Many thanks to Newsnight for providing the material for a lesson about monopsony power - if nothing else, it makes a change from taking Tesco as the model for this topic.
On Friday, Newsnight carried a report about Premier Foods, a conglomerate which owns many different grocery brands such as Mr Kipling, Ambrosia, Bisto and Oxo. Their allegation is that Premier Foods has been using its power as a major customer to request payments from its suppliers; if they don't pay up, they are 'delisted' from supplying the company. In other words, monopsony power.
The online report comes with a 5-minute video clip which sets up the topic nicely. Newsnight's Laura Kuenssberg interviews engineer Bob Horsely, who had a contract to supply maintenance services to Ambrosia's factory in Devon. He received a letter from Premier Foods saying that "We are aiming to work with a smaller number of strategic suppliers in the future that can better support and invest in our growth ideas. We will now require you to make an investment payment to support our growth."
When he queried this, he received another letter: "We are looking to obtain an investment payment from our entire supply base and unfortunately those who do not participate will be nominated for de-list."
Premier Foods has been in financial trouble recently, and says that it is trying to invest in growth; it makes the point that, if it succeeds, that can only be to the benefit of its suppliers. However, there are calls for this case to be referred to the Competition and Markets Authority.
If a supermarket behaved like this, it would be against The Groceries Code which regulates relationships between supermarkets and their suppliers (....but see below*); however, that code doesn't cover manufacturers like Premier Foods.
The article presents a good opportunity for a class exercise, leading to questions like:
- What form of market failure is demonstrated by this case?
- Can Premier Food's statement that "...our suppliers benefit from opportunities to secure a larger slice of our current business. They also stand to gain as our business grows in the future." be justified?
- Should the Groceries Code be extended to include producers as well as retailers?
- What other actions could governments take to prevent this market failure?
- What are the risks of government failure?
* Supermarkets and Suppliers - back to Tesco
There can be no doubt that in this relationship, the power is in the hands of the supermarkets: according to an online report, Britain’s top ten supermarkets owe about £15billion to suppliers for goods at any one time, giving them leverage to 'negotiate' extra payments.
However, listening to The Report on Radio 4 recently, I was really taken aback by the extent of those pressures, as they were explained by current and ex-suppliers and ex-staff of Tesco.
As much as a third of Tesco's gross profit comes, not from sales of goods and services to customers, but from payments they receive from suppliers. Some of those are called “rebates”, reported here in the FT: "Rebates are payments that Tesco receives from suppliers for hitting a certain level of sales, or for support for promotions. For example, Coca-Cola could offer a percentage discount on 2-litre bottles if 20m of them were sold in a specific period – but it will only pay this rebate if the sales target is hit.
Tesco’s UK sales volumes have dropped as it loses market share to competitors, so there is a risk that such volume-driven rebate targets could be missed." The report in the FT is a fascinating one, very accessible to students, about the way in which such payments are pre-estimated by the retailers in order to be included in their accounts, and this practice has been largely responsible for the 'black hole' of £250mn in Tesco's accounts.
Rebates are clearly common in the industry, and a report in The Grocer implies that many suppliers see this as 'fair enough' - if Tesco can shift huge numbers of the goods, the suppliers and manufacturers benefit by selling more, producing at closer to full capacity and gaining economies of scale.
However, there are other payments as well. There are listing or gate fees, in which the supplier pays tens or hundreds of thousands of pounds in order to get their products onto Tesco's shelves, more fees in order to get them displayed at eye level, and more recently, payments demanded in order to avoid having products delisted.
The radio report carried several instances of small scale suppliers who simply couldn't make such payments, and so lost their contract to supply. As a sales negotiator quoted in The Grocer says, when a buyer says 'give me £4mn or I won't stock your product any more', things are getting desperate. Meanwhile, Groceries Code Adjudicator Christine Tacon has urged suppliers to come forward with “hard evidence” to allow her to investigate alleged breaches of the Code.
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