The recent increase in grocery prices has prompted the CMA to investigate the grocery sector in the UK to ascertain whether weak or ineffective competition between retailers has contributed to those increases.
Although the CMA initially found that recent high price inflation for groceries “does not appear to have been driven at an aggregate level by weak or ineffective competition between retailers”, it has also confirmed that it intends to further investigate the drivers of prices; for instance, by considering whether there is a lack of competition in other parts of the supply chain. The latest update about the investigation was published on the CMA’s website in July 2023.
The lag between consumer price inflation and food inflation
Although food price inflation has started to decline (after the highest peak in 45 years of 19.1% in March 2023), the price of food is still expected to rise until mid-2024. This lag of consumer food prices has spiked concerns that weak competition in the food supply chain may be causing food inflation to persist.
The CMA did not find evidence for these concerns. Rather, it found that a contributing factor was the nature of the contracts across the supply chain since input costs only change when the agreements are renegotiated, regardless of whether the market price for the commodity has fluctuated in the interim. One example of this relates to energy costs where fixed contracts apply but lower prices take time to be reflected in product prices.
Consumer response to food price increases
Between 2003 and 2023, the four largest supermarkets (Tesco, Sainsburys, Morrisons and Asda) and the two discounters (Lidl and Aldi) accounted for over 80% of the grocery market in Great Britain. The financial statements of these supermarkets in the most recent financial year showed that revenues had fallen below the rate of inflation. The CMA found no evidence to suggest this was due to weakened competition but instead that consumer behaviour had changed.
Where they are able to, consumers are shopping around to get the best deals and purchasing from multiple retailers. In addition, the share of branded products sold by many retailers has declined as consumers switched to own-brand alternatives. Not only are consumers “trading down” within ranges, but they are also changing the types of products they buy, for instance swapping fresh vegetables for frozen alternatives.
Consumers are more price-sensitive than ever and are less likely to be willing to pay more for the ‘in-store experience’, benefitting the discounters and increasing their market shares. In turn, this exerts pressure on other retailers to lower their prices to sustain their position in the market.
However, not all consumers can benefit from competition between grocery retailers (in particular lower income households, those who shop primarily at discount stores, or those who have difficulty in shopping around for the best deals). The discounters are inaccessible for those consumers where travel is not an option (with no online shopping option), preventing them from accessing lower prices. Additionally, those consumers may be more reliant on convenience stores, which tend to be more expensive and mainly stock branded products.
How retailers set prices
The CMA looked at the extent to which rivalry and competition between retailers ensures prices remain as low as possible. Retailers usually set their prices by tracking competitors’ prices and matching or undercutting them, particularly for commonly-purchased grocery items. For certain retailers, competitors’ pricing was a more vital factor when deciding retail prices than input costs and supplier prices were.
Many retailers have cut prices for certain staple products including milk, bread, pasta, and oils. This is due to declining input costs and in order to stay competitive in the market. Retailers also suggested this was to encourage customer loyalty, attract new customers, and as a reaction to price movements by competitors.
Grocery retailers are planning to increase their operating margins in the current year. However, the existing competitive environment is likely to restrict the extent to which retailers can achieve higher margins without losing market share. To reduce input costs, retailers are looking for efficiencies and ways to cut overheads (self-service tills and shift optimisation to reduce labour costs). As input costs fall, the CMA will continue to monitor the competitive landscape. However, not all costs are expected to fall. For instance, food supply is a labour-intensive industry, and labour costs are likely to remain as they are, if not increase. In addition, with increased focus on sustainability and healthy eating, certain regulations – such as the plastic packaging tax – have come into force which are likely to increase costs across the food supply chain.
Retailers’ relationships with their suppliers
Own-brand products represent around half of all sales for many retailers. Relationships between retailers and suppliers have become closer over the last two years, enabling them to work together to ensure lower prices for consumers. Larger retailers in particular have the bargaining power to ensure that prices they pay to own-brand suppliers are competitive.
Branded suppliers generally operate at a higher margin than own-label suppliers. Certain branded goods within a product category are perceived to be the only “credible” brand, such as Heinz baked beans. Retailers have less bargaining power in these situations, and therefore less ability to challenge the price charged by the supplier. The CMA has indicated that it will continue to gather evidence from suppliers to consider competition at this level of the supply chain.
Where does the CMA go from here?
The CMA plans to further investigate other parts of the grocery supply chain to assess whether it is working effectively for consumers, and to understand price and competition dynamics. Given the complexity of the wider supply chain, the CMA has also identified several product categories it will investigate over the coming months including baby formula, bread, pet food, poultry, milk, mayonnaise, baked beans, chilled desserts, ready meals and lemonade.