KEY POINTS:
An important issue for capitalism is the desire of big business groups to amalgamate and create powerful monopolies or duopolies. This is anathema to the free enterprise system because it stifles competition.
The economic history of the United States has been littered with a huge number of anti-monopoly
and duopoly issues, from John D. Rockefeller's Standard Oil to Bill Gates' Microsoft. The US Government has consistently taken the view that it is extremely important to create and maintain a free and competitive market place.
The Commerce Commission plays a vital role in maintaining a competitive business environment in New Zealand.
Its decision regarding The Warehouse has been overturned by the High Court but it would not be surprising if the commission appealed because Justice Jill Mallon's decision will strengthen the Foodstuffs/Woolworths duopoly in the domestic supermarket sector.
This could have serious implications for the economy because it reduces the prospect of any new entrants and it could lead to higher food prices. This would be a double negative for consumers, particularly as Reserve Bank Governor Alan Bollard said this week that interest rates would stay higher for longer, partly because of rising food prices.
This story begins in May 2001 when Progressive Enterprises, which was owned by Australian Foodland Associated, applied to the Commerce Commission to acquire Woolworths NZ. Woolworths NZ, which was owned by Dairy Farm International, operated the Woolworths, Big Fresh and Price Chopper stores.
The commission decided in favour of the application even though the new company would have a 42 per cent market share (Progressive had 24 per cent and Woolworths 18 per cent) compared with Foodstuffs' 58 per cent. Foodstuffs successfully appealed the decision at the Court of Appeal.
Five months later Progressive made another application to acquire Woolworths but this was turned down because a change in legislation meant that the commission had to judge any proposal on a "substantial lessening of competition" rather than a "dominance" basis.
Progressive successfully appealed the commission's decision before the Privy Council and acquired Woolworths NZ in June 2002.
In December 2005 the Australian giant Woolworths acquired Progressive Enterprises including its Woolworths NZ operations.
An anonymous group of suppliers complained to the Commerce Commission because Woolworths, with its massive Australian operations, would be able to exert significant market power in its negotiations with grocery suppliers.
The suppliers' appeal was rejected although the commission noted that its enquiry was hampered by the unwillingness of the complainants to reveal their identity. This reflected their fear of upsetting Woolworths because it would impact on their future business prospects.
As a result of these decisions and transactions, the New Zealand supermarket sector is a duopoly between Foodstuffs (Pak'n Save & New World) with an estimated 58 per cent share and Woolworths (Countdown, Woolworths & Foodtown) with 42 per cent.
Together they have an estimated 78 per cent of the total New Zealand retail food market, including dairies, petrol stations etc. Few other countries have this degree of market concentration.
The first faint hint of a duopoly buster appeared on June 8, 2006 when The Warehouse opened its first Extra facility at Sylvia Park, Auckland. These Extra stores supply a full range of groceries and fresh food in addition to the company's traditional general merchandise offerings. Further Extra stores have been opened in Whangarei and Te Rapa, Hamilton.
The day before the Sylvia Park Extra store opened Foodstuffs began purchasing 10 per cent of The Warehouse at $5.00 a share.
This share purchase suggests that Foodstuffs believed the Extra concept would be successful and/or another party might bid for The Warehouse and help develop its new supermarket operation.
This Extra format, called super centres or hypermarkets overseas, was first introduced by the French retailer, Carrefour, in 1963. The concept, which is a mix of supermarket and general merchandising, has been successful in North America, South America, Europe and Southeast Asia although it has not yet worked in Australia.
Wal-Mart, which operates more than 2200 US super centres, has probably been the most successful company in this area but it started slowly. The giant US retailer opened its first super centre in 1988 but had only nine outlets four years later. Store openings accelerated dramatically in the late 1990s after the format proved to be successful.
The Warehouse's Extra/super centre format has become the focus of attention since Woolworths acquired a 10 per cent stake in September 2006, at $6.50 a share, and both it and Foodstuffs applied to the Commerce Commission for permission to acquire 100 per cent of the country's largest retailer.
The commission rejected the applications on the basis that "it was not satisfied that the acquisitions will not have, or would not be likely to have, the effect of substantially lessening competition in a number of local supermarket markets".
The commission believed that The Warehouse was in the best position to offer a supermarket option in smaller centres - where either Foodstuffs or Woolworths had a monopoly - as the NZX listed retailer had the branding, store location and financial clout to offer an alternative to the current duopoly.
It can also be clearly inferred from the commission's report that if The Warehouse couldn't establish a competitive supermarket format then no one could and the Foodstuffs/Woolworths duopoly would continue for a long, long time into the future.
Is this the best thing for consumers, especially in one-supermarket towns?
Woolworths, Foodstuffs and The Warehouse jointly appealed the commission's decision and Justice Mallon found in favour of the appellants and against the regulator.
This is the third time in recent years that the commission's attempt to create a more competitive supermarket environment has been overturned by the Courts.
The issue boiled down to whether the Extra concept would be successful or not, with Justice Mallon's judgment in places appearing more like a retail analyst's report than a legal opinion.
The commission argued that The Warehouse had a super centre roll out plan, it had the financial resources to do so and was prepared to give the concept time to work. In other words The Warehouse had the best chance of offering competition to the entrenched duopoly and it should be given the opportunity to see it through.
Foodstuffs and Woolworths argued that it is "very unlikely that the Extra concept will continue on a scale necessary to be viable and that it is very likely that it will be abandoned altogether".
Justice Mallon agreed with the latter point of view and wrote "there is the real prospect that the Warehouse Extra will be trialled for a further period and then abandoned without any further stores rolled out".
She also believes that even if 15 Extra stores were rolled out, The Warehouse would continue to focus on general merchandising and would not be a price leader or "shake up" the competition between Foodstuffs and Woolworths.
Investors greeted Justice Mallon's decision with great excitement but it probably means that it will be a very long time before there is a successful supermarket or general merchandise start up - or another Stephen Tindall - because this will be crushed by either a Woolworths/Warehouse and Foodstuffs duopoly or a Foodstuffs/Warehouse and Woolworths duopoly.
That is not a very exciting prospect for consumers or next-generation NZX investors.
* Disclosure of interest: Brian Gaynor is an Executive Director of Milford Asset Management and owns shares in The Warehouse.
