Evaluation Of Market Power For Australian Super Market

Market Power of the Companies

Discuss about the Evaluation of Market Power for Australian Super Market.

The report aims to analyse the nature of Australian super market industry and its structure. The study mainly focuses on the market power of two supermarket giants Coles and Woolworths. Coles is the firm which has showed steady performance while other firms have suffered from lower profit margin. Australian super market industry is oligopolistic as a market power is acquired by a few numbers of firms operating there. Coles has 37.3% and Woolworths has 32.5% market share in this industry (Chung, 2016). Woolworths and Coles together have 1760 supermarket stores in Australia. Consumer base of both companies are strong compared to other market player. The first section of this report analyses the super market power of these companies and the later section discusses on competition between two companies.

Australian grocery supermarket industry is oligopolistic in nature as total market share is entitled to a small number of firms and imperfect competition prevails in this industry. The major market power in this market is Woolworths, Coles, Aldi and Costco. There are other firms, which together hold a small portion of the market share. They engage in price war to increase profit and market share. A fierce competition exists in this market. Woolworths and Cole has economies of scale in this market and hence price cut is easier for them compared to other small firms (Dwivedi, et al., 2012). Another strategy that these two firms use to increase market share is product differentiation and expansion of product range.

Market power is determined by market share, range of products, customer base, and number of employment. As stated by Tyers (2015), market power is determined by the ability of the firm to raise profitability by setting price over the marginal cost. Market power of the firm indicates power to raise prices without losing number of consumers. Leigh (2016) argued that firms that have low market power are price take in the industry. Therefore, it can be inferred that the firm, which can control over the price and output in the market, get a market leadership in the industry. In the view of Hughes et al. (2013), market power is determined by the barriers to entry in the market and availability of substitute in the market.

An oligopolistic firm has negatively sloped demand curve. The firm has rising marginal cost curve. Equilibrium price is determined at the intersection point of marginal cost and marginal revenue curve. However, as the firm has some extent of market power, the oligopolistic firm sets price above the competitive price level and as per average revenue (Hughes, et al., 2013)). The market power of the company depends on the power of raising price over the marginal cost. It depends on the elasticity of the demand curve of the firm. The market power is higher when elasticity of demand is less (Tyers, 2015). Demand curve of the firm is less elastic, when is less options available to the consumers. Food supermarket in Australia is oligopolistic as Woolworths and Coles follows all these criteria.

Price determination power

Chung (2016) stated that Australian people spends $100 per week at Coles and Woolworths stores. These two firms have able to create the brand awareness so that consumer always gives first preferences to either Coles or Woolworths. Keith (2012) mentioned that Coles and Woolworths controls around 70% of the market share in Australian super market industry. Concentration of market power of these two firms has led the Australian Competition Commission to inquire into this matter. Profitability of both companies has increased substantially over the years. According to Lawrence, et al., (2013), these two firms put pressure on farmers and on the food chain regarding prices, volume of transaction and commercial strategies. Therefore, they influence the terms of trade in favour of their profitability.

Market power of these two companies can be evaluated from the price determination power. As mentioned by Hughes, et al., (2013), when the food supermarket industry was facing deflationary problem in Australia due to global financial crisis, the food price decreased significantly. However, Woolworths and Coles raised prices of food products to boost up the prices. During 2012-13, Woolworth increased price by 2.9% and Coles increased by 1.7%. However, there is a controversy regarding this price rise. Study of Citigroup has shown that price raised by Woolworths two times between May and June in 2014. Prices raised by 1.3 % and 8.7% consecutively. This instance can indicate towards market power of two companies. However, Wardle (2015) argued that these two firms have used price cutting strategy several times.

The volume of sales matters in this respect. Supermarket is favourite place to the customer due to availability of range of choice. People get multiple options for buying consumer goods. They can even made choices regarding the price of the product. As the supermarkets such as Woolworths and Coles have large scale of operation, they keep an extensive range of product in the retail stores. The problem is that food products have durability. As there is possibility of food wastage after a curtain period, theses companies limit their orders. Farmers often depend on the giant supermarket firm as the rush of people is concentrated there. Therefore, when big firms like Woolworths and Coles limit their product demand, farmers has to cut their production or has to destroy their production by making loss (Knox, 2014). This instance implies that these firms exercised monopsony power while dealing with foods suppliers and the farmers.

Another indicator of market power is barrier to entry into the market and market share. Firms can enter into the market when exiting firm can make significant positive profit. However, as said by Leigh & Triggs (2016), firms can create barrier to entry if cost structure is very high in this industry or there are presence of wide range of differentiated products. There are limited numbers of firms operating in this industry. However, Aldi is a growing super market firm that is giving tough competition to these giant firms in present days. Aldi has potential to grab market share from existing firms. Although Aldi has low market, this firm is growing at a faster rate to catch Woolworths and Coles. Inspite of advent of Aldi in the food super market industry, it can be said that Woolworths and Coles have significant market share as they have been able to create entry to barriers over the years. Price cut and product differentiation have been important strategies for these firms. Therefore, it can be said that concentration of market power has turned the food super market industry from oligopoly to duopoly.

Competition between Coles and Woolworths

Keating (2015) opined that competition in an oligopolistic market is good for consumer as it maximises consumer welfare. Although Woolworths engage in price war, it rarely responds to price rise but frequently responds to price falls. Tyers (2015) stated that oligopolist firm follow kinked demand curve through short lived price war. During short term price wars between two firms, both firms try to snatch market share. Kinked demand curve predicts that the firm can maximise output at the level Q1 and the price P1. The marginal cost cuts MR at the discontinuous portion. The equilibrium price and output remains unaltered even if the MC curve shifts upward due to rise in cost. Price stability is a characteristic of oligopoly market.

In the view of Keith (2012) if any oligopolist like Woolworths or Coles behaves according to the kinked demand curve, it does not respond to the hike in the price of the product above P1. However, as discussed above, it has been seen that price rise by Woolworths has been followed by price hike by Coles. Lawrence, et al., (2013) argued that price hike after global economic crisis was an instance. Response for price hike rarely occurs. The price hike is not profitable for one firm. Reason behind this is if one firm increases price as well, there is a fear of losing market share. Consumers may shift to other firms to purchase same product at a lower price. Therefore, decrease in number of consumer decreases sales volume of the firm and hence negatively impact on the profitability. Therefore, price increase is not profitable and rational.

On the other hand, price fall is followed by both firms. If price falls below P1, the rival firm decreases price as well. If the firm does not respond, profitability reduces. By lowering price, a firm can attract more consumers. Therefore, they engage in price war. This reduction in price is beneficial for the consumers in the short run. Leigh & Triggs (2016) argued that this price war often results in loss for both the firms. However, in reality, Woolworths and Coles both engage in price war as fierce rivalry exists between them. Therefore, continuous reduction in price may reduce profit margin.

In the view of Dwivedi, et al., (2012), as price of product falls, firms reduce their supplies and hence, choices to the consumers decrease. Moreover, quality of the product also decreases. Firm increases there supply when price of the product rises as per the rule of supply. Upward sloping supply curve of the firm shows that firms increases production with the increase in supply price.

When price decreases, quantity demanded by the consumer increases, however, firms are not able to supply at the point of market demand. Those excess demand created in the market can be absorbed by other competitive firm. In order to hold the market share, both Woolworths and Coles take various strategies such as online retailing. Aggressive marketing strategy makes consumer better off as consumer surpluses increases. However, aggressive marketing strategy may reduce product quality which may decrease consumer satisfaction. As reported by Chung (2016), Woolworths decided to reduce price as in order to regain its market share.

Increasing market share of two firms are treat for the farmers and suppliers. Cost of supply of grocery products increases for the suppliers. As both the firm has market power, they can purchase products at a lower price from the farmers and other suppliers. In the view Feng, et al., (2014), they may even face financial problems in their business operation. As both firms restrict the product demand and emphasise to promote local brand, the big brand gets lesser opportunity to explore in the Australian market. As a result, food security in Australia has been under question. Competition policy is making Australian food market worse off.

 A healthy competition between two companies is good for the economy. However, as stated by Bariacto & Nunzio (2014), aggressive market strategy may ruin sustainability of their business in long run. Firm gets economies of scale when average cost of supply is falling for a long range of output. Barriers to entry in this market reduce due to price competition. Therefore, chances of new entry increase. New entry such as Lidl, Aldi is threats for Woolworths and Coles of reducing market share. However, if the competition shifts from price to product differentiation and product innovation, that would be beneficial for both the companies and the consumers. Marketing strategy of both firms is more or less similar (Dagge, 2016). Therefore, it can be said that fierce competition between two firms may reduce barrier to entry and increase competition in this market. Entry of new firm may make competition healthy.

In order to improve competition policy in the food super market industry, firms may take other policies such as cost leadership, product differentiation or strategic alliance. Cost leadership is the strategic policy to achieve long run sustainability in the industry. This strategy can give competitive advantage, economies of scale and the market leadership. An oligopolistic firm can be a leader or follower in the market. A follower can take decision after observing the steps taken by the leader and acts accordingly. Another strategy may be strategy alliances between two firms. Cartel formation cans significant barriers to entry in the market by reducing the competition. However, this policy is desirable for the firms but not for the consumer welfare.

Conclusion

The study presents a report on the market power and competition policy of two giant firms in Australian food super market. The study finds that these two companies hold more than 70% market share in the Australian super market industry. They are able to make growing profits over the years and create significant barriers to entry. However, entry of Aldi in the market has proved that barriers to entry are not high in this market. Product differentiation strategy and the cost leadership make competition easier. Market power of these two firms is such that the super market industry has turned from oligopoly to the duopoly market.

References

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