Supermarkets, size and competition

Gerard Jackson
BrookesNews.Com
Monday 16 June 2008

Since the 1920s the size of firms has caused much confusion in neo-classical economics, giving birth to the myth that competition means a mass of small firms selling the same product in the same market. The failure to see that competition is a process and not a numbers game has resulted in mistaken economic policies. Supermarkets are frequently cited as an example of anti-competitive behaviour where the big boys have used their economic muscle to squeeze out much smaller competitors. This view has given rise to three major complaints about supermarkets:

(a) Service has never been worse and it's not getting better because conglomerates have forced service out of the market place. They have been aided in this by "consumers who will get out in the cold and rain to fill their own car with juice rather than detour off the main strip to a secondary main road where they can pay the same price for someone else to fill their tank".

(b) Supermarket labour saving policies must eventually reach a stage where so little labor is employed to provide goods and services demand falls away.

(c) Companies are not listening to their customers but marketing consultants.

(d) Big retailers and banks have exploited individuals for short-term gain during the last 20 years.

One can see that these criticisms tend to be directed at size and assume, if tacitly, that small is basically better. Now services have been reduced at petrol stations, for instance, to economise on labour. This process always happens as economies progress and that is why we don’t have lift operators anymore. Put very simply, as economies more capital intensive real wages rise.

But this means that many labour intensive services are reduced because customers are not willing to pay enough to cover the costs of the service. However, some small operators might still provide these services but where this is so one usually finds that they are marginal operations with a narrow range of other services. Being small, and probably owner-dealers, it is the operator or a family member that usually mans the pumps, so to speak. It should be borne in mind that companies will always hire more labor when it pays them to do so.

This brings us to labor costs. Services can decline where the cost of labour has been driven beyond its market clearing value. Where this occurs one should expect to see a rise in casual and part-work. This is precisely what has happened in Australia where about 26 per cent of employment consists of these types of jobs. Naturally, firms will try to arrange production in a way that minimises the cost of labour. In retailing this might take the form of lower quality services which usually appear in the form of queues.

Unfortunately, declining services and above market labour costs are rarely linked to each other, even by many economists. I should point out that if gross wage rates (this includes oncosts like superannuation) are allowed to fall behind the rate of GDP growth and inflation, a tendency will emerge for labor costs to fall relative to the value of labour's marginal product, which means the demand for labour will rise. In this instance, one should expect casual unemployment to fall as more people are taken on as full-time labour.

In addition, those who criticise supermarkets for “lousy” service are free to shop at the local milkbar. That most consumers still prefer to shop at supermarkets demonstrably proves that their services are not quite as inferior as critics make them out to be. Critics overlook the fact that service doesn’t just mean more checkouts, it also includes lower prices, loss leaders and, especially, a massive range of goods that no corner shop could ever hope to stock. In other words, critics are taking a very narrow view of the meaning of service.

Point (b) that using less labour reduces demand is one of the oldest economic fallacies about. There are two implicit assumptions here: (1) that demand springs from consumption instead of production and (2) that there is a fixed amount of work to be done. Yet economic progress means labour producing more and better goods per unit of time. Rising productivity, which is caused by increasing per capita investment, raises individual purchasing power.

It is this process that raises demand. The suggestion that social welfare payments have actually helped keep supermarkets afloat simply does not hold water. Welfare payments are transfer payments. That is to say they involve the transfer of purchasing power from one group to another group, leaving total purchasing power unchanged. In plain English, the government takes money from A and gives it to B to spend. This clearly reduces A’s spending power while raising B’s. How this process is supposed to maintain economic activity beats me?

Now point (c) argues that companies are not listening to their customers might be true for banks, which are still largely protected against competition, but it does not hold up for supermarkets which are obviously in fierce competition with each other. Also ignored is that supermarket competition is mainly responsible for real grocery prices falling during the past 20 years by about 40 per. Moreover, critics should bear in mind that only companies protected against market processes can ignore their customers for very long periods.

The charge in point (d) that big retailers and banks have exploited individuals during the last 20 years is absurd with respect to supermarkets, especially when we consider that supermarket operations are the main driving force behind falling real grocery prices. If this is exploitation, then let’s have more of it. In any case, how can companies with an average 3.4 per cent rate of return, as is the case for supermarkets, be said to be exploiting the public mystifies me.

The banks are, however, in a different position. They are privileged by law which protects them against real competition from the outside. This should make it clear that their behaviour cannot be logically blamed on free markets. Big is not always better and small is not always beautiful. As Professor Coase pointed out about 65 years ago, only the market can optimise the size of a firm.