Supermarket price war eases inflation

Yesterday’s FT reads “Supermarket price war eases inflation”, “hurrah” jeer the public, finally a slow up in inflation, albeit a 0.2% slow up to 5%, 3% above target and crucially above the rate of wage inflation. Nonetheless inflation is on its way towards the 2% target, let’s not put a downer on it, George Buckley of Deutsche Bank describes the drop as “the first of many declines over the coming months”. This said, I can’t help but ask the question: who actually pays for supermarket price wars? Should we all cheer the decrease in inflation? Does the 0.2% drop expose any unerring truths?

With the economy flat-lining and a lack of confidence throughout both domestic and foreign markets, supermarkets have helped the everyday consumer by initiating a series of price guarantees: Tesco’s Big Price Drop, Asda’s Rollback, Sainsbury’s Brand Match, Morrisons’ Price Crunch and Waitrose’s Brand Price Match. These supermarkets are jostling for market share as their sales volume decrease for the first term in a decade. How have supermarkets financed these price drops? Have their costs of production decreased or have they reduced their supernormal profit margin? The first observation to make is that since the start of the month the price of Brent crude has increased; furthermore, one would have thought that regardless of their monopsony power, supermarkets would not have significantly decreased their costs to suppliers within the space of a month. Whilst other costs, such as the energy price hike, will play a role in the price of supermarket goods they are more minor and they would put inflationary pressure onto the price of goods rather than deflationary. If the cost of production hasn’t decreased, and if anything gone up, then it would seem as if the supermarkets have sacrificed their holy profit margins… Gasp.

Having looked at the intricacies of the price drop, let’s contextualize things to see how the consumer and the supermarkets stand. “Sainsbury’s annual profits rise by 12.8%”. “Morrisons’ profit rises”. “Tougher times- but profits up for Tesco”. These headlines were all first page hits after a quick Google search; so how is it that despite this month’s price war, quarterly and yearly profits seem to grow? I must tread carefully so I don’t generalize too much; a Guardian article written at the start of October reads “Asda profits hit by price war”, the article then proceeds to say how Asda’s revenue has increased to a paltry £20.5bn and that its operating margin increased to 4.9%. Furthermore, whilst the headline pins the £93m decrease in profits on the price war, the article seems to give far more weighting on “one-off costs” such as a £137m increase in royalties. Indeed, price war is only mentioned once in the article, so how much the price war is to blame for the drop in profits is dubious.

Where do the supermarkets stand? As the headlines show they are still making abnormal profits and despite this month’s price war antics but I suspect the profits will remain relatively untouched, the reason is threefold. Firstly, food and drink inflation dropped from 6.4% to 5%; in effect prices are going up at the same rate as other prices in the economy from a previously elevated level, so it’s not as if the prices of food and drink are falling in real terms. Secondly, this week’s data only represents the price changes of the past month whilst profits are published quarterly and with the festive season closing in supermarkets can expect an increase in footfall and average transaction cost. Thirdly, the price guarantees simply aren’t all they seem: supermarkets accused of hiking up prices to make the savings seem larger, supermarkets state to be eligible for the guarantees customers must spend a minimum amount and certain price matches apply to certain supermarkets only.

Where do the consumers stand? Same old: incomes stagnant, general price level rising, savings dipped into and the outlook is bleak. Fear not, food and drink is only rising at 5% so things are better than before, despite 19.9% increases in energy bills just as the weather takes a turn for the worse. Whilst consumers are shopping around, using discounters such as Aldi and Lidl, visiting their local market and using price comparison websites, supermarkets remain every shopper’s failsafe. Unfortunately, a side effect of the market structure in supermarkets is for prices to be rigid and stay high as firms collude covertly and tacitly. The five major players in the supermarket industry are reported to have 75% of the grocery market, such a high five-firm concentration ratio breeds collusion which is so hard to prove for the OFT, so often goes unpunished. Even a ‘price war’ is limited at some stage, if it were a true price war firms would undercut each other until the point where revenue is the same as their costs (limit pricing), is this realistically going to happen? “Tesco report yearly pre-tax profits of £0, down £3.4bn from 2010”… “Oh, and pigs fly!”

George Buckley’s words have been repeated today by Sir Mervyn King, predicting that inflation will undershoot the target of 2% in 2012. Worryingly, this situation seems may be more dire than the current stagflation. The current inflation hike sadly isn’t a result of economic prosperity, consumption, investment or strong exports; it’s a result of inflated commodity prices causing supply side problems. Whilst supply side shocks are very severe, see 1973 oil crisis, they tend to be more short term than demand related depressions; consumers will inevitably rejoice the fact that they can buy more for their buck, but it is a worrying thought that inflation will free-fall to near zero levels and could potentially result in a lost decade. Yes, this is a very gloomy picture but the worries have been echoed all across the world, the fact that the Bank of England are considering more quantitative easing when we are currently at 5% CPI sums this up very neatly. Instead of hypothesizing on potential Armageddon I’ll take a more objective view on recent events. Yes, inflation is down. Yes, in real terms we are slightly better off than a month ago. Yes, supermarkets are continuing their price guarantees. And yes, inflation is due to come down even more in the next few months. Let’s try and put some (blind) faith in the people at the top to restore growth, rein in inflation and get the ball (not bubble) rolling!

Now for a final word on what this means for those in the market industry: does this bode well for outdoor markets or is the net effect negligible? As discussed, consumers are scouting around for the best deals, in this sense markets should prosper particularly with regards to fresh food. This phenomenon is clear to see, over recent years Quarterbridge has witnessed rejuvenation in interest of markets. Another crucial change in shopping habits, spurred on by bargain deals, is the bulk buying culture. This would seemingly spell bad news for the markets, the pragmatic element of supermarkets seems to trump all independent retailers, however to make such a statement the basket of goods that have deals attached to them should be considered. Products with the highest value-added (tinned goods, dry goods and utilities) are the goods that are mostly bought in bulk and being not such popular market buys, I would argue that bulk buying culture shouldn’t affect markets too negatively at all, particularly since markets such as Queensgate and Kirkgate now facilitate bulk buying through the availability of trolleys and ‘pay now, pick up later’ facilities. The net effect on markets then seems to be the same as before with a growing awareness of all the benefits of buying from knowledgeable, independent traders. While markets offer genuine value for money, support for local retailers and inject life into the local economy, look at what supermarkets actually offer with a more objective eye. Peel back the façade of price guarantees and price crashes and a different picture emerges. This is what Quarterbridge have seen for some time and a picture that everyone should be aware of.