One plus one - does it add up to higher prices?

In 2001, Consumers Institute head David Russell warned food prices were likely to rise once the supermarket industry shrank from three big players to two. Photo / Brett Phibbs

In 2001, Consumers Institute head David Russell warned food prices were likely to rise once the supermarket industry shrank from three big players to two.

"I'm delighted to say that by and large my prediction was wrong," he says now.

Russell, who has since left the institute, was subsequently convinced that competition was helping to keep prices down. However, he admits he hasn't seen any recent research.

Last year an Australian academic caused a stir with a study that appeared to show food prices have risen in Australia and New Zealand by more than 40 per cent over the past decade - well ahead of most countries in the developed world.

Frank Zumbo, an associate professor in the School of Business Law and Taxation at the University of New South Wales, says the only unique factor he was able to pinpoint to explain the sharp rise was the lack of competition.

"They say we have smaller markets and what have you, but if we're getting price gouged then that's a big price to pay," he argues.

Zumbo derides as "spin" suggestions from the supermarkets - and even the Australian Competition and Consumer Commission - that other factors were to blame.

"Our minister was also defensive because if they acknowledge the problem, that's an acknowledgement that they have failed on policy."

Current Consumers Institute head Sue Chetwin was supportive of Zumbo's conclusions. "It does confirm that the cosy duopoly does work to keep prices high, and there really isn't as much competition as there should be," she said at the time.

Chetwin told The Business this week it was also notable that Fonterra dominated the supply of dairy products to supermarkets in this country.

"The Fonterra situation is unusual in that most big dairy companies internationally supply largely to a domestic market whereas Fonterra's biggest markets are overseas. That makes us subject to the prices it can get for its products overseas - or so they say."

However she also notes that Consumer's sister organisation in Australia, Choice, recently sent a writer to New Zealand to compare supermarket prices. The outcome: groceries are still cheaper here.

In 2007 Woolworths commissioned a report from Frontier Economics which appeared to show prices fell across its 200 most popular products following the merger of Progressive and Woolworths NZ in 2002. When the Commerce Commission attempted to independently analyse the data, it decided the information was so unreliable that it was useless.

Tim Morris of Coriolis Research is highly critical of Zumbo's study.

While he admits the New Zealand food price index did show a big rise between 1998 and 2008, he believes this can mostly be explained by a boom in global dairy and meat prices, and other factors such as the drought in Australia.

A long-term study published by Statistics New Zealand last year appears to confirm this. The study confirms food prices have generally moved in line with overall inflation over the past 50 years. Although some items (such as milk) have become significantly more expensive, others (such as eggs) have become substantially cheaper.

"At the end of the day, if the things [Zumbo] was saying had any basis in reality these guys would be making lots of money, and they're not," Morris insists.

Analysis of Woolworths' annual reports does indeed show that its normalised New Zealand dollar earnings before interest and tax have remained almost constant at around 4.2 per cent of overall sales each year for the past four years.

The National Distribution Union says it will be watching closely to see if that continues.

When it bought Progressive, Woolworths made it clear its aim was to cut costs, and pass those savings on to consumers. According to the NDU, there is some evidence that is happening.

However, according to general secretary Robert Reid, Woolworths put extra pressure on its New Zealand managers by including a huge amount of goodwill on its balance sheet when it acquired Progressive for $2.5 billion at the end of 2005. Morris agrees it probably paid too much.

More recently, Progressive has slightly increased its gross margins. But given the huge amount it is reinvesting in the business, it is understandable it might want some return on that.

Foodstuffs' margins and profitability are slightly harder to determine given its unique structure, and the fact that as a private company it is not obliged to publish detailed financial accounts.

In February it fiercely opposed a suggestion by the Australian Treasury that large privately-owned New Zealand companies should be required to open their books, as they are required to do in Australia.

Foodstuffs argued that because of its co-operative model, this would require each store to disclose its individual profitability - and its owner's earnings. It warned it was prepared to spend "whatever it takes" to keep such information private.

In the end the Government decided to stick with the status quo.

There are anecdotal reports that owning a Pak'N Save or New World store is, like many large franchises, a solid route to riches. And many in the industry agree that the grocery business can indeed be a lucrative career, especially for someone who is prepared to work their way up from the bottom.

Greg Foran, who started out packing shelves in a Hamilton supermarket in the '70s, earned around $2.3 million last year as a member of Woolworths' executive team, according to its annual report.

According to the NDU, Foodstuffs managing director Tony Carter stopped disclosing his salary several years ago when the union questioned head office costs, but in 2007 he was said to earn around $1.4 million.

While it was easy for critics to point the finger when food price inflation was soaring, that is no longer the case.

After hitting an annual high of more than 10 per cent in September 2008, food price inflation has since steadily declined, and in the past seven months has fallen to almost zero.

Carter says he has never seen anything like it, and Foodstuffs is forecasting the situation to remain much the same for the foreseeable future.

According to Carter, there are three main reasons for the sudden slowdown: lower global commodity prices, a high New Zealand dollar and a plentiful supply of local fruit and vegetables due to a spectacular summer.

Morris says consumers simply have to get used to the idea that local prices are often affected by export prices, and that supermarket pricing is often about balancing those fluctuations.

While it is certainly true that supermarkets tend to wring higher margins out of fresh produce, that's only so they can offer other goods at or below cost, he says.

Green MP Sue Kedgley argues that such practices are effectively a tax on healthy eating. And she has warned that many local growers are choosing to get out of the industry rather than continue to see their own margins eroded.

The collapse of the New Zealand garlic industry is a case in point, she suggests. Most garlic now sold in New Zealand is from China, and local onion growers are understandably nervous that the Chinese have applied to bring in onions as well.

Morris argues that such swings and roundabouts don't have much effect on the overall economics of grocery retailing in this country.

"From the publicly available information, there is no evidence that supermarkets in New Zealand are any more profitable than supermarkets anywhere else," he insists. "Sure, competition is good, and more competition is better. But you've got to balance that among 4.3 million people. We are in line with other peer-group countries. You find a similar situation in Norway, Finland and Switzerland."

There is, however, one important difference: there are five main competitors in Norway and Finland, and four in Switzerland. According to Coriolis' own research, New Zealand is the only developed country to have just two.