Believe it or not, supermarket ‘price gouging’ is not to blame for your high grocery bill

If you go down to your local Coles or Woollies, you're likely to find goat on the menu. That is, goat spelled "scapegoat."

Australia, like the rest of the world, is experiencing elevated inflation, and some of the perpetrators of that inflation are looking for someone to blame.

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As grocery prices have been rising along with everything else, and as most people's direct experience of inflation is through those prices, one potential explanation for inflation is that it is due to "price gouging" by the retailers of groceries.

Blaming supermarkets for inflation is an old Labor habit, with the Rudd government in 2007 establishing a website called Grocery Choice meant to put downward pressure on supermarket prices.

It never worked and finally had to be put down in 2009 by then Competition Minister Craig Emerson.

Ever since the last election, Labor-aligned drums have been beating the supermarket rhythm again.

We've heard from The Australia Institute blaming inflation on "excess profits." The Australian Council of Trade Unions (ACTU) narrowed it down to supermarkets and have conducted their own inquiry. We've also had a variety of farmers groups, like the National Farmers Federation, also complaining that supermarket prices only weakly reflect the price that farmers are paid. This is also coupled with calls to increase prices paid to farmers which would actually increase the prices supermarkets charge-but that's special interest lobbying for you.

The pressure was enough for Prime Minister Anthony Albanese to establish an inquiry into the Food and Grocery Code of Conduct under the same Craig Emerson, since retired from politics, the politician who had to give the last rites to Grocery Choice.

That wasn't good enough for some and the pressure was maintained on the government. While the ACTU's inquiry isn't due to report until February, its chair, Alan Fels, has pre-empted that release calling for an ACCC inquiry into the sector.

The government has obliged, but the announcement was made in such haste that even the ACCC doesn't know what the exact terms of reference will be, although they intuit, "The inquiry will examine the pricing practices of the supermarkets and the relationship between wholesale, including farmgate, and retail prices."

But is that really the whole picture?

So who is to blame for inflation, and what real role do supermarkets play in it?

The blame for inflation lies primarily with the government - this one and the last one.

Our response to COVID-19 was unbalanced and involved borrowing to flood the economy with money so people didn't mind taking their enforced gap year. When we came out of COVID-19, this coupled with a supply shock due to disruption of worldwide logistics pushed our inflation rate up towards 8 percent.

While the Reserve Bank of Australia belatedly, but ultimately appropriately, hiked interest rates to dampen demand, the government went in the other direction.

They allowed out-of-control immigration to collide with overly ambitious spending plans, re-regulation of some sectors of the economy, dauntingly generous public sector wage settlements, and tampering in energy markets, to push in the other direction.

All of this was aided and abetted by the trade unions and will only get worse if the inaptly named "Closing the Loopholes" industrial relations legislation is passed.

On the other hand, the case against the supermarkets should never leave the prosecutor's desk.

If "price gouging" were driving inflation, then you would expect the increase in food and groceries to be greater than the general rate of inflation.

Yet in the year from September 2022 to September 2023, the CPI increased 5.4 percent while that of food and non-alcoholic beverages was only 4.8 percent.

If anything was driving inflation, it was insurance and financial services (8.6 percent), housing (7 percent), transport (5.6 percent), recreation and culture (5.6 percent), and health (5.4 percent).

Then, if you look at the financials of the two major supermarkets you find that their after-tax profit amounts to somewhere between 2.53 percent (Woollies) and 2.57 percent (Coles) of turnover.

What that means is their scope to lower average prices without going out of business, once you take account of their company tax, is no more than around 3.5 percent, or around a third less than the increase in the CPI, and that would be a once-off effect only.

Coles and Woollies are sometimes described as a duopoly, which leads to calls for more competition in the sector. I think it would be difficult to introduce another competitor of similar size, and I don't think it would make much difference.

The big two only account for 65 percent of the grocery market between them. The other 35 percent consists of Aldi, who generally beats them on price, Metcash, which is the franchisor of the IGA chain and trades more on convenience, and other smaller chains and private operators.

So they have a large market share, but still, one in every three grocery dollars is spent somewhere else. They also compete pretty keenly against each other.

It's been tried, tested, and failed

I wonder how the government thinks it might control grocery prices.

The reason the Grocery Choice website failed was because it aspired to have the price of every product for every supermarket on the web in a format where you could comparison shop before actually going out to buy.

The task proved too complex because prices vary from store to store. If supermarkets do "price gouge," it is in the richer areas where prices are generally higher.

You might call this "redistributive retailing" because these higher prices are cross-subsidising tighter margins in poorer suburbs.

While Coles and Woolworths aren't franchises, individual store managers have a lot of discretion in what they stock. You should see the range of coffees I can get in the Coles in cosmopolitan Woolloongabba near Brisbane CBD, compared to what is stocked in the affluent Racecourse Road, Ascot, for example.

So each individual store is in a competitive situation, significantly different to every other store, which leads to considerable variation, and does not make the whole amenable to centralised price setting.

How supermarkets work

Grocery retailing is a complex business with wafer-thin margins and fast stock turnovers (Woollies appears to turn its stock over completely at least 17 times every year).

Retailers have three large factors that they can control, and nothing else really matters. Those factors are rents, wages, and cost of goods.

The rent is determined maybe once every 10 or 20 years when a store enters into a new lease. Once signed, the rental increases are based on formulas that relate back to the market as a whole, which will reflect what your competitor is paying. So rents will be pretty similar over time.

Rents also have to reflect economic reality for the developers, and there is a level below which they will not fall.

Wages are determined through an Enterprise Bargaining Agreement (EBA) with the unions. There is some competition here between the unions, but again costs are pretty much fixed once you enter the EBA.

Cost of goods is the last significant factor, and here they have some control over some products, and not much over others.

What about the farmers? Well, it's not that clear cut either

Farmers have successfully propagated the line that the big two are rapacious negotiators when it comes to buying farm products. While they are certainly tough, farmers are not forced to sell to anyone at any price, but most of the price fluctuations have to do with markets that go from feast to famine.

When there is more than enough produce to satisfy the retail market's needs the supermarkets are going to pay less, and some farmers are going to be potentially faced with selling below the cost of their production.

You never hear them complaining when the boot is on the other foot and shortages push the price of produce well above the cost of production. Like all businesses with volatile prices, farmers only make a good living on average, and some years absolutely stink.

There was a long-running dispute over the price of milk, while at the same time, there were a lot of dairy farmers happily and profitably selling to Coles and Woollies. It had more to do with the deregulation of the industry, and larger, more efficient producers out-competing the old cottage industry farms, than price pillaging.

Food is only one part of the supermarket offering. When it comes to many other products, they are negotiating with companies many times their size and who have real pricing power.

And there is also intense competition on every supermarket's shelves. If they have 20 different brands and types of pasta, then each of those products has to justify its shelf space.

If they are not priced and specified in a way that sees them turnover at the right rate, then they will be abandoned, to be replaced by some other product that consumers have demonstrated they will buy at an appropriate margin.

While supermarkets do their best to control product costs, again they have limited power to change much.

All of these three factors more or less dictate the price that must be charged to make a profitable business, and those prices have to be spread over 20,000 to 25,000 different products.

Dancing on a tightrope

So pricing is done more based on heuristics of what has worked over time, as well as recommended retail prices.

There are the products that consumers will look for in specials, which are priced with one eye on the competition, but you can't comparison shop your whole store.

Prices will also vary depending on your own needs. Fruit, vegetables and meat are all perishable.

The closer to their expiry dates, the more likely is it that they will be marked down in price. The same is true for most other stock items, although timelines will be longer.

Each supermarket manager is trapped in a delicate dance. Most of their costs are fixed, and they can only play around to a limited extent with staff productivity, increasing turnover through marketing, and optimal pricing strategies.

I doubt whether from minute to minute most managers are even sure they are going to make their miniscule margins apart from what their historical records show them. There certainly is no room for drastic reductions in grocery prices. Nor could they be said to be driving inflation.

In reality, they are the victims of inflation as much as the rest of us.

Inflation raises their finance costs, and erodes margins on their existing stock, making quick turns even more imperative, and it diverts staff from selling and merchandising to constantly adjusting the price on items.

Expect the inquiries to tell us everything we already know

As the long and unsuccessful history of government interference in this area shows, there is not much that can be done about controlling grocery prices by controlling supermarkets.

The real solution lies in an efficient, freely operating economy that will deal with each of the inputs to prices in the most effective way.

Unfortunately, which brings us back to the need for scapegoats, this is the opposite type of economy to the one that the Albanese government has decided we must have. The economy needs less regulation rather than more.

Given the nature of inquiries, the ACCC will have to find something to change. You can't spend all that money and get nothing in return.

Let's hope those recommendations don't do too much to raise grocery prices, because they are unlikely to do anything to lower them.