Harper Review: a mixed basket for Coles and Woolworths

The findings and recommendations of the Harper competition review are a mixed bag and likely to meet with a correspondingly mixed reaction from stakeholders in the retail grocery sector.

Consistent with concerns aired in a string of sector-related inquiries and investigations in recent years, submissions were made by independent grocery retailers alleging that the major supermarket chains, Coles and Woolworths, misuse their market power, including through “predatory pricing” and other anti-competitive tactics.

Suppliers too raised previously well ventilated concerns about misuse of market power and unconscionable conduct by the major chains, as well as about reduced innovation and consumer choice through the growth of private brands.

An “effects” test for misuse of market power

In a general recommendation - not specific to the retail grocery sector - the panel proposed amendments to the prohibition on misuse of market power (section 46 of the Competition and Consumer Act 2010).

The essence of the proposal is to replace the prohibition on a firm with substantial market power “taking advantage of that power for an anti-competitive purpose” with a prohibition on such a firm engaging in conduct “with the purpose, effect or likely effect of substantially lessening competition”.

Section 46 has a long chequered history and, as with previous reviews, debate over its efficacy occupied much of the panel’s time.

The arguments for and against adopting an “effects” test, and the form of panel’s recommended amendment, have been canvassed at length elsewhere (including on The Conversation). Suffice it to say there are good reasons to regard the case against as overheated, particularly the charge that it will “chill” competition. More likely to have that effect is the structure of the market, characterised by high concentration and barriers to entry.

Properly interpreted and applied, the effects test should not capture pro-competitive or efficient conduct. As noted in the Harper report - and reflected in Australian and international competition law - just because conduct harms a competitor or competitors, will not mean that it substantially harms the competitive process.

The panel has usefully recommended that the amendment provide guidance to courts to weigh pro-competitive and anti-competitive aspects of the conduct in question. This is a task US courts have been undertaking for years and one that Australian judges are just as well equipped to perform.

Nor should the objection that the change will create uncertainty and raise compliance costs for big business hold much sway. At the risk of flippancy, it could be observed that any measure that increases costs for Coles and Woolworths can only assist in levelling the playing field in the sector.

More seriously, an effects test is not some novel invention of the review panel. It replicates the test which has applied in the Australian competition rules dealing with mergers and exclusive dealing for many years and is also aligned with international approaches.

It is worthwhile remembering that similar claims that uncertainty would deter discounting were made about the notorious “Birdsville amendment” to s46 (an amendment aimed specifically at predatory pricing) some years ago. In the end, no such effect was discernible. Ironically Harper has recommended repeal of the Birdsville amendment - not because it created uncertainty, but because it was misguided and unnecessary, a result of the politics of big versus small business in this country.

Coles and Woolworths will continue to lobby against the recommended change to s46, claiming higher prices for consumers as amongst the potential effects. The Business Council of Australia has expressed concern over the uncertainty for business and lawyers remain divided on the issue. Of the few economists who have had a say, there is also little common ground (see here, for example, the divergence between two former ACCC Chairmen on the issue).

Given this, and despite strong support by the ACCC and others, the likely adoption of the panel’s misuse of market power recommendation is at best uncertain. One possible outcome is a modified version of the proposed amendment that reflects a compromise between interest groups. Such a compromise risks distorting the law to make it economically incoherent and practically unworkable. Regrettably, there is no shortage of precedent for this type of outcome in Australian competition law history.

Wait and see on unconscionable conduct

On the prohibition on unconscionable conduct, the panel adopted a “wait and see” approach, pointing to the ACCC’s recent successful litigation against Coles for unconscionable conduct involving its suppliers as indicative of the prohibition working as intended.

At first glance, the $10 million penalty seems substantial. But it has to be looked at in the context of the maximum penalty for conduct of this kind being set $1.1 million per contravention. (The penalty for Coles reflecting the fact that there were so many contraventions.) In something of an understatement the judge in the case observed, this is “arguably inadequate for a corporation the size of Coles”.

Regrettably, the review panel did not address the question of maximum penalties for unconscionable conduct.

Code of conduct

The panel also noted that introducing a properly designed and effective industry code should protect suppliers. The Food and Grocery Code of Conduct was established in February 2015 and the ACCC has identified compliance as a top enforcement priority this year.

The Code has its fair share of sceptics but its introduction should be seen at least as a positive acknowledgement by the major chains that some change in their supply chain management strategies is necessary.

That said, industry codes under the Competition and Consumer Act lack teeth and it is disappointing that the panel shied away from recommending meaningful civil penalties for code breaches.

Even if the approach taken by Franchising Code in January this year were extended to other codes (a measure the panel neither supported nor opposed), the penalties are relatively light - a breach exposes a franchisor or franchisee to $8,500 penalty issued by the ACCC or a pecuniary penalty of up to $51,000 imposed by the court. These are likely to be meaningless in the retail grocery sector context.

Regulatory reforms to remove entry barriers

In preserving competition, the panel’s primary focus was on removing impediments to the entry and expansion of new players, including planning and zoning law reform, reviewing regulatory restrictions on liquor sales, and deregulating retail trading hours. As noted by the panel, these reforms will require significant political leadership and incentives at all levels of government.

The panel largely dismissed concerns about the domination of Coles and Woolworths stultifying competition. But it would be far-fetched to suggest that the sector is anything other than a duopoly, despite the continued growth by Aldi and Costco.

And while the panel focused on regulatory barriers to entry, it did not say much about strategic barriers – that is, the use of pricing and other commercial strategies designed to keep competition at bay. Perhaps the panel viewed any such strategies can be tackled under the re-energised section 46.

Predictions that such litigation will be brought by small business would be fanciful. Indeed the panel set out at length the hurdles that small businesses face in taking enforcement action in their own right.

Of course, the ACCC might well bring proceedings and under chairman Rod Sim, has demonstrated a commitment to litigating more under the Act. But the ACCC lacks the formidable resources of the large companies that it would be taking on and it will have to be strategic about the cases it chases.

Expansion into other sectors

The panel also gave fairly short shrift to concerns surrounding the expansion of chains into other retail sectors such as hardware, liquor, electronics, gambling.

It may well be right that such diversification creates efficiencies for the firms concerned and could increase competition in these sectors.

However, this view does not necessarily address the long term concerns that these sorts of growth strategies may lead ultimately to concentration and the creation of strategic entry barriers in other important retail sectors at the level currently in retail grocery.

Social disruption

The panel acknowledged submissions about adverse social changes, in particular the loss of community amenity caused by a move of supermarket chains into regional and rural areas.

But these “are not matters to be addressed by the competition law. They reflect broader economic and social changes that are often the outcome of competition.” Technically, this is correct. However, it raises the broader issue for government as to whether competition should trump other non-economic values and interests in our society (see my related comment here).

Prediction?

If any prediction can be confidently made concerning the retail grocery sector, it is that the review will do little to dampen the controversy that this sector has attracted and will continue to attract into the future.

Caron Beaton-Wells is leading a research project on supermarket power funded by the Australian Research Council.