Hong Kong's competition regulator faces challenges in supermarket sector

Hopes are high for HK's competition law but its enforcers will have much to do when probing a murky world of supermarket pricing

PUBLISHED : Monday, 30 June, 2014, 1:40am
UPDATED : Monday, 30 June, 2014, 7:14pm

Ahead of next year's long-awaited competition law, food industry insiders describe a sector where prices are controlled and shenanigans commonplace as suppliers and supermarkets jostle for margin and market share in the fight over who fills your shopping basket.

The dominance of two companies in the supermarket industry - Dairy Farm International Holdings and AS Watson Group - has long concerned consumer rights advocates. Last year, the industry was the subject of a Consumer Council investigation.

Is [near identical pricing] a pure coincidence or a tacit agreement not to compete?

Several suppliers explained how in-store prices are regulated.

Larger supermarkets monitor prices at competitors and if they see a supplier's product selling cheaper elsewhere, depending on the contract terms, they can claim the difference back.

"For example, one litre of milk, if Dairy Farm sells it at HK$17 and maybe 759 [Store] sells it at HK$15, Dairy Farm has the right to charge the HK$2 per pack back to the supplier," said Ringo Wong, a director at Wilson Fine Foods, a division of Wilson International Frozen Foods (HK), the city's largest privately owned food supplier.

Supermarkets rarely enforced this provision, said two suppliers, but it gave them the upper hand during negotiations, and it put the onus on suppliers, rather than supermarkets, to control prices.

When supermarkets write to suppliers to complain prices are lower at another retailer, "the wording has to be careful", said Lily Sutanto, a former supermarket buyer with responsibility for sourcing food products. "Legally, they cannot force someone to follow the standard price."

Almost identical product pricing between supermarkets has bemused observers for some time. "Is this a pure coincidence or a tacit agreement not to compete? Without a full investigation of the sector it is impossible to say," said Mark Williams, an executive director of the Asian Competition Forum and an expert on competition law.

Several food importers interviewed were uncertain whether an investigation into food prices would lead to cheaper groceries. Many said Hong Kong was a high-cost operating environment and industry profit margins were not especially high.

For now, food and accommodation are the heaviest costs for the average household and any increase in food prices has disproportionately hit lower-income families the hardest, according to data from the Census and Statistics Bureau.

Public housing residents spent 39 per cent of their income on food in 1995. By 2010, this rose to 45 per cent, according to the bureau's household expenditure survey published every half decade. By contrast, grocery spending by wealthier private-housing occupants increased from 22 per cent of monthly wages to 23 per cent over the same time frame. The International Monetary Fund Commodity Food Price Index, which tracks meat, cereals, and fruit products, rose 80 per cent during this time.

Suppliers that knew a supermarket's profit expectations, could tailor their sale price accordingly, said several food importers.

"The only way to stop other chains from selling at a low price is for the supplier to sell to them at a relatively high price. For example, if Dairy Farm requires a 40 per cent margin, you supply them a certain price. If 759 only requires a 30 per cent margin, then, basically, the principal needs to sell them 10 per cent more expensive so you can counter off the difference. Otherwise, they will always sell 10 per cent cheaper," Wong said. His company's product range includes celebrity chef Jamie Oliver's range of seasonings and sauces and Prestat chocolates.

If the supplier wanted to increase a product's price, "it must synchronise the date between supermarkets", said Sutanto, otherwise the supplier's supermarket account managers would complain.

Wong said supermarkets would not penalise suppliers if a product's price was dropped for a short-term promotion at a rival chain, although in this case, suppliers sometimes talked to their supermarket partners to ensure everyone was aware when each supermarket would do a product promotion.

Suppliers said the larger supermarkets used hardball negotiation tactics like withholding payments and cancelling promotions with suppliers when angling for better trading conditions. Stopping a promotional campaign "will hurt the supermarket but it hurts the supplier more", Sutanto said.

One supplier described another tactic whereby retailers dragged out price negotiations until a supplier's in-store stock ran out. If the supplier fails to deliver new stock, it can be contractually penalised. This puts suppliers under pressure to agree to the supermarket's terms or face sanctions.

In a report published in December last year, the Consumer Council said it was concerned the two leading supermarket chains abused their dominance, and questioned whether there was a minimum price system for products. Such agreements are banned in many developed economies.

Any breach of the law "depends on whether or not [the supermarket] has market power", Williams said. He expects there to be political pressure to investigate the supermarkets once the new competition law comes into force.

The law tackled "cartels" and "serious anti-competitive conduct" and would combat "undertakings with the object or effect to prevent, restrict or distort competition", said Timothy Lear, an executive director of the Competition Commission.

CLSA estimates Dairy Farm, which operates Wellcome stores, and Watson control 65 to 75 per cent of the market when ranked against other corporate grocery store operators, but only 30 to 40 per cent of the market when wet markets and smaller operators are included.

"From an analytical standpoint, the question is whether these guys squeeze others out or have been a victim of their own success, and that is a tricky question to answer," said CLSA's Singapore head of research, Jonathan Galligan.

Dairy Farm declined to comment for this article. A spokesman for Watson-controlled ParknShop said the company had a "professional and ethical relationship" with suppliers, and believed "a fair and level playing field environment is vital for the retail market in Hong Kong".

Suppliers said that while there was competition between the two main supermarket firms, this was also an industry where suppliers respected each other so everyone could make some money. Rocking the boat by undercutting rivals, even though it would benefit consumers, is frowned on.

In December last year, the South China Morning Post profiled Jim Coke, an importer who undercut the local price for the popular Blue Mountain coffee beans from Jamaica. Rather than compete on price, his Hong Kong competitors pressured Coke's supplier to stop selling him the coffee. Fighting back, Coke started sourcing directly from the government-run Jamaican coffee industry board, which supervises the market, and he now has his own branded coffee in local supermarkets.

The head of 759 Store, Lam Wai-chun, also complained that some suppliers stopped working with him after he priced its goods cheaper than those of competing stores. Lam is the chairman of CEC International Holdings, an electronic component manufacturer, and he largely built his stores by sourcing products direct from overseas. He started in 2010 and now has about 200 outlets.

Lam said some landlords placed restrictions on what items he could sell. These include staples like rice. However, he does not think his firm is being deliberately targeted by the larger property development companies.

Lear said "arrangements between undertakings up and down the supply chain" including agreements where there was a set minimum resale price might be in breach of the new competition law.

The Competition Commission, charged with policing the new law, has yet to formally announce which sectors it will target. It recently poached Lear and Rose Webb from the Australian Competition and Consumer Commission, a government agency with a history of supermarket industry investigations. Like in Hong Kong, the Australian food retail industry is dominated by a duopoly.