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Collateral Damage

Business Strategy
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If economics was warfare, inflation would be a “weapon of mass destruction.” Beyond its impact on consumer buying power lies the specter of collateral damage caused by actions designed to influence pricing practices.

The federal government’s recent invitation for 11 foreign grocery chains to operate in Canada is a case in point. This initiative grew out of last year’s hearings on food pricing. Those hearings failed to secure the voluntary compliance of major chains with a “grocery code of conduct” designed to control prices.

The government believed the added competition would create greater price competition. This is a demonstration of “moral suasion” – persuading a person or group to act in a certain way through rhetorical appeals, persuasion, or implicit and explicit threats – as opposed to the use of outright coercion, physical force or regulatory actions.

There is nothing wrong with moral suasion as an instrument of government policy. But while this initiative seeks to influence the behaviour of the major chains, the policymakers may not have fully considered whether it is sustainable and how it might affect others in the grocery food chain, especially independent grocers.

Does might make right?

There are aspects of this initiative that make sense. First, given the substantial concentration of all commodity volume and market share in the major domestic chains, any change in their practice will manifest itself in the wallets and purses of a substantial majority of consumers and potential voters.

Second, the focus on foreign-based retailers is understandable. Since you can only price as low as your costs allow, any new competition that could cause the domestic chains to cut prices must be able to match the volume-based sources of efficiencies of the existing domestic chains: scale economies, market power and the capacity to invest in technology-based sources of productivity. Without those capabilities, government subsidies or tax breaks may be needed to attract new competition; if so, we haven’t so much improved affordability as we have moved payment from the checkout aisle to your tax bill.

Third, initiatives like this not only send a message to the major domestic chains; they send a signal to consumers that their government is taking tangible action to protect their interests.

However, many question whether inflation control should be initiated at the tail end of the distribution channel. Asking grocers to keep a lid on prices while absorbing increases from their suppliers is tantamount to asking them to accept lower margins at a time when constraints on buying power weaken primary demand – declining profit is inevitable.

Moreover, unless programs are launched to control inflation at earlier stages of the distribution channel, there is little to suggest the margin declines will end. The chains would have to offset the margin loss by reducing other costs, which usually means more automation, less service, less innovation and less marketing. It also means tougher negotiations between vendors and retailers. In a race to the bottom, no one wins.

Where does this leave the independents?

Independent grocers usually follow a value-based strategy. While they cannot match the low costs of their larger competitors, they control costs enough to allow competitive pricing. Once their prices are within a reasonable range, the marketing challenge for independents is to convince consumers that any price premium is justified by the independents’ differentiating characteristics; they must find, service and promote something that is not usually found in (the more cost-constrained) chains.

The price difference between independents and the chains will likely grow. The cost-cutting capability of the chains is sourced in volume. Lacking scale, it is hard to imagine independents matching the costs (and prices) of the chains. This threatens the value-based strategy of independents; given a larger price difference, additional sources or levels of differentiation will be needed. But providing higher levels of current differentiators usually increases unit costs due to the law of diminishing returns: independents will need to spend more at the same time they will be expected to reduce prices.

The bottom line

It seems inevitable governments will do “something” to affect food pricing before the next election. A focus on chains seems logical, given their collective market share. However, those proposals cannot be allowed to form without consideration of the independent retailers and the differences between their operations and those of the chains. Otherwise, independents may well find themselves collateral damage.

Ken Wong is a distinguished professor of marketing at the Stephen J.R. Smith School of Business at Queen’s University

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