11 Supply chain and vertical issues 11.1 Introduction The first 10 chapters of this report focused on horizontal competition at the retail level. The remainder of the report focuses on supply chain issues and their impact on retail prices. Supply chain issues are relevant to the inquiry for three reasons: • if there is a lack of horizontal competition at any level of the supply chain, this weakness will flow through to consumers in the form of higher prices • if changes in prices at one level of the supply chain, are not reflective of higher costs, this could reflect market power at that level of the supply chain • buyer power in the supply chain can damage efficiency, by eroding investment and innovation in the upstream markets, resulting in a less competitive supply chain overall. To explore the first issue, it is necessary to examine some features of the various supply chains through which groceries pass. Issues such as the number of participants, the market share of those participants, how prices are set and the outside options available to participants are all relevant when considering whether there is effective competition throughout the supply chain. However, in the timeframe available the ACCC has not been able to investigate the potential market power of every manufacturer, processor and wholesaler for the many thousands of standard groceries. Accordingly, only a selection has been examined in detail in the next chapter. To explore the second issue, it is necessary to consider the relationship between prices in the supply chain, particularly the gap between wholesale and retail prices. The key question to be answered is: When retailers increase retail prices, is it because they are facing higher wholesale prices (which, assuming effective competition elsewhere in the supply chain, reflect higher commodity prices, climate shocks and increased production costs), or are they raising prices even in the absence of such changes to their costs?1 To explore the third issue, it is necessary to consider whether any party in the supply chain has buyer power and, if so, whether they are exercising it in such a way that it damages the long term efficiency of the supply chain. In particular, the focus in this inquiry report is on the buyer power of the MSCs and Metcash. The brief general introduction to the supply chain contained in this chapter is followed in chapter 12 by eight case studies, which provide a detailed analysis of the competitiveness of the supply chains for a selection of standard grocery items. A broader discussion of the gap between farm gate and retail prices occurs in chapter 13. The report then considers issues concerning buyer and bargaining power. Chapter 14 provides a theoretical framework for considering buyer and bargaining power and chapter 15 considers evidence provided to the inquiry about buyer and bargaining power, including an analysis of trading terms. The issue of private label products, which is also related to buyer power, is specifically considered in chapter 16. Chapter 17 outlines the main conclusions on supply chain issues. Finally, chapter 18 considers whether changes to the Horticulture Code are necessary to improve vertical relationships in the horticulture supply chain. 1 Assuming no change in the retailers’ costs of doing business. Report of the ACCC inquiry into the competitiveness of retail prices for standard groceries 217 11.1.1 Assessment of the efficiency of the supply chain The efficiency of a particular supply chain depends on the nature and extent of horizontal competition at each functional level of the supply chain as well as the vertical relationships between different levels in the supply chain. Those vertical relationships may, in turn, impact on horizontal competition throughout the supply chain. In assessing the efficiency of the supply chain, the ACCC has therefore examined the horizontal competition at the various functional levels as well as the vertical relationships between parties in different functional levels. This assessment has been facilitated by information obtained by the ACCC using its information gathering powers. Much of this information was provided in confidence. The ACCC considers that concerns about potential impediments to the efficient supply of groceries to consumers are only likely to be realised if market power exists in any of the functional levels of the supply chain. Market power is more likely to exist where there are high barriers to entry, high levels of concentration and limited import competition. In the absence of market power, the ACCC is confident that the supply chain would deliver groceries to consumers in an efficient manner, which would result in greater choice and lower prices for consumers. This assessment also applies to the potential effect of vertical relationships on the efficiency of grocery supply chains. Generally, vertical relationships or vertical integration helps to coordinate interdependent stages in the supply chain and minimise the transaction costs of doing so, to the benefit of efficiency and consumers. However, where there is market power, some vertical arrangements, typically known as vertical restraints, can have anti-competitive effects by raising barriers to entry or by foreclosing actual and potential competitors. In examining the nature of relationships between the various vertical layers of the supply chain, the ACCC has considered the extent to which any aspects of those relationships unnecessarily constrain each party involved in a way that may be anti-competitive. The next section of this chapter looks briefly at some of the major supply chains for standard groceries. Due to the vast range of supply chains, this section necessarily provides a broad introduction only. More detailed analysis of individual supply chains is undertaken in the case studies presented in chapter 12. 11.2 Introduction to the supply chain During this inquiry it has become evident that the supply chains for each grocery category vary considerably. For fresh produce there is typically a short supply chain, that mostly comprises three functional levels— produce is purchased at the farm gate by a wholesaler and is then on-sold to retailers. For some fresh produce, such as dairy and meat, more complex processing occurs after the farm gate and before wholesaling, resulting in a four-level supply chain. For the MSCs, ALDI and Franklins, the wholesale function is primarily performed in-house by the retailer. For most other grocery retailers and specialty stores, the wholesale function is performed by wholesalers and consolidators for fresh produce and by Metcash for packaged groceries. Fruit and vegetables The supply chain for fruit and vegetables is varied. It is estimated that there are more than 2800 commercial vegetable production enterprises around 218 Report of the ACCC inquiry into the competitiveness of retail prices for standard groceries Australia.2 The majority of vegetable growers are small in terms of the area they crop and most focus only on a single vegetable crop.3 Similarly, fruit production also involves large numbers of small-sized participants spread throughout Australia. Australia’s varying climate and soil conditions mean that different regions are amenable to producing different ranges of fruits and vegetables. Given the geographical size of the country, this creates a need for significant transportation of fresh produce to ensure continuous fresh supply. Similarly, Australia’s varied climate means fruit and vegetable produce grown in different regions will become available at different times of year. To counteract deterioration of fresh produce, farmers, and in some cases processors, may chill the produce immediately after harvest or use controlled atmosphere storage (with lower levels of oxygen and higher levels of carbon dioxide than normal air) to further slow deterioration.4 This enables crops that would otherwise be more susceptible to seasonal fluctuations in sup`ply to be released over a longer period. Increasingly, fruit and vegetable growers are by-passing wholesalers and entering into direct supply arrangements with the major supermarket chains (MSCs) and other retail outlets. The ACCC understands that the majority of fruit and vegetables sold in the MSCs and ALDI do not pass through a wholesaler. It is estimated that only 20 to 30 per cent of MSC produce is now purchased from wholesalers. The ACCC understands that most fruit and vegetables sold in independent stores are supplied by wholesalers (typically this is not Metcash, although, as discussed in chapter 7, Metcash has commenced wholesaling fresh produce through IGA Fresh.5) Restaurants also usually obtain their fresh produce through wholesalers or providores. Wholesalers and providores may also be used to source product to some extent by some processors and exporters. The majority of wholesalers operate from the central wholesale markets located in Melbourne, Sydney, Brisbane, Adelaide and Perth. Not all farm produce consumed as food goes through wholesale markets or is sold to MSCs. Large quantities are sold directly to manufacturers and processors of various kinds. Processing of fruit and vegetables predominantly consists of manufacturing fruit and vegetable juices, or canning, preserving, freezing or drying produce. Fruit and vegetables are also key inputs into many products such as sauces, jams, prepared meals and snacks. Certain products, such as potatoes, often tend to be used in processing. For example in 2004, 56 per cent of the domestic