ANANISH CHAUDHURI: What should we do with our supermarkets?

In an attempt to address cost of living concerns political parties have proposed various solutions to improve competition in New Zealand’s supermarket sector. What’s proposed and what might bring prices down?

Labour

Labour’s proposal has two primary pillars. First, break up the wholesale operations of Foodstuffs and Woolworths to create two independently operated wholesalers.

Second, prohibit “price gouging” of essential goods and services.

Let’s start with the second.

Rates of public utilities such as electricity, gas or water are regulated. The rate should be one that keeps the price affordable for households while guaranteeing the business a fair return on its investment and risk-taking.

While doing this for one or a few goods may be practicable, this is unlikely to work for supermarkets.

A typical supermarket stocks thousands of products, many of these “essential”. How many should we regulate? Should we “audit” a few goods and check for excessive profit margins? 

Supermarkets then may well decide to stop stocking goods whose prices are “controlled”. A regulatory agency set up for this purpose would require a huge workforce and massive budget.

This is why we typically let market forces dictate prices rather than rely on a centralised bureaucracy. The prices act as signals of what we should produce more or less of.

Creating separate wholesale and retail businesses

In the 1990s, when Microsoft was sued by the US Department of Justice for anti-competitive behaviour, one proposal mooted, but not implemented, was that Microsoft be split into two entities: one dealing with operating systems and a second dealing with software applications.

Labour’s proposal is similar. The argument is that this will allow other businesses to be able to buy from the wholesale entity and create greater competition.

While this is possible, this will likely create a problem of double marginalisation, which arises when firms at different stages of the supply chain exercise market power.

Now the separate wholesale and retail units will both attempt to maximize profit, a problem that does not arise when the supply chain is integrated. This implies higher wholesale prices and, in turn, higher retail prices. Similar concerns were raised about the proposed break-up of Microsoft.

Green

The Green Party is calling for the creation of a government-owned supermarket chain.

However, if this were to happen then the government owned grocery stores will be competing alongside privately owned ones. This will make it difficult for the latter to be competitive. 

Private supermarkets will have to bear all of their overheads and operating costs while the government owned ones will be subsidized by taxpayers.

I note that in New York, Mayor Zohran Mamdani's plan to open five municipally owned grocery stores has prompted legal action from small local businesses such as convenience stories concerned that the city-run stores would unfairly disadvantage existing retailers.

National

The National Party is proposing to split Foodstuffs into two entities. This method has been tested in the past.

One example in the mid-1980s, was when US telecommunications giant AT&T, which controlled both long-distance services as well local phone companies, was sued for anti-trust violations by the Department of Justice. AT&T reached an agreement whereby they retained long-distance services but gave up local operations.

Under this agreement the giant monopoly was broken up into a set of smaller companies called ‘Baby Bells’. Though over the next couple of decades, many of these Baby Bells merged so that today much of the industry is again controlled by AT&T, and Verizon.

There’s some evidence to suggest that the AT&T break-up created greater competition and possibly hastened the advent of mobile phones and internet competition.

It is possible that part of the reason for New Zealand’s high grocery prices is that given the smallness of the New Zealand market, supermarkets are not able to exploit economies of scale. 

This implies that their average costs are generally high since they’re not able to spread their overheads over a larger sales volume.

If breaking up entities results in even smaller scales then the average costs faced by those constituent units will be higher and this would result, perversely, in higher prices once the businesses add a mark-up on top of those higher costs.

This is also another reason Labour’s attempts to stop price gouging in supermarkets is problematic. A regulator does not necessarily have sufficient information about cost structures. 

Further, the mark-up over costs represents both the cost of procurement as well as the overheads. It is not easy to separate these out.

New Zealand First

New Zealand First’s policies are close to those offered by National in terms of splitting up Foodstuffs.

NZ First is also arguing for strengthening the powers of the Commerce Commission and the Grocery Commissioner. It appears to me that through the Commerce Act, the Grocery Industry Competition Act and the Fair Trading Act, the Commerce Commission already has adequate power.

The key issue is better enforcement rather than enhanced power.

ACT

ACT opposes breaking up supermarkets and instead is arguing in favour of creating the conditions for greater competition. In some ways the Commerce Commission is already following this approach. The commission has already taken enforcement action against anti-competitive practices. 

In 2024, the High Court fined Foodstuffs North Island for using restrictive land covenants intended to prevent competing supermarkets from opening or expanding in particular areas.

Enforcement of such anti-competitive practices is critical.

The arrival of Costco in Auckland has certainly had an impact, but nationally the two large chains continue to control more than 80% of the market.

Creating conditions that make entry by competing chains easier is certainly a key consideration. But this is a longer-term strategy and is unlikely to have much effect on the cost of groceries in the short-term. 

In my view, National’s policy has the advantage of creating greater competition while avoiding the double marginalisation pitfall. It’s also possibly the one that will have the most impact on prices in the short-term.

Ananish Chaudhuri is the Professor of Experimental Economics at the University of Auckland and the author of Economics: A Global Introduction

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