Changes in food retail trade

Rapid expansion of foreign-owned hypermarkets and supermarkets characterised the transformation of retail trade in Hungary in the 1990s. According to international studies, one shopping center can normally serve 100-150 thousand inhabitants; in Hungary, however, a lot more outlets were built in several large towns. In international comparison, the store structure in Hungary is still not concentrated. The number of food stores per 10,000 inhabitants is 19 in Hungary, 15 in the Czech Republic and 7 in Austria [European Commission (2013)].

The smallest businesses with less than 30 square meters shop space were hit harder by the economic crises and the strong competition than large shops. The number of shops over 2500 m² (hypermarkets) has increased by approximately 80 percent, whereas, the number of small shops decreased by almost 25%. Supermarkets and hypermarkets have a growing share in the total daily consumption expenditure of households, as can be seen in Table 2.

Table 2: The share of different types of shops in the daily consumption of households in Hungary (2000–2014)

Share of different types of shops in the daily consumption of households (%) Types of

shops 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2013

Hypermarket 14 17 19 21 22 24 24 25 23 24 25

Source: Kereskedelmi Analízisek (Commercial analysis), 2012, 2014, GfK and KSH (Hungarian Central Statistical Offi ce)

The evaluation of the impact of foreign direct investments (FDI) on food trade is a debated issue, with arguments to support both sides of the debate. FDI can have some positive results since FDI can be a source of valuable technology, know-how and infrastructure, and the consumer is benefi ted by improved selection of products [ÁRVA–KATONA–SCHLETT (2014)]. The concerns about FDI are the competition to domestic companies and the monopolization of the market. An increase in imports can upset the country’s balance of payments.

Another concern is job loss: while international chains create 80 – 100 jobs, twice as many jobs are lost. Domestic small scale retail shops and local trading practices would be hurt, working conditions would become poor and the sales of domestically produced goods would decrease [WERHEIM and DUBE (2005)].

3.1. Retail chains and food industry

Purchasing opportunities of trade are ranging from agricultural producers, food manufacturers, wholesalers, retailers and importers, but the extent of

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private imports and the purchase from private producers is also expanding.

The commercial infrastructure has an impact on the agricultural sector as well as large-scale development is required to have competitive advantage over the potential international competitors. Quality and consumer protection issues also have an impact on production, as the development of quality assurance systems in the food industry aim to protect the consumer at all stages of the production.

Retailers are considered to have a stronger market position than producers because they are in contact with consumers and they convey to the ultimate consumer needs. On the other hand, food companies often undertake sales promotion activities, advertising or in-store promotion, etc. as well. It is clear that retail chains hold a dominant position that was achieved through vertical integration and the resulting stronger bargaining power. With their strong positions, the powerful stores are able to extract benefi cial trading terms from suppliers, to pressure them into making price concessions or to demand long terms of payment, sometimes even late payment.

In the 1990s, the share of food companies with major foreign ownership was signifi cant. Foreign investors sometimes bought production capacities in Hungary to increase their market access, and then the processing plants ceased operations to reduce potential competition in their home markets.

Concentration in many industries allows economies of scale. In sectors where large investments are required (e.g. oil, alcohol, sugar, confectionary, meat and milling) the market is virtually monopolistic, oligopolistic or oligopsonistic.

Food safety, environmental and quality requirements signifi cantly increase the minimum effi cient scale. Since trade mostly takes place among buyer groups or with increasingly fewer foreign-owned retailers, food companies must be able to provide a wide variety of standard, consistent supply [CSÁKI–JOHNSON

(1995)]. However, retail chains have been undercutting the prices of goods which facilitate retailer cartels. Company managers usually have a personal contact with each other, but the bargaining power of buying groups is strong.

Large producer companies with strong market power disadvantage the smaller competitors who can provide fewer brands, as it is easier for a buyer to negotiate with only one large supplier than with many individual producers that can provide only one product or one brand.

Large food companies may limit competition that raise the issue of the

“portfolio effect” where a company enjoys signifi cant monopoly power on a market of a product or a combination of products. The portfolio effect can be expected for instance on the spirits market where a buyer is pressured to buy not only one product but a complete range of different products. A bigger range

or variety of products may facilitate bundling or tying (the two concepts are often used interchangeably), i.e. situations where the seller of a product requires his purchasers to take another product as well, i.e. customers that purchase the tying product are required to purchase another product from the tying product as well) and it may enable the buyers to interfere with the sales policies of the retailers. The portfolio effect is more applicable in situations where the bundled or tied products have the same buyer (typically the retailer). The seller, due to the portfolio effect, may have a dominant position and may have signifi cant economic power since they can offer a wide range of products that the retailer sells in large volumes. As a result, the retailer – for competition reasons – can apply tying or can even refuse to supply the tying product unless the buyer purchases the tied product [NÉMETI (2005)].

Yet, due to the concentration of sales, retailers are in a more dominant position than producers. However, long term relationships would be more benefi cial for both parties. Retail chains form buying groups and can strongly exploit they buyerpower. There is a signifi cant information and power asymmetry between the buyers and the producers. Therefore, retailers can make use of their market power by practices as excessive 60-80-day payment deadlines, listing fees, slotting fees, pay-to-stay fees, progressive bonuses, contribution to promotion expenses, etc., and they can achieve lower prices and further concessions.

Suppliers can lower the prices by 15-20% therefore hypermarkets can have a 20-35% of profi t margin (Consumer International Report). Nevertheless cooperation is of vital interest to food suppliers because the threat of being squeezed out of the market is constant. The market share of hypermarkets is around 45% and it is expected to further increase in the future.

3.2. Retail chains and small-scale producers

Concentration and vertical integration can strengthen the bargaining power of retailers against agricultural producers as well. If many producers are present in a market, retailers might enjoy some degree of monopsonic power [SERES

(2006)].

Information asymmetry between retailers and suppliers strengthen the bargaining power of retailers: retail chains have information about the market conditions, buying habits of customers, due to having direct contact with customers. Barcodes enable retailers to store data about consumer preferences, habits and behaviours and this information can be used against the competing

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suppliers which may have distorting effects on the retail market. Retailers have information about the economic situation of the suppliers as well. Suppliers, on the other hand, have information only about the marketing plans of their own products therefore, due to the information asymmetry they have less bargaining power [BALTO (1999)].

In the case of agricultural products price is determined not only by supply and demand but by the linking of buyers and sellers on the market as well.

Agricultural producers are usually price takers rather than price setters. Their prices are determined by the demand for their products. Producers (small-scale farmers) have access to fewer alternative large buyers and therefore they have less bargaining power. Small-scale producers often do not have access to working capital, and it is not unusual that they have to buy even the seeds and propagating material from the purchasers. Contracts (often at predetermined prices) can ensure a stable income and make a direct contribution to the producer’s annual household income. Long-term contracts, however, reduce the fi nancial uncertainty and small-scale producers can gain a reliable fl ow of income.

As a result of concentration and integration, agricultural producers become more dependent on food processing and food retailing companies. Most agricultural auction-type, perfectly competitive markets are replaced by vertical control through the use of long-term production and marketing contracts.

Small-scale producers become strongly dependent on purchasers who exercise their dominant buyer power over the producers. Contracts may also be a device to consolidate the buyers’ market power that may result in the hold-up problem (e.g. excessively long delays in payment for the delivered product, the producer is forced to accept disadvantageous terms later or ex post renegotiations of terms).

In addition to the traditional role of retailers as purchasers, retailers today have had a new role as they have advance information about the markets, in-depth knowledge of their customer base and they have acquired increasing market power (Consumers International Report). Branded goods are increasingly replaced by own-brand (private label) products. Compared to Western Europian countries, in Hungary the share of own-brand products in the daily consumption of households is relatively low, however, it is increasing signifi cantly. On the basis of consumer needs and preferences, retailers explore the market and select a potential supplier that is able to produce and supply the goods effi ciently at low prices. Suppliers of own-brand products often team up with retailers to design, develop and market-test new own-brand products [GUBA (2001)].

Own brands make retailers serious competitors to branded good suppliers and shift the market power to retailers. An imbalance of bargaining power between retailers and their suppliers may foster abusive buying practices, claim suppliers (e.g. slotting fees, late payments for products already delivered, squeezing out branded goods, etc.). As the profi tability of smaller suppliers is decreasing, the production of own-brands or specialisation may increase their market power. Suppliers may build their own production or manufacturing capacities and provide store brand products for themselves. If they have enough buying power, they might be able to negotiate a reduction in the retailer price.

Own-brand prices are on average 20% to 30% cheaper than branded prices because of the absence of brand development, packaging, and marketing costs.

Own-brand products often surpass the performance of manufacturer brands but they are often inconsistent quality and do not always meet the required quality standards. [HOCH (1996)]. The rate of sales of own-brand products versus branded products are infl uenced by the allocation of shelf space and in-store promotions as well. Some forms of brand positioning – i.e. different messages can be vested with the own-brand goods (“Tesco Economical”, “Tesco Value”) – are important tools for image creation. Brands provide identifi cation of their products with unique associations to the stores, therefore retailers can make higher gross profi t margins on own brands [OXERA (2010)].