry, one can predict behaviour (conduct) of the firms in that industry, will able to determine how structure influences the industry in terms of efficiency and profitability (performance) along with evaluation of how the structure of an industry persuades the options that are obtainable to any firm in that industry in terms of marketing strategies and pricing. An efficient competition law organization is necessary to budding economies experiencing fast and noteworthy deregulation, privatisation and trade liberalisation. Constructing a competition ethnicity is of the essence and adequate knowledge of competition principles has to be produced and sustained among other government agencies, business, academia, and the common public Wessels (2006). Only a handful markets in practice can be categorized as a pure monopoly or perfectly competitive. The massive majority of firms do compete with other firms but with aggression quit frequently, and so far they are not price-takers and still hold some degree of market power. Therefore, most markets hold themselves between the two extremes of perfect competition and monopoly and are known as imperfect competition. Oligopoly is a type of imperfect competition which can be applied to U.K. supermarket industry. Its market structure comprises few firms which dominate whole market which is in case of U.K. supermarkets where ‘big Four’ namely Tesco, Asda, Sainsbury and Morrison’s are the dominate ones and indulged in oligopoly. This essay is basically structured to explain relationship of organisation and market and how UK supermarkets is an oligopolistic firm on the basis of oligopoly theories , its characteristics , product, innovation and lastly on the basis of geographical area and thereby having clear understanding that why these supermarkets are frequently inspected by the competition authorities.

RELATIONSHIP BETWEEN MARKET AND ORGANIZATIONS

The essential approaches to competition policy (Boner and Krueger, 1991) take in three key aspects which are Structure, Performance and Conduct. The traditional point of view emphasis on market structure and the degree of business concentration. A probable problem is that there could be an assumption that being big is in itself apprehensive. They penalise victors and help losers in the market place, critics of competition policies/laws may argue that without neglecting structure and performance the modern tendency is to scrutinize in detail conduct Douma and Schreuder ( 2002).The core of the matter is whether any economic agent is engaged in the abuse of market power and thereby undermining fair competition. Assessment of the state of competition necessitates a comprehending of how the relevant markets function in practice.

Market structure of UK supermarket

Tesco, ASDA, Sainsbury, and Morrison’s are 4 biggest supermarkets in the UK and they accounts for 67.9% of the grocery market. Tesco has 28% market share, chased by ASDA (15.2%), Sainsbury’s (14.3%) and Morrison’s (10.4%). After Somerfield, been purchased by the Cooperative, this group now has 8% market share (Cooperative at 6.3% and Somerfield at 2.7%). Other UK supermarket chains comprise M&S, Iceland, Waitrose, and so on. (Mintel)

There is a ample range of distinct types of grocery retail operators which include:-

Symbol groups- It can be described as multi-store chains where there is a single fascia but where ownership can be disjointed for example:- Musgrave, which controls the Budgens and Londis fascias, and Spar.

Supermarket multiples- They include Asda, Morrisons, Sainsbury’s and Tesco (the four largest supermarkets) and 11 smaller chains such as Somerfield, Waitrose, Marks & Spencer, Aldi, Lidl and Netto.

Independents- These are self managed or independently managed stores which are not operated under a brand symbol.

Co-ops- These operate almost in a similar way to symbol groups.

National market concentration

It demonstrates the variation in the overall grocery sales since 2002 by different types of retailers. The national market share of the five largest supermarkets in 2002 and four in 2005 after the acquirement of Safeway by Morrison’s has been roughly constant at approx. 75% by value of the grocery market. In relation to the augmentation in market share of Tesco who is the current market leader concentration has elevated. Remaining of the market like smaller brands including some symbol groups have enlarged as well for e.g. Spar, Costcutter whereas some independents have lost market share. The obvious boost in the concentration is due to the mergers which were permitted by the competition commission. The increase in concentration has also been driven by expansion in the Tesco as well as decline in the market share of Morrison’s.

There are three broad trends in market structure that are appropriate to competition in the supermarket:-

• In comparison to other countries in grocery sector the national market concentration is reasonably high.
• Some of the supermarket operators have stimulated in convenience store sector.
• The choice available to consumers at local level gets limited due to market concentration in some areas.

CRITICAL EVALUATION OF UK SUPERMARKET: AS AN EXAMPLE OF OLIGOPOLY

UK supermarket chains are a good example of oligopoly. More than 75% of the combined market share is captured by the largest four supermarket chains. Moreover there are merely one or two supermarkets for many consumers within their area.

ON THE BASIS OF CHARACTERISTICS AND THEORIES OF OLIGOPOLY

The government’s Office of Fair Trading in 1999 acknowledged three chief areas where the supermarkets gain from the use of market power which are:-

a.1 characteristics

Barriers to entry

The most significant barrier in the entrance is the complexity in getting planning permission for the commencement of a new supermarket. The enormous buying power and the large economies of the reputable supermarkets would make it almost impossible for a fresh player to compete with their low costs.

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Relationship amongst suppliers and supermarkets

The supermarket chains massive buying power and selling power is one of the most arguable issues. By forcing suppliers to propose discounts they have been able to drive costs down. A lot of suppliers such as growers have found their profit margins cut to the bone though these cost savings haven’t been conceded on from supplier to shopper.

Lack of effectual price competition

A system of shadow pricing have been adopted by supermarket chains which is a form of tacit collusion whereby they all notice each other’s prices and guarantee that they stay at similar levels. It has limited the true price competition. Supermarkets do compete on prices and ever since in 1999 the £6.4 billion takeover of Asda by Wal-Mart price wars in the supermarkets have become more cut-throat. On several products Asda has sliced there prices. To maintain the position of being UK’s number one supermarket Tesco in response initiated its price cutting campaign. Office of Fair Trading in 2006 decided to refer the big four supermarkets to the competition commission for the investigation. The Office of Fair Trading was worried about their elevated power regarding some aspects of their pricing behaviour such as below cost selling on certain lines and the opening of convenience store like Tesco Metro, Tesco Express and Sainsbury’s Local which was driving self-regulating retailers from the market among 2000 and 2004 as a consequence of which 7337 independent retailers went out of the business.

Non-price competition

To raise demand and develop brand loyalty among consumers it engages the utilization of advertising and marketing strategies. Additional policies will be used to raise market share by businesses.

• Enhanced quality of service including guaranteed delivery times and free servicing
• Longer opening hours
• Extended warranties on new products
• Discounts on product upgrades

For example, many supermarkets spend £millions in advertising. The profit maximizing rule to advertising is applied by some supermarkets. If the marginal benefit (or revenue) from extra sales go over the cost of advertising campaign then the advertising campaign is profitable. Other supermarkets see advertising simply as a way of increasing sales revenue. Comparatively high spending on marketing is significant for new business commencements. Some of the best examples of non-price competition have occurred in the food retail sector

Traditional advertising / marketing

Reward card schemes

Banking and other Financial Services

In-store chemists / post offices

Home delivery systems

Discounted petrol

Extension of opening hours

Self-scanning technology for shopper

Incentives to shop at off-peak times

Internet shopping

Price Leadership

Price leadership is a kind of oligopoly in which one leading supermarket puts prices and all the minor supermarkets in the industry go behind its pricing policy. The price-leadership model outcome is the quantity demanded in the industry is split amongst the main firm and the group of minor firms Griffiths and Wall (2005). By the amount of market power of the dominant supermarket this division of output is determined. In order to establish a monopoly the dominant supermarket has an incentive to push minor supermarkets out of the industry. It is when one supermarket has a dominant position in the market and the supermarkets with lower market shares follow the pricing changes prompted by the dominant supermarket.

Price Fixing

Price fixing symbolize an effort by suppliers inside a market to organize supply and fix price at a level near to the level we would prospect from a monopoly. Some effective collapse of several high profile price-fixing agreements have been observed in recent years.

a.2 theories

The Kinked Demand Curve

It is a model of oligopoly in which the demand curve facing each individual firm has a “kink” in it. The kinked-demand theory of oligopoly demonstrates the high degree of interdependence that exists among the firms that make up an oligopoly Wilkinson and Nick (2005). The model presumes that a business might face a dual demand curve for its product based on the probable responses of other firms in the market to a modification in its price. The operational conjecture is that firms in an oligopoly come across to protect and keep up their market share and that rival firms are unlikely to match another’s price increase but may possibly match a price fall.

If supermarket A increases price and others leave their prices invariable, then we can anticipate quite a large replacement effect as supermarket A would lose market share and there total revenue is expected to fall while if supermarket A decreases price and other supermarkets follow suit therefore the relative alteration in price is much smaller and in respect of the price change the demand would be inelastic. Trimming the prices when demand is inelastic also leads to a collapse in total revenue with little or no effect on market share.

Predatory Pricing

Predatory pricing is the practice of a large, powerful firm driving minor firms away of the market by momentarily selling at an artificially low price. Such behaviour became against the law in the United States with the passage of antimonopoly legislation around the turn of the century Tucker (2008) Economically predatory behaviour causes welfare problems because competent competitors might be dragged out of the market leading to a too elevated price-level in the long run. Such consequences would of course generate losses of welfare. For the stated reason predatory behaviour is prohibited by competition law in most countries.

For e.g.:-There were raised concerns on the subject of the use of local vouchering by some supermarket chains, chiefly Tesco, in the perspective of possible predatory pricing approach. During July 2003 and January 2004, Tesco used strategy of local vouchering in two different campaigns at its new store.

Game Theory

Game theory helps to analyze oligopolistic behaviour of versatile strategic moves as well as spontaneous counter moves amongst opponent firms Wilkinson and Nick (2005). In a comparative business area major supermarket chains in UK are in competition within themselves for growth and market share. There are several ways in which supermarkets can grow like commencing new stores in new areas, by advertising, by attracting customers from other stores or by reducing their prices. Supermarkets like to run their businesses at ease profit margins but in normal occasions there is a standard mark-up on the majority products that gives a sufficient return on the company’s capital employed. Occasionally one of the major players decides to attract more customers by significantly cutting their prices on a large range of standard products simultaneously the rival players will reduce their prices too in order to prevent the loss of its buyers.

“The country’s two biggest supermarket groups, Tesco and Asda, went head to head with price cuts on thousands of everyday products on Thursday, stepping up the battle to attract shoppers hit by the economic downturn”- Reuters

http://uk.reuters.com/article/2009/02/26/uk-asda-idUKTRE51P4CW20090226

http://www.oup.com/uk/orc/bin/9780199257843/ch_12.pdf

b.) on the basis of product and innovation

B.1 OLIGOPOLY POSSIBLE IN OWN-LABELLED PRODUCTS

Mostly, all supermarkets have similar products such as food companies, like Kellogg’s, Warburton’s, and Cadbury’s and so on, will supply their products to all of the supermarkets. Therefore, supermarket manufacturing its own generic goods for some product-lines, such as the Safeway Savers and Asda Smartprice range is the only way in which supermarket’s products vary from each other. However, the concerned issue is that these generic goods are produced at the same production line but just by labeling them differently for the different supermarkets, they construct fake demarcation of foodstuffs. This is a distinct feature of oligopoly as these are the same food products which are on sale in different supermarkets under their own-label.

Own-Label Products in U.K. Supermarkets

In recent years, the role of own labels in the supermarket offers has turn into more complex structure as retailers have started to fragment their own-label products into different groups. The first sign of this is introduction of a restricted number of ‘economy’ or ‘value’ product lines. One of its example can be Tesco who offers three categories of own label such as a premium range called ‘Finest’, standard owns label and the low-priced Value choice of over 300 product lines, whereas Asda offers two own-brand ranges an economy Farm Stores range and its standard Asda brand which is projected to match the branded goods in terms of product quality.

B.2 PROCESS INNOVATION and Oligopoly market

When a new product or method is effectively integrated into a firm’s production process, it leads to innovation .Oligopolistic market are associated with Process innovation and increased levels of research and development to differentiate their products ,which is also supported by William Baumol (2002) who states the fact that oligopoly as market structure is more compatible for innovative activities. Innovation is supposed to be compulsory for a firm that needs to set up a considerable lead in product quality or cost-advantage over their competitors. Opportunity crop up from access to plentiful resources and motive arises due to interdependent competition.

Home shopping and electronic commerce

Several initiatives are currently being functioned or trialled by the larger supermarkets in this area based on distinct models apart from the information that none of the approaches have come up as dominant.

Home delivery

Home delivery is where customers visit a store, select the stuff they require, pay for them and instead of taking those goods to home these are delivered to the customer’s address which is suitable especially for elderly and infirm. For e.g. Iceland offers home delivery services to their customers from all their stores.

Call and Collect

Call and collect are the services where a customer calls, does a fax or email there orders to a store however go and collect the goods according to their convenience. This form of service helps consumers to avoid delivery charges as well as long time waiting for home deliveries. For e.g. Sainsbury and Safeway are the major promoters of these services.

Electronic Home shopping

The service includes usage of internet to order products online, pay online as well as pick a convenient time for delivery. Asda and Sainsbury are opening depots from where home shopping services can be operated. Asda has commenced depots in Croydon and Watford which offer home delivery services.

C.) on the basis of geographical area

The chief determinant of market structure is the geographic size of the market. It is the geographic area over which firms compete with each another. Therefore, location of the supermarket is directly related to its success. In selecting a site for the opening of new supermarket, the main concern is the shopping district and due to growing supermarkets and limiting shopping district sites, there could be increased competition between supermarkets within a geographical area which could further lead to price war. For e.g. The Competition Commission was concerned that there is so stiff competition in certain areas that some superstores have started snapping up land on which their competitor could build. Out of 408 sites held in land banks, 190 are possessed by Tesco. This type of activities shows presence of Oligopoly in U.K. supermarkets

On the hand, it is very important to keep in mind while measuring the market is that whether it is the national market, the regional market or local market. For example, though Tesco acquires a national market share of approx. 28%, its market share may be considerably larger in some geographical areas .For example, the competition commission report states that found that in some places the large superstore have huge market shares such as Tesco having approx. 40% share in Milton Keynes, Uxbridge, Twickenham, Salisbury and Cambridge and similar is the case with Safeway in Dumfries and Sainsbury in south-west London. The Competition Commission also recommended that to generate competition along with giving consumers new choice, new planning legislation was be required.

Fig: Grocery market % share by retailer

Caonclusion

Today, there has been rising market concentration in nearly all the retail sectors. The increased market share and concentration could be a result of the acquisition of rival floor space, totting up of new stores, and the careful execution of operating strategies which are purely customer-focused. In the U.K. Grocery market there has been indication to a ‘big five’ in mid 1980’s or ‘big four’ thereafter in 2005. U.K. supermarkets are dominated by multiples, Tesco, Asda, Sainsbury and Morrison’s. Oligopoly would be a fair explanation of present situation of U.K. supermarkets as nearly half of the net output is in control of major four firms and business strategies implemented states that these supermarkets are essentially oligopolistic in their structure. These oligopoly strategies includes national coverage , formats of new stores and their geographic location, the expansion of product and service levels, paying greater importance on competitive pricing and enhancement in store ambience.

The big four’s oligopoly powers have allowed them to be dominant in buying products from their suppliers, to fix price levels by driving the prices down when products brought from suppliers and forcing higher than necessary prices for buyers. This means that they gain gratifying margins for themselves but at a cost to buyer’s welfare. Therefore, it can be concluded through various examples of oligopoly in U.K. supermarkets mentioned above in this essay that the ‘big four’ covers approx. 60% of one stop grocery market, there is not much scope for new entrants due to significant barriers to entry caused by scarcity of new sites and existing product niches, intense but muted price competition where there is inclination to chase prices instead of cutting them and hence making these supermarkets , a perfect example of Oligopoly in U.K.