Food retailers need to tread carefully as prices soar

Major chains need to balance the needs of all stakeholders – consumers, suppliers and shareholders – to avoid greater scrutiny.

Australia’s major supermarket chains are engaged in a delicate balancing act as food prices rise at the fastest pace in decades, adding to pressure on household budgets.

Coles, Woolworths, Aldi and wholesaler Metcash face a backlash from consumers if there is any indication they are profiteering from global inflationary pressures by raising shelf prices at a faster rate than wholesale prices.

The ACCC is closely monitoring food retailers to ensure they are not exploiting current challenges to the detriment of consumers.

With a review of the Food and Grocery Code of Conduct under way, retailers face greater regulatory intervention if they are accused of being too tough on suppliers by refusing to grant, in part or in full, requests for price increases.

And as British retailers Tesco and Sainsbury’s have found, retailers also face a reckoning from shareholders if they don’t pass higher costs on to shoppers and margins and earnings are squeezed. Tesco shares fell to a six-year low in October after it warned investments in price reductions to minimise inflation would contribute to a profit crunch this year.

Inflation is generally beneficial for retailers, as rising prices make it much easier to offset rising costs. But if gross margins and net margins rise too far, retailers risk being accused of not doing enough to mitigate the pain for consumers grappling with higher mortgage, rent and energy costs.

If gross margins fall too far, investors will inevitably accuse retailers of acting irrationally and investing too much in price to defend their market share, triggering a share price revaluation.

Food retailers and competition regulators will no doubt be closely watching the outcome of an inquiry launched last month by Canada’s competition watchdog, which is examining whether competition factors are having an impact on the price of food.

The investigation follows growing concern that the country’s three major supermarket chains have been taking advantage of runaway inflation to bolster earnings, with Canada’s federal agriculture committee calling for an investigation into grocery retailer profits.

Global supply chain disruption, the impact of climate change on the agricultural sector and soaring energy and grain prices triggered by Russia’s invasion of Ukraine are widely acknowledged as the key reasons for soaring food prices.

However, retailers’ profits have come under scrutiny in Canada after the three largest grocery chains – Loblaw, Metro and Empire (which owns Sobeys, IGA and Safeway) – lifted profits by a combined $C241 million over the course of the pandemic.

In Canada, about 80 per cent of grocery sales are controlled by five chains – Loblaw, Empire, Metro, Walmart and Costco. The Australian market is even more concentrated, with the top four players – Woolworths, Coles, Metcash’s IGA network and Aldi – controlling 81 per cent of sales. Woolworths and Coles alone account for at least 65 per cent of sales.

Assistant Minister for Competition, Charities and Treasury Andrew Leigh says the ACCC is closely monitoring food retailers to ensure they are not exploiting current challenges to the detriment of consumers.

“In addition, the government is closely monitoring the effectiveness of the Food and Grocery Code of Conduct,” he tells Window Shopping.

So far, no one has accused Coles, Woolworths and Metcash of profiteering during the pandemic, though their earnings have risen strongly over the last three years.

This is partly due to the shift in consumer spending from hospitality to supermarkets, which helped to offset COVID-related costs and higher supply chain costs.

Coles’ supermarket earnings rose to $1.7 billion in 2022 compared with $1.19 billion in 2019, Woolworths’ Australian food earnings rose to $2.42 billion in 2022 from $1.86 billion pre-pandemic, and Metcash’s food earnings reached $200.3 million in 2022 compared with $182.7 million pre-pandemic. (Aldi manages to escape scrutiny because its earnings are undisclosed).

According to Morgan Stanley, food retailers’ gross margins, which essentially represent profit on the cost of goods sold, are 100 to 150 basis points higher than they were pre-pandemic. Coles’ gross margin, for example, has risen to 26.3 per cent from 24.8 per cent pre-pandemic and Woolworths’ to 30.4 per cent from 28.7 per cent.

The cost of doing business has also risen, but not to the same extent as gross margins, enabling Coles and Woolworths to deliver higher EBIT margins. Woolworths’ EBIT margin has risen to 5.3 per cent from 4.7 per cent pre-pandemic and Coles’ to 5 per cent from 3.8 per cent, while Metcash’s food margin is little changed since 2019 at 2.1 per cent.

Retailers are working hard to minimise price rises by forcing suppliers to justify requests for price rises, encouraging suppliers to cut costs rather than pass on higher inputs, and collaborating with suppliers on co-funded price campaigns such as Coles’ Locked and Dropped, Woolworths’ Prices Dropped and Metcash’s Low Prices Everyday and Price Match programs.

Despite these investment and promotions, average prices rose 7.1 per cent at Coles and 7.3 per cent at Woolworths in the September quarter as the retailers passed on higher prices from suppliers for packaged groceries and fresh food such as dairy products, meat and bread.

Coles’ CEO Steven Cain says higher prices don’t necessarily flow through to higher profits, and most of Coles’ margin gains over the last few years are due to strategic sourcing initiatives and its Smarter Selling program, which is on track to cut costs by $1 billion.

“You have to think about all the stakeholders involved,” Cain said. “We have to look after suppliers – some are doing it tougher than others – we have to look after our customer base … also there’s our shareholders to consider as well.”

Coles appears to be taking a tougher approach with suppliers over price rises than Woolworths and Metcash, judging by the number of products on its “Dropped and Locked” programs, recent market share gains and supplier feedback to independent reviewer Chris Leptos, who is conducting a review of the Food and Grocery Code of Conduct complaints process.

“I have received very positive feedback on the informal [complaints] process from Woolworths and Metcash,” Leptos says. He declined to comment on Coles. In the 24 months ended June 2022, five official complaints under the code were made about Coles, whereas Woolworths, Aldi and Metcash received no official complaints.

Cain believes Coles’ relationships with suppliers are strong.

“We have 4000 product suppliers and the number of complaints is relatively low,” he says. “We take all complaints seriously, and they’re thoroughly investigated and if Jeff [code arbiter Jeff Kennett] makes a decision, we abide by that decision.”

Woolworths is also doing what it can to ease the budget squeeze on shoppers, dropping the prices of 150 products in addition to weekly specials and personalised discounts to loyalty scheme members.

“Making sure customers get their Woolworths worth is a key priority,” CEO Brad Banducci said at the September quarter sales results last week. “We are very focused as always on balancing the needs of our customers and the practical reality suppliers are operating in.”

Leptos says the process of considering price increase requests from suppliers appears to be going more smoothly under the code, with less reliance on confidential data and fewer threats of range reviews and demands for additional marketing support.

“I think it is more widely accepted now that asking for confidential information will trigger concerns with the code arbiters and the independent reviewer,” Leptos says.

However, after reviewing the code for more than a year, Leptos believes there are gaps that need to be filled to improve the complaints process.

Neither the independent reviewer nor the ACCC has the power to call up the files of code arbiters to see how they are conducting their reviews. Leptos also believes the independent reviewer should be designated a “super complainant” for the ACCC – requiring the ACCC to conduct an investigation if requested by the independent reviewer.

Hopefully by the time the code review has been completed by April next year, food inflation will have peaked and pressure will have eased on retailers, suppliers and consumers alike. In the meantime, retailers need to tread carefully to avoid the same scrutiny as their peers in Canada.


Extracted from AFR

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