Wednesday, June 26, 2019

News from the shopping trolley: retailers are doing it tough

If I told you that a big reason we're feeling such cost-of-living pressure is the increasing profits of the big supermarket chains, department stores, discount stores and other retailers, would you believe me? A lot of people would.

But that would just show how little we understand of the strange things happening in the economy in recent years. The economy in which we live and work keeps changing and getting more complicated, the digital revolution is disrupting industry after industry, but we have far too little time to check out what's happening – especially behind the scenes – so we rely on the casual impressions we gain along the way and on our long-held views about who's ripping it off and who's getting screwed.

Which are often off-beam. Perhaps because in many respects it's a good news story, few people realise the way digital disruption is putting retailing - a pretty big part of the economy, and a big part of household budgets - through the wringer.

If this meant retail staff were being laid off in their thousands we'd have heard about it. If it meant big retail chains were jacking up their prices, we'd have been told.

Instead, increased competition between retailers is making it much harder than usual for them to put up their prices, and causing some prices to fall.

It's all explained by Matthew Carter in an article in last week's Reserve Bank Bulletin, using data from the Australian Bureau of Statistics and the Reserve's regular contact with many medium and large retailers.

The article covers about a third of the "basket" of goods and services bought by Australian households, the changing prices of which are measured by the consumer price index. That is, not just food and other things you buy in supermarkets, but clothing and footwear, furniture, household items and much else, though not motor vehicles and fuel. Nor other classes of consumer spending not done through retailers, such as the costs of housing, healthcare and education.

Since the early 2000s, the increased competition in retailing has come first from online shopping – competition not just between local and overseas retailers, but between those local retailers who use the internet and those who don't, as well as between those who do.

The other main source of increased competition in retailing is the arrival of big new international companies, such as Aldi, Costco and, of course, Amazon, which is both online and a big new arrival from overseas. (The article doesn't mention two other disruptive developments: the advent of "category killers" such as Officeworks and Bunnings, and the decline of the department store.)

The basic model of markets used by economists assumes that businesses compete with each other mainly on price. In real-world Australia, however, the two, three or at most four big companies that dominate most markets much prefer to compete via product differentiation, marketing and advertising, and avoid price competition.

That's what online shopping has changed. And it's not just that the internet has made it infinitely easier for shoppers to compare prices. It's also that, on the net, it's much easier to compare prices than to compare colours or quality.

And when a big foreign player decides to try to break into an established market, price competition is the main way it tries to gain market share.

The result is that retailing has become more price conscious. And retailers are telling the Reserve Bank that their customers have become more price sensitive – which isn't surprising considering how slowly their wages are growing.

Nor does it matter much that, so far, not many people do their grocery shopping online, or that Aldi is still much smaller than Woolies or Coles. The others have protected themselves from losing market share by matching their rivals' lower prices.

Another effect of digitisation is to make it a lot easier for retailers to change their prices (as well as to find out what their rivals are charging). And the greater price consciousness of their customers means that 60 per cent of retailers now review their prices weekly or even daily.

This means many retailers more frequently discount their prices - put them "on special" - and make the discounts deeper.

The Reserve Bank's survey of retailers shows the main reasons they lower prices is because their competitors have cut their prices or because demand has weakened.

Carter has analysed the Bureau of Statistics' industry statistics and found that the net profit margins of both food and non-food retailers had fallen by about 1.75 percentage points (that's 1.75¢ in every dollar of sales) since 2011-12.

It may not sound much, but it is – especially in supermarkets, which are low-margin, high turnover businesses. Further analysis confirms that this decline comes from reduced ability to mark-up wholesale prices, rather than higher operating costs.

However, retailers are fighting back, trying to improve their mark-ups by offering more own-brand products (cuts out the wholesaler) and more premium brands (higher mark-up), while some non-food retailers are joining the supermarkets in moving from the traditional "high-low" pricing strategy ("specials" and frequent "sales") to an "everyday low price" strategy. By selling more, they gain more power to bargain with wholesalers.

Of all the things that are making our lives tough, higher retail prices ain't one of them.