Is Supermarket Margin Expansion Fuelling Inflation in Australia?

By Nick Hurley

By Nick Hurley, 19th November 2023.

Since the start of the pandemic Australia’s two dominant supermarket chains, Woolworths and Coles, have significantly boosted their profit margins, fuelling allegations of profiteering and prompting an inquiry by the Australian Competition and Consumer Commission (ACCC).

But why is an increase in margins at supermarkets so pernicious when it comes to inflation and more importantly, inflation expectations in the economy? Read further to find out.

Key takeaways:

• Australia’s two largest supermarket chains, Woolworths and Coles, have significantly increased their profit margins over the past few years.
• This increase in margins has coincided with a period of rising inflation, raising concerns about the supermarkets’ role in driving price hikes.
• Consumers are increasingly using changing grocery prices as the main input into their inflation expectations.
• If supermarkets continue to raise prices, it could lead to higher inflation expectations and make it more difficult for the central bank to control inflation.
• Policymakers need to carefully consider the potential benefits and costs of any intervention in the grocery sector. The goal should be to promote fair competition and protect consumers from excessive pricing without unduly restricting the ability of supermarkets to operate efficiently and profitably.

How are the supermarkets able to exert pricing power?

The Australian grocery market is highly concentrated, with Woolworths and Coles holding a combined market share of about 65%. This is significantly higher market concentration than seen in other comparable developed economies. This concentration of power has allowed the supermarkets to exert significant control over pricing and suppliers.

Canada, albeit with a (~50%) higher population, has seen significant margin increase in their supermarket sector, even with a less concentrated market than Australia’s. In Canada, about 80% of grocery sales are controlled by five chains – Loblaw, Empire (Safeway), Metro, Walmart and Costco.

In the UK, about six chains make up 80% of the market, Tesco (27%), Sainsbury’s (14.8%), Asda (13.7%), Aldi (9.9%), Morrisons (8.6%) and Lidl (7.6%).

The Australian market is even more concentrated, with the top four players – Woolworths, Coles, Metcash (IGA) and Aldi – controlling 81% of sales. Woolworths and Coles alone account for at least 65% of sales.

Localised, geographic market concentration can also be an issue but isn’t captured in aggregate, nationwide market share analyses. For example, Costco has a significant market share overall but isn’t present in some major population centres eg Geelong, Vic.

By how much are they expanding their profit margins?

Woolworths and Coles have witnessed a steady rise in profit margins over the past few years. Woolworths’ net profit for the full 2022-23 financial year increased by 4.6% to $1.62 billion, while Coles’ net profit surged by 17.1% to $643 million. Coles’ supermarket gross profit margins increased from 26.1% to 26.5%, while Woolworths’ supermarket gross margins rose 0.48 of a percentage point to 30.7%.

Overall, margins at the two chains are 100 to 150 basis points higher than they were pre-pandemic, according to Morgan Stanley.

These gains were driven by a combination of factors, including a reduction in COVID-related costs, an increase in grocery prices, and a decline in tobacco sales.

However, the timing of these margin increases has coincided with a period of rising inflation, putting pressure on household budgets and raising concerns about the supermarkets’ role in driving price hikes.

If consumers are aware of inflation being elevated, they are likely to be much more tolerant of prices going up (price inelastic) across most lines, even if input costs for the supermarkets haven’t changed.

The fundamental issue with surging grocery prices is that they are primary input into people’s inflation expectation calculations and it is rising inflation expectations that have a huge part to play in driving inflation even further.

Consumers Using Changing Grocery Prices as the Main Input into Their Inflation Expectations

Consumers are increasingly using changing grocery prices as the main input into their inflation expectations. This is because groceries are a frequent and unavoidable purchase for most households, and changes in grocery prices are often felt more immediately than changes in other prices, such as housing or transportation.

A recent study by the University of Chicago found that consumers who experience extreme changes in grocery prices are more likely to base inflation expectations on those changes than those who see little or moderate grocery-price movement. The study also found that positive price changes loom larger than negative price changes in consumers’ inflation expectations.

This suggests that supermarkets may have a disproportionate impact on consumer inflation expectations. If supermarkets continue to raise prices, it could lead to higher inflation expectations and make it more difficult for the central bank to control inflation.

Implications for Policymakers

The ACCC’s inquiry into the grocery sector should consider the impact of supermarket pricing on consumer inflation expectations. If the inquiry finds that supermarkets are using their market power to raise prices and drive inflation, policymakers may need to consider taking action to address this issue.

Possible policy options include:

• Introducing a price cap on groceries: This would prevent supermarkets from raising prices above a certain level.
• Regulating the relationship between supermarkets and suppliers: This could involve preventing supermarkets from engaging in practices that squeeze suppliers, such as demanding unjustified price cuts.
• Encouraging the entry of new competitors into the grocery market: This could involve reducing barriers to entry, such as zoning regulations that make it difficult for new supermarkets to open.

Conclusion

Policymakers need to carefully consider the potential benefits and costs of any intervention in the grocery sector. The goal should be to promote fair competition and protect consumers from excessive pricing without unduly restricting the ability of supermarkets to operate efficiently and profitably.

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