Nordic Food Markets - 5. Competition for the store shelves

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"Nordic Food Markets"

5. Competition for the store shelves

5.1 Introduction

Relationships between food industry manufacturers and retailers have changed fundamentally during recent years. International deliveries together with the formation of retail buying and selling joint ventures and other forms of cooperation have become common in a large number of product areas.

The sales of retail chains which are present in several countries measure up to is considerable, cf. figure 5.1.

Figure 5.1. Sales of the big retail groups, 2004.

Source: Danish Agriculture Council – May 2005

Furthermore, retailer groups' own market research and their closeness to consumers have provided them with considerable amounts of market information based on which they control in-store merchandising and shelf space management. Their private labels also provide them with cost information.

The increasing market power of retail groups has led to a situation where suppliers often have to pay allowances to get products on the store shelves. Furthermore, retailers increasing interest in developing their private label products has given them new interest in control of the shelf space in the supermarkets.

Agreements between the retail groups and the suppliers often have a duration of one year or more. However, grocery manufacturers and supermarkets deal with each other daily as supplier and customer. In these roles, they have to agree upon a wide variety of conditions. In this paragraph, the key issues addressed are shelf space entry, procurement and distribution, private labels, rebates and ECR –systems (“Efficient Consumer Respons”).

5.2 Shelf space entry

Even though the average sizes of retail stores are growing, the competition for shelf space has become tougher for the producers. Retailers are now part of large chains, with up to 400 shops, and the retail market is concentrated. In all the Nordic countries 3-5 large retail groups dominate the market. Thus, the retail chains have considerable buying power.

Moreover, the chains evaluate the sale from every inch of shelf space in order to get the highest profit. The retail chains control the assortment in the chain shops. This is done by placing the products in different assortment and marketing categories. For example, if a product is placed in one particular category, every shop in the marketing chain must have these products in the shelves. If the product is placed in another marketing category, the shops are free to choose from these products. Obviously, it is vital to the supplier to get as many products as possible placed in the most favourable categories.

New products, food and non food, enter the market constantly. It is, of course, impossible for the chains to stock all available products. Thus, there will always be competition for shelf space. Moreover, by reducing their assortment the chains may increase their buying power. This is one of the fundamental ideas underlying the discount chains. By reducing the number of goods in each category, the price competition between suppliers becomes more aggressive, and the prices thus lower. The entry of discount chains therefore has made the competition for shelf space tougher.

The bargaining process between suppliers and retail chains comprise a range of different aspects. The retail chains control the scope of distribution by placing the products in different assortment and marketing categories, they control the physical placing in the shops, other kinds of marketing carried out by the chain, and they decide which close substitutes are available in the chain shops. The suppliers are willing to pay to get favourable outcomes on these aspects. The payments may take the form of lower unit prices. However, it seems to have been increasingly common that suppliers pay annual bonuses, slotting allowances, marketing support, loyalty bonuses, etc. for these services. These payments are sometimes directly connected to the individual services, but it is also common that none of the payments are tied directly to any of these.

Slotting allowances is one special kind of payment for shelf space entry that has been widely discussed the latest years. Slotting allowances are predetermined fixed amounts paid by suppliers to retailers, independent of the purchased volume. The nature and scope of the trade-offs negotiated by the chains in return for promoting sales in the individual chains have increased considerably. A report from 2005 by the Norwegian Competition Authority (NCA) provides a summary of some of the systems in place in Norway with a particular emphasis on systems where shelf space is conditional on payment.⁶²

Such payments can be up to 20 per cent of the retailer's rebates. The NCA concludes that the use of slotting allowances may yield efficiency gains in the relationship between supplier and retailer. It may also, under some circumstances, have a rent shifting effect, so that the retailer's profit increases at the expense of the supplier. Provided there is sufficient price competition between the chains, this will also lead to lower consumer prices. Slotting allowances may, however, also have negative effects. Under some conditions slotting allowances may be used in a strategic way to soften competition⁶³. Slotting allowances may also be used to pay for exclusionary agreements, but in such cases their effect is not significantly different from the effect of other payments. The NCA therefore concluded that the use of slotting allowances should be assessed on a case to case basis.

Another important aspect concerning shelf space entry is private labels. Hard discounters mostly sell private labels. The retail chains develop and market these products. They secure a prominent position for their own brands on the shelves. This leaves less space for producers' brands. It is thus getting tougher for the producers to get access to the best shelves in the shop, unless they pay for it. This often leaves small producers with fewer financial resources without shelf space at all. The competition for shelf spaces is thus increasing.

This has changed the relationship between shops and producers, and producers must increase their efforts to provide (and sell) branded products. However, processors are likely to bear increasing shares of promotion costs (increasing shelf-space charges) to get their products before consumers. The study from The Norwegian Competition Authority shows that the retailers use their knowledge of the cost of private labels to get the prices down on branded goods⁶⁴.

Does the competition for shelf space reduce the product assortment under the efficient level? Economic theory cannot provide an a priori answer to this. The retailers, especially hard-discount chains, reduce the number of products to increase the suppliers' competition for shelf space. This, however, leads to lower consumer prices if the price competition between the chains is sufficient. For the consumers there will be a trade-off between these two effects, and the result may be that the consumers are better off. However, when slotting allowances are used as payment to a retail chain for foreclosure of (potential) competitors, this is done because the supplier finds it profitable – for example because the weakened competition makes it possible to raise the prices. In that case, the consumers face both higher prices and a narrower assortment.

The development towards a concentrated retail level, and integrated retail chains, presents the smaller suppliers with some new challenges. Producers operating with small production volumes and capacity might have difficulties to meet retailers' volume requirements. A larger counterpart, when competing for shelf space in retail stores hence easily displaces them. The increasing market power of the retail level could therefore increase consolidation pressures on smaller processors who could have trouble finding outlets for their products if they cannot meet scale requirements by large retail operations. A Swedish study suggests that the no. 2-5 processor in most markets have lost market share in the last five year. This is due to the retailers' shelf space management⁶⁵.

5.3 Procurement and distribution

A small number of vertically integrated chains dominate the Nordic retail sector. They control the distribution and logistics of the food products to a large number of shops and form an important element behind the increasing power of the retail sector within the Nordic countries.

The retail chains have gained many advantages after they took over distribution. Primarily, they can reduce cost by more volume, which creates higher efficiency and a better use of stocks and warehouses. It also gives them strategic advantages toward the producers and other (independent) shops as the producers in order to keep their contracts give better and more specific offers to the chains. The retail chains stronger position often creates buying power, as the suppliers grow dependent of a few large retail chains. Thus, a producer with large fixed cost may want to run his plants at more or less constant capacity, and this may mean that he will accept significant price reductions rather than loose an order.

The retail chains demand on-time delivery and other specific requirements to the producers such as proof of ethical behaviour, special branding/labelling, product documentation, packaging, and bar codes. The number of demands can depend on the product but most chains have standard requirements.

Some manufacturers still deliver their own products directly to individual stores. However, it is expensive and reserved for the manufactures, who deliver large volumes (at a low cost). Direct supplies by the manufacturer to the retailer are common particularly with milk, bread, soft drinks, and beer, which individually place special demands on the methods of distribution, for instance demand for special temperatures. In Norway and Denmark, it is not unusual for dairies to carry other fresh products such as meat, poultry, vegetables and fruit, in their refrigerated vans also.

There are, however, still numerous examples of mostly large supermarkets, hypermarkets, etc., making a point of including local produce in their range. Often consumers will feel a certain loyalty towards beer from the local brewery, meat and cold cuts from the local abattoir or fresh vegetables from nearby growers. But their share of total sales keeps falling.

The suppliers who deliver to the chain distribution centres have no immediate access to information on how their products sell in the individual chain stores and to which groups of customers. It will also be hard to obtain information on marketing at store level without cooperation with the chains. Information on consumer's reactions to new products or new campaigns at the store level may be valuable and the sole access to such detailed knowledge may be exploited by the retailers in their negotiations for supplies⁶⁶.

On the other hand, centralised purchasing in bulk provides for example smaller producers of high quality food with an opportunity for penetrating the market extensively because their products will get access to the shelves in numerous supermarkets merely as a result of the conclusion of one agreement.

Recently, retailers' have started to use auctions to get the best offers, especially when they seek new producers to their private labels. One reason for the increased interest for auctions is the internet, which facilitates cheap opportunities for participation of a wide range of companies. International auction houses organise these auctions where producers from many countries compete to get the orders. Especially for goods with low transport cost, this means fierce competition among the suppliers as the auction draws interest from suppliers from different countries.

5.4 Private labels

The number and market share of private label products are growing. The value share of private labels accounts for 10–30 per cent of consumer goods in most European countries with Germany and the UK at the top. In the Nordic food markets, the aggregate market share of the private labels is app. 10 per cent, but increasing, cf. figure 5.2.

Figure 5.2. Share of private labels in selected countries¹,²

Note 1.Denmark's share is exclusive figures from Coop Denmark
Note 2.Private label is defined as ”any brand sold exclusively by a specific retailer or chain”.

Source: ACNielsen: A review of growth trends around the world 2003 and 2005.⁶⁷

Food products are among the product areas with a high share of private labels. Refrigerated food (for example milk and complete ready meals) and frozen food (for example vegetables, potato fries and pizza) are among the products groups with the highest share, whereas beverages (alcoholic and non-alcoholic) and baby food generally have low private label shares^68,69.

A contributing factor to the growth of private labels has been the growing presence of hard discounters. Hard discounters sell a limited selection of products at a very low price. Moreover, hard discounters mostly sell private label products. Within Aldi, private label products account for approx 95 per cent of sales internationally⁷⁰.

In essence, there are two driving forces for these changes: brand value and better prices and margins. Large retail chains see private labels as a strategic weapon in order to differentiate their identity from their competitors with strong brands of their own, allowing them to cut costs, improve profitability and keep the entire supply chain in their hands from product planning to the customer. Private labels, however, do not mean that the retailers will not sell branded goods. Some times branded goods give better profits and the consumers expect that the retailers have some of the well-known international or national brands in their shops.

Private labels are not a new issue. For many years, the Nordic Coops had their own productions plants and mills⁷¹. They produced for instance fats, cereals, flour, coffee, and bread. Moreover, Coop developed products that they had produced by private companies. Coop gave up this strategy as it became too expensive to produce exclusively for the coop sector and began to concentrate 100 per cent on retail. However, the company still has many private labels compared to their competitors.

The retail chains often use private labels if they miss a product in the value chain within a category, be that a high-end, low price or mid price products. A number of English private labels are for example high-end products, while German retailers have low price private labels. Private labels make it difficult for the consumers to compare prices.

For the producers private labels represent a challenge not only because they substitute their own brand but also because they are competing with them in-store. The retail chains have very low cost on marketing their private labels, while the suppliers not only must market their brands so the consumers can identify them, they must also pay to be part of the retail chains' marketing including marketing of private brands⁷². In addition, buyer power may be stronger for private labels, as the potential sourcing market may be wider.

Moreover, retailers decide the price both for their private brands and for the producer's. Thus, prices for private labels are generally set lower, than manufacturing brands. Figure
5.3 illustrates the price differentials at the shop level between manufacturing brands in selected countries and private labels. The comparison is made on a category by category basis and must thus be interpreted with some caution.

Figure 5.3. Price differential between private label and manufacturing brands by country

Source: ACNielsen: A review of growth trends around the world, 2005⁷³

Regarding the net effect on prices there is convincing theoretical as well as empirical research that indicates lower prices, although this may not always be the case (HUI 2005). As indicated in figure 5.3 prices of private labels are usually set at low and competitive levels reflecting the better margins and the retailers' objective of maximising sales. Branded products may respond by lowering the prices charged to retailers which may, depending the degree of competition among retailers, be passed on to consumers. The empirical evidence, albeit somewhat fragmented, points in the direction of lower prices with growing shares for private labels.

Most private labels take the shelf space from the producers' brand. The most vulnerable producers are minor ones, as the retail chains need the strong international or national brands in their assortment and shelves. Some minor producers find themselves omitted from a number of retail chains. Their only way to stay in the market is perhaps to win procurements on private label production.

The competition to get the private labels orders can be hard too, as producers with strong market position also participate. For the large producers whose brands are present on most shelves, private label production gives them the opportunities to get the newest information on taste patterns from the retail chains. Furthermore, they can use their production facilities more efficiently. Even though the profits from producing private labels are not as high as the profits from producing their own brands, the volume from private labels gives them better opportunities to develop new products. Finally, by winning procurements on private labels production large companies can close or take over smaller competitors.

In this respect, more private label production is no bulwark against concentration on the market. Some retailers are well aware of this. They have therefore developed long-term strategic contracts with smaller producers in order to give them an opportunity to remain in the market. The retailers gain another advantage by this, as the producer grows dependent on the contract with the retailer.

Private label production also has an impact on R&D. Since the pay-off from new innovations is lower in a world with high market shares for private labels, one would expect R&D expenses would decrease with detrimental consequences for the development of new products. On the other hand, the only option for suppliers eagerly protecting their brands is to offer even better products than before, which is an argument that points in the opposing direction. Thus, large producers generally have superior knowledge of the markets internationally and know how to exploit this and have the resources to do so. These few producers see R&D as one of their best means to stay in business and expand. They believe that if they can continue to develop new products, the retailers will be more reluctant to take their brands off the shelves.

On the other hand, if low price private labels continue to win a higher percentage of the market, the strategy to keep developing new products that appeal to the consumers and which are copied by the competitors will get tougher. Industry claims that the retail sector cannot afford to make the necessary R&D to develop new products. So, if consumers really want diversity of new products, which demand extra resources to research and development, retailers may turn to reserve part of the floor space to such products whether they are branded or not. For high-end private labels, this will give new opportunities for the producers or independent researchers.

For some food categories, branding is less important. Generally, fresh meat and vegetables are not sold under brand names. Preferences for certain manufacturing brands or private labels are not generated. This influences price competition and the range of different products in the retailers portfolio. Moreover, without brand awareness it may be difficult for foreign producers to penetrate the market and differentiate their products from those already available. Another aspect of this is that it is difficult for producers (especially small producers) to get credit for special properties, qualities of their produce.

5.5 Category Management and Efficient Consumer Response

In category management, retailer and a leading supplier cooperate about how to create the most efficient shop when it comes to meeting consumer demands. Under category management, the retailer and the chosen supplier make decisions about product selection, placement, promotion, labelling, pricing, etc on a category-by-category basis with an aim of maximizing the profit of the category as a whole. (A category can for example be all kinds of hard cheese).

The retailer gives the supplier detailed point of sale statistics, while the supplier has R&D and brand promoting knowledge. Even though a single supplier is in charge (a so-called Category Captain), the category management agreements are not supposed to be exclusive. The retailer expects that a supplier chosen as captain comes with plans on how to reach the best result for the whole category.

Efficient consumer response (ECR) is another form of cooperation between the food industry and the retail trade. ECR is information sharing between retailers and suppliers. The goals central to the development are customer-orientated performance, good attainability of products, rapid processing of deliveries and an overall saving of costs. Logistics and information management play a key role in ECR. Food industry processors can benefit from the massive amounts of consumer purchasing information from the retailers even if they have to bear an increasing share of the product development risk. An increasing number of retailers share their frequent shopper data with manufacturers and marketing information companies, including registrations on how certain events, displays, ads and price reductions influence sales⁷⁴.

Category Management and ECR build on modern IT which makes it possible at a low cost to improve the knowledge of sales through extensive registration, systematisation and analysis of data on the sales realised in stores. Articles are bar coded to allow the IT system to identify them at all stages of the supply chain and transmit the price to the cash register. By combining data on the sale of individual products with purchasing data it becomes possible to react promptly whenever there is a need for replenishments and perhaps place automatic orders with wholesalers and suppliers.

A new form for identification of individual articles is RFID (Radio Frequency Identification), where every article is tagged with a chip embedded with a radio signal allowing the store to know where the products are at all times. Such systems may transform the entire distribution process.

The purpose of the cooperation between retailers and leading suppliers is to get higher efficiency and thus lowering the cost. This can lead to lower prices for the consumer.

However, category management also paves the way for practices which give cause for concern under competition law; one supplier is given preferential treatment which it may use to its own advantage and detriment of competitors⁷⁵. This is particularly so where the category captain also is a dominant undertaking on the market. Category Management seems to benefit the leading brands within a category as well as the retailers' private labels.

Indeed, some investigations show that the retailers can be able to favour their own private label products even more than as agreed with the Category Captain⁷⁶.

There is also the potential risk that the same, possibly dominating, supplier is selected as the category captain of several competing chains. That would put the supplier in a position to coordinate competitors' practices in a manner which is contrary to the general efforts to promote effective competition. The threat of cartelisation is also present if the retail chain invites several competing suppliers to prepare the category programme.

5.6 Rebates and loyalty systems

Suppliers' rebates are an important and often positive part of the pricing practises. The use of for example cost-based rebates, or fixed slotting allowances, may create efficiency gains. Different kinds of rebates, bonuses and slotting allowances may also help the chains to make the most of their buying power, thereby shifting profit from the suppliers to the retail chains. Provided there is sufficient price competition between the retail chains, this will lead to lower consumer prices.

However, the use of rebates, bonuses and slotting allowances may also have negative effects on competition. In some cases, such payment schemes foreclose actual or potential competition or put some parties at a disadvantage, for instance if they receive a higher rebate from a dominant supplier than their competitors without any objective reason. For the consumers the results of such exclusionary practices are higher prices and a poorer product range.

Such problems may arise upstream or downstream. Generally, it is not likely that rebates from suppliers will harm the competition downstream (the competition between retailers) in the Nordic food market unless there is market power. Differences in rebates, bonuses etc. from a dominant supplier may, however, have an exclusionary effect if for example a newcomer – a new retail chain – gets considerably poorer conditions than the established retail chains. If several suppliers offer poorer conditions to the newcomer, he may have a major disadvantage in the competition with the established retailers.

Dominant suppliers may also use rebates, bonuses, slotting allowances, etc to foreclose smaller suppliers. When a supplier is sufficiently strong, it may be profitable for him to pay a retailer for exclusivity. This is the case especially in markets where only the dominant supplier has a strong label, is the sole supplier in the other chains, or the only one with the production capacity to cover the chains' total demand. Suppliers may use rebates, bonuses, or slotting allowances as payment for exclusivity in such cases.

Loyalty bonuses are rebate schemes where the retailer gets extra rebates for being loyal to the producer. Such schemes include every kind of payment from the producer. If this means that the retailers get a better bargain without other objective reason than that the retailer buys solely or a pre-set large share of his goods from the producer, such bonuses can have a strong loyalty effect. When such a scheme is used, the small supplier will have difficulties to enter the market unless he offers the retailer very low prices, cf. the Finnish example in the box.

Box 5.1 The Valio case

Another example is the Finnish Competition Authorities'(FCA) prohibition to the producers to make agreements solely to the retail chains and make invoice through the chains obligatory. The reason for this prohibition was a suspension that the invoice agreements led to a decrease in suppliers assortment.

Recently, in September 2005, the Norwegian Competition Authority (NCA) announced its intension to fine Tine, the dominant supplier of cheese in Norway, for violating the Norwegian competition act by entering into an agreement with Rema1000 on Tine's exclusive supply of cheese to the chain.

5.7 Conclusions

Vertical relationships are today very different from a few decades ago. Retailers integrate most of the activities that formerly was performed by wholesalers and other middlemen. Buyer power at the retail level has increased, and it is increasingly important to exploit economies of scale both in the negotiating game with producers as well as in the distribution system to the consumers. Is this development only to the benefit for consumers? Not necessarily so. Whereas larger corporate structures are frequently better able to enhance productivity, they are also in a stronger position on the market. It is up to a sound competition in the market to determine the consumers' share of the benefits.

In getting a grip on the extent of buyer power in the market, buyer concentration is a primary parameter to explore. Buyer power naturally rises with the concentration in the retail market, which determines the number of alternative buyers in the market for suppliers and their relative size.

Given some degree of buyer power, a retailer group may impose terms and conditions upon suppliers, vertical restraints, aimed at either enhanced efficiency or to extract rents. An example of a vertical restraint that improves logistic efficiency is the requirement on suppliers to supply distribution centres rather than stores directly. Such a restraint is likely to be welfare-improving in most situations. Other restraints, such as listing fees, slotting allowances, special payments and so on, may also improve efficiency, or they may rather represent a retailer's efforts to extract economic rents from suppliers.

The outcome of increasing buyer power in terms of welfare is determined by the competitive situation. This, again, is influenced by the structure on upstream and downstream markets. Generally, an increase in buyer power among comparably weak retailers may result in better conditions offered by mighty suppliers which, in the end, benefits consumers by lower prices and possible a better product variety. On the other hand, if retailers are already strong, and suppliers comparably weaker, consumers may not benefit from a power shift to the advantage of retailer groups. The welfare effects of an, say, increase in buyer power are therefore uncertain and depends on the specific situation⁷⁷.

If a supplier has a dominant position, the use of various forms of vertical restraints may have anticompetitive effects among suppliers. For instance, it can be profitable for a supplier to pay a retailer to gain exclusive shelf-access, i.e. to pay for exclusion of rival suppliers. The buyer's market share is vital for the outcome. If alternative retailers are absent or inadequate to compensate for the loss in market channels for these rivals, consumers may be harmed in terms of higher prices, restricted choice and possibly negative dynamic consequences in terms of research and development of new products. If, on the other hand, alternative ways exist to reach the market, such anticompetitive effects are much less worrisome.

Strong retailer-buyers are naturally also large which may facilitate various efficiencies associated with distribution, development and transaction. Depending on downstream market conditions, such efficiencies may work to the benefit of consumers.

In conclusion then, it cannot be argued that the development experienced today with increasing buyer power among retailers automatically benefits consumers. A concentrated retail market, with strong buyer positions for retailers may even be harmful for competition and for consumers.

Fodnoter

62 Norwegian Competition Authority: Payment for shelf space, 2005

63 Shaffer (1991) shows this.

64 Betaling for hylleplass, virkninger for konkurransen for dagligvaremarkedet i Norge, Konkurransetilsynets skriftserie 2/2005

65 Anselmson, Johansson, Larsdotter & Nilsson: Svenska dagligvareleveran-törers strategier i konkurrensen mot egna varumärken, Lund International Food Studies 2004/3

66 Market researchers such as ACNielsen and GFK gather data from the store checkout lines and consumer panels, but these data will not be as detailed as the data available directly from the stores.

67 ACNielsen includes in the retail data views from 80 different categories within 14 larger product areas as alcohol, snacks, baby, frozen food etc.

68 ACNielsen: A review of growth trends around the world, 2005.

69 Dairy private labels have traditionally only accounted for small market shares in the Nordic countries, whereas they have commanded shares of 30-60% in countries as France, Germany and UK.

70 ACNielsen: A review of growth trends around the world, 2005. The share of dairy private labels has however started to increase. The entry of hard discounters to the market is part of the explanation.

71 Coop Norge still have some plants left.

72 Recent registrations from Denmark show that the chains increasingly market their private labels through the weekly promotional brochures. In 2005 more than half of the adds has been for private label products.

73 Data from 80 categories within 14 product areas.

74 Cf. the study by the Food and Resource Economic Institute in Denmark: Are retailers' promotional and advertising campaigns effective 2004 analysing how the demand for food is affected by retailers' marketing. The study was carried out on the basis of the information obtained by retailers at inter alia checkout counters.

75 Global Competition Review 2005 refers to an action in the USA (RJ Reynolds Tobacco v Philip Morris Inc, 199 F Supp 2nd 362 (MD NC 2002)) brought by several tobacco suppliers against a category captain that had recommended a system of discounts and specific marketing initiatives which in reality discriminated against those retailers that did not join the system 100% but chose to cooperate with competitors of the category captain as well.

76 The Commissions' investigations on the merger between Procter & Gamble and Gillette, Case No Comp/M3732, 15/07/2005, 134-151.

77 Clarke R., S. Davies, P. Dobson and M. Waterson (2002), Buyer power and competition in European food retailing, Edward Elgar, Cheltenham UK

Version 1.0 December 2005 • © Danish Competition Authority.
Published by the Danish Competition Authority, http://www.ks.dk/
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