Tag: suppliers

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Supermarket price wars and the effect on suppliers

The retail food industry is an oligopoly – a market dominated by a few big firms, with interdependence between them. This means that each firm considers the reaction of all its competitors when making any decision. Pricing is one of those key decisions and this is one of the reasons why price wars tend to break out in this industry.

For consumers, price wars are usually seen as a good thing, as it means prices in the supermarkets get forced downwards, thus reducing the cost of living. Low prices in this case are one of the key benefits of competition. However, there are costs of such fierce competition for suppliers. As final prices to customers are pushed down, small competitors are likely to feel the squeeze and may be forced out of the market. The other losers are suppliers. The big supermarkets are likely to pay lower prices to their suppliers, thus adversely affecting their livelihood. Research suggests that throughout 2014, 146 food producers entered insolvency, which is significantly higher than last year.

Accountancy firm, Moore Stephens, has blamed the supermarket price war for this rise in insolvencies in the food production sector. Duncan Swift from this firm said:

“The supermarkets are going through the bloodiest price war in nearly two decades and are using food producers as the cannon fodder…Supermarkets have engaged in questionable buying practices for years, but it’s getting worse and clearly wreaking havoc on the UK food production sector.”

The British Retail Consortium has said that placing the blame in this way was too simplistic. A commentator suggested that many suppliers have long-standing relationships with the supermarkets they deal with, suggesting that relations were good and sustainable. Furthermore, it was suggested that the demise of these producers may be due to many other factors and the data on insolvencies did not show that those firms affected were suppliers to the supermarkets. There is a Groceries Code Adjudicator in place to ensure that the supermarkets do not abuse their power when it comes to dealing with their suppliers, but the power of this person is limited, leaving suggestions remaining that suppliers are vulnerable. The following articles consider both the good and bad of price wars.

Articles

Questions

  1. What are the characteristics of an oligopoly? Why do price wars tend to break out in oligopolies, such as the supermarket industry?
  2. Apart from the supply-chain pressure from supermarkets, what other factors could have caused so many small food producers to become insolvent?
  3. How does the supermarket supply chain work and why have the price wars led to suppliers being squeezed?
  4. Use a diagram to illustrate the impact of the price war on (a) the supermarkets and (b) the suppliers.
  5. How important is the Groceries Code Adjudicator and should she be doing more to protect suppliers?
  6. If supermarkets are cutting prices, is this an indicator of unfair competition or good competition?
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Is Amazon a monopolist?

The market structure in which firms operate has important implications for prices, products, suppliers and profits. In competitive markets, we expect to see low prices, many firms competing with new innovations and firm behavior that is in, or at least not against the public interest. As a firm becomes dominant in a market, its behavior is likely to change and consumers and suppliers can be adversely affected. Is this the case with Amazon?

Much attention has been given to the dispute centering around Amazon and its actions in the market for e-books, where it holds close to two thirds of the market share. Critics of Amazon suggest that this is just one example of Amazon using its monopoly power to exploit consumers and suppliers, including the publishers and their authors. Although Amazon is not breaking any laws, there are suggestions that its behavior is ‘brutal’ and is taking advantage of consumers, suppliers and its workforce.

But rather than criticizing the actions of a monopolist like Amazon, should we instead be praising the company and its ability to compete other firms out of the market? One of the main reasons why consumers use Amazon to buy goods is that prices are cheap. So, in this respect, perhaps Amazon is not acting against consumers’ interests, as under a monopoly we typically expect low output and high prices, relative to a model of perfect competition. The question of the methods used to keep prices so low is another matter. Two conflicting views on Amazon can be seen from Annie Lowrey and Franklin Foer, who respectively said:

“Amazon relentlessly drives down prices for goods and services and delivers them fast and cheap. It ploughs its profits into price cuts and innovation rather than putting them in the hands of its investors. That benefits millions of families – full stop.”

“In effect, we’ve been thrust back 100 years to a time when the law was not up to the task of protecting the threats to democracy posed by monopoly; a time when the new nature of the corporation demanded a significant revision of government.”

So, with Amazon we have an interesting case of a monopolist, where many aspects of its behaviour fit exactly into the mould of the traditional monopolist. But, some of the outcomes we observe indicate a more competitive market. Paul Krugman has been relatively blunt in his opinion that Amazon’s dominance is bad for America. His comments are timely, given the recognition for Jean Tirole’s work in considering the problems faced when trying to regulate any firm that has significant market power. He has been awarded the Nobel Prize in Economics. I’ll leave you to decide where you place this company on the traditional spectrum of market structures, as you read the following articles.

Amazon: Monopoly or capitalist success story? BBC News, Kierran Petersen (14/10/14)
Why the Justice Department won’t go after Amazon, even though Paul Krugman thinks it’s hurting America Business Insider, Erin Fuchs (20/10/14)
Is Amazon a monopoly? The Week, Sergio Hernandez (19/11/14)
Big, bad Amazon The Economist (20/10/14)

Questions

  1. What are the typical characteristics of a monopoly? To what extent does Amazon fit into this market structure?
  2. Why does Paul Krugman suggest that Amazon is hurting America?
  3. How does Amazon’s behaviour with regard to (a) its suppliers and (b) its workers affect its profitability? Would it be able to behave in this way if it were a smaller company?
  4. Why is Amazon able to charge its customers such low prices? Why does it do this, given its market power?
  5. Is there an argument for more regulation of firms with such dominance in a market, as is the case with Amazon?
  6. The debate over e-books is ingoing. What is the argument for publishers to be able to set a minimum price? What is the argument against this?
  7. Should customers boycott Amazon in a protest over the alleged working conditions of Amazon factory employees?