Report on the relations between manufacturers and retailers in the food sector Report on the relations between manufacturers and retailers in the food sector Contents Report on the relations between manufacturers and retailers in the food sector Executive summary 4 1. Introduction 10 2. Grocery retailing in Spain 14 2.1. Concentration in grocery retailing 17 2.2. Retailing formats 28 2.3. Retailer own brands 34 2.4. The bargaining power of retailers 56 3. Commercial practices in retailing 76 3.1. Context 77 3.2. Analysis of commercial practices not based on prices 78 3.3. Competition risks posed by each of the practices identified 84 3.4. Iniciatives in other countries 114 4. Regulatory barriers in conditions for opening setting up and operating retail outlets 118 4.1. Analysis of the barriers of Department Sotores (DSs) 120 4.2. Effects of the barriers 127 5. Conclusions 130 6. Recommendations 138 Bibliography 142 Annex 1. Regional retail regulations 146 Index of graphs and tables 158 4 Comisión Nacional de la Competencia Executive summary Report on the relations between manufacturers and retailers in the food sector 5 Retail distribution is the final link between manufacturers and consumers. Retailers perform an essential function for consumers. For one, they select, stock and store the goods produced. And second, they facilitate purchasing decisions by providing information on the goods sold. As in other countries, food retailing in Spain has undergone a sweeping change in recent decades, which has been mainly characterised by the pre- vious model based on the traditional commercial format being replaced by another one in which large-scale retailers have firmly established themselves and supermarkets and hypermarkets have achieved a clear predominance. This transformation, moreover, has come in a particularly important sector of the Spanish economy, in which there is growing social concern over the consequences of the increasing bargaining power of retail distribution over operators in the rest of the food supply chain, specifically, in the last link, and over end consumers. In its Resolution of 15 June 2010 in case S/0165/09, Gran Distribución Gali- cia, the Council of the CNC held that these issues required in-depth analysis from the standpoint of competition. Pursuant to the mandate set out by the Council in that decision, the CNC has carried out a study on the impact on competition in the market of the changes which have taken place in recent years, paying special attention to the development of retailers’ brands. The analysis underscores three main trends that have been driving the sec- tor’s evolution in Spain. First, increased concentration of retailers. Nationally, the combined market share of the four biggest operators expanded from 48.7% in 2002 to 58.0% in 2009. At the regional level, concentration in food retailing has increased in most of the Autonomous Communities. Second, the ever more important role of medium and large supermarkets versus other retail formats. Supermarkets are the dominant format at present, concentrating 47% of grocery purchases by households. In recent years, the growing importance of this commercial format, spurred by the restrictive nature of the law regulating the retail sector (Act 7/1996 of 15 January 1996; the Ley del Comercio Minorista, hereinafter LCM), has been accompanied by a decline in the role of traditional retailers, whose market share dropped from 35.6% in 1995 to 27.7% in 2009. Third, the rise in the market share of retailer own brands (ROBs) from 22% in 2003 to 34% in 2009. This increase has been seen across practically all categories, although there are notable differences between products. All of these factors, together with other trends that have also been charac- terising the sector’s development in this period, such as the tendency toward vertical integration, the creation of group purchasing organisations and the heightened restrictiveness of commercial legislation beginning in the mid- 1990s, have contributed to a sharp gain in the bargaining power of retailers versus manufacturers. 6 Comisión Nacional de la Competencia In the short-term, the increased bargaining power of major retailers may have a positive impact on social wellbeing, provided there is sufficient competition between them and retailers pass on to consumers all or part of the gains in the terms of trade obtained from their suppliers thanks to their greater bargaining power. In the long term, however, the implications of that bargain- ing power for society are ambiguous, as the positive effects may be wiped out by the risk of that greater power working to undermine both inter-brand competition between manufacturers and intra-brand competition between retailers, as well as undercutting the incentive and capacity of manufacturers to invest and innovate. The development of the ROB plays an important role in this regard. The growth of ROBs can reduce competition between producers as those private labels gradually replace manufacturer brands (MBs). Although the introduc- tion of ROBs in a category initially widens the range of choices available for the consumer, over time these brands tend to displace the weaker MBs, which also contributes to a relative strengthening of the leading manufacturer brands. In the long term this phenomenon may lead to product markets that have only one or a few leading MBs and a ROB for each retailer; in such scenarios the lessened intensity of interbrand competition would also be accompanied by less product variety and quality. Furthermore, the better purchasing terms obtained by the large retailers can lower intrabrand competition by giving them a significant competitive edge over other retailers. That competitive advantage stems not just from the fact that some large retailers are able to buy their goods at lower prices than their rivals, but also because suppliers may find themselves forced to increase their prices for retailers with less or nil bargaining power in an effort to recoup the margin lost in offering the powerful retailers the discounts they demand. Both effects are compounded by the fact that the smaller retailers do not usually have the same capacity as the big retailers for developing their own brands. All of this may contribute in the long term to driving retailers with less bargaining power out of the market or, at least, to a notable weakening of their capacity to exert competitive pressure on the large retail chains. Lastly, the greater bargaining power may reduce the capacity and incentives for suppliers to invest and innovate. If suppliers expect they will not be able to capture an adequate portion of the overall profits, they will have less incentive to spend on capacity and innovation, although the latter effect could be offset by the stimulus to differentiate their MBs from ROBs. In addition, if producers see their margins pinched by the increased bargaining power of retailers, they will have less resources available for investment and innovation. The medium and long-term impact of retailers’ higher bargaining power depends to a large extent on how they exert that power and on the actual degree of competition between retailers. The broader and more consistent the use by large retailers of certain commercial practices, and the lower the degree of competition in retailing, the higher the likelihood of anti- competitive consequences and harm in terms of consumer welfare. Determining the characteristics and real impact of those commercial prac- tices in Spain has therefore been a very important element of this Report, especially given that access to that information is confronted by major Report on the relations between manufacturers and retailers in the food sector 7 obstacles. In particular, differences in bargaining power and the existence of individual situations in which certain suppliers are economically depend- The Report analyses ent on their retailers in the short term make it more difficult for the affected suppliers to oppose or eventually file complaints against situations that may the risks in terms of be contrary to the laws and regulations on industrial property, unfair trading and competition. competition and the Certain factors at work in Spain increase the risk that, in the long term, the real impact in Spain negative effects of retailers’ higher bargaining power on competition and wel- fare will outweigh the positive ones. The research which has been conducted of the most widespread confirms that certain commercial practices which are harmful in terms of competition are indeed being carried on simultaneously by the major retailers, commercial practices and, also, the persistence of a series of legal restrictions on competition in the retail trade that hinder the entry of new operators with capacity to compete and of those that are and limit the emergence of alternative distribution models. potentially the most The Report analyses the risks in terms of competition and the real impact in Spain of the most widespread commercial practices and of those that are dangerous for potentially the most dangerous for competition. Of those practices, the ones that pose the biggest risks are commercial payments, the failure to establish competition. contract terms and conditions in written form and retroactive contract vari- ations that are neither agreed nor expected, the excessive anticipation with which retailers ask suppliers for information on certain characteristics of the products, the most favoured customer clauses and the requirement for sup- pliers to provide sensitive commercial information on the other retailers with which they work. The higher bargaining power major retailers enjoy increases their capacity and incentives to use those commercial practices in the relations with their suppliers, which, in addition to allowing retailers to obtain supplies on terms which are unattainable by their competitors, also foster the development of retailer own brands. This generates a feedback effect and also contributes to a progressive reinforcement of the retailers’ bargaining power, which gives rise to the negative effects which have been described above.