Last fall, it became common knowledge that Canadian grocery store chains were earning more profits than usual. As most of these chains were public companies that paid dividends to shareholders, it was hard to hide those profits.
The social justice warriors found a new cause. They made so much noise that the Canadian government created a commission to address the “excessive profits.” So we had several weeks of hearings where people who were already earning a healthy salary squared off against the chain CEOs. Consultants from both sides got paid $500 a day (or more) to talk to MPs earning $500 a day. Kind of like the rich against the rich to get richer. To my knowledge, nothing was changed with this commission.
The chains tried to explain that they were just adjusting for inflation. And if they were all thinking in this way, then they anticipated a 6% price increase, but inflation was only 3% so the other 3% went into profits. I’m not quite buying this logic: eventually the free market forces would have seen that extra 3% turn into a price decrease as the chains compete against each other. There is a lag time, and eventually profits would have returned to their normal levels.
I have another reason for these “excessive profits.” The CEOs of the chains would never publicly admit to these reasons because these reasons are more complicated than “adjusting for inflation.” The public will become more suspicious if my reason was stated. And the social justice warriors just don’t know enough about commerce to understand my reasons. So the commission danced around the issue.
The Real Reason?
In Logistics of the Fuel Industry, I described my three months working at a gasoline station. As I was observing the basic operations, I came to an interesting business hypothesis: if a business fears running out of a product it is selling, it will sell at an-above market price.
There are two reasons for this business strategy. First and obviously, there is more profit by selling at the higher price. If a seller is going to run out, why not maximize the profit? Second, customers who come to buy might be annoyed at a higher price, but they will be more annoyed at the product not being available for sale. So the higher price helps ensure the product is not sold out. After all, a considerable effort has been invested to stop at a gasoline station. Just imagine pulling to a gasoline pump and seeing a sign “We have no gas.”
In a like manner, the grocery store chains in Canada employed a similar strategy. If the chain knows one of its popular products is facing supply issues, the store will raise the price of that product. In this way, the shelf dedicated to this product never goes bare and the customers choose whether to buy at the higher price or seek a cheaper substitute product. For the chain, that means more profit and less customer annoyance than having a bare shelf.
Covid & supply chains
Supply chain issues were common in post-Covid times. Reliable distribution channels were broken for lack of critical inputs. Reliable suppliers suddenly found new customers willing to pay more than current customers. Business was more dynamic in these times, with the MBAs trying to keep current working deals in place, while finding new deals to address shortages — or find more profit.
Supply chain issues were anticipated in the grocery store sector. I was not in the back rooms, but I suspect the higher-level managers created a list of products that were likely to have supply chain issues. These products were assigned higher prices, which was a technique to ensure that the shelf space for the product never went bare. Some customers would still buy at the higher price; other customers would find a cheaper substitute.
I think that is a reasonable strategy to keep store shelves full and allow customers to have a choice. This is just the invisible hand of Adam Smith working its magic.
But here is where this strategy went off the rails. All the stores were probably doing this for the same products. So most stores were increasing their price for Product X by 5%. So there was no market force for shoppers to change their favorite store. And it seemed the higher prices really did not deter a lower sales volume; most of us did not seek out a cheaper substitute; we just grumbled at the higher price. So grocery stores could keep the prices high and the sales volume would remain almost the same. Then if the supply chain issue was still expected, then the price could increase by another 5% to reduce demand. Maybe even another 5% could be added. So when prices could increase by 15% on some products — and the input price was the same, that 15% became pure profit. Especially if the supply chain issue never happened.
My hypothesis suggests that most of the “excessive profit” in the grocery store chains came from anticipating supply chain issues in advance. Whether or not these supply chain issues were realized, eventually margins would have fallen as the chains compete against each other. Sometimes Adam Smith’s invisible hand works a little slow.
Bad, bad business
The Commission pointed that the grocery store chains have immense bargaining power over most of their food suppliers. A chain could tell a supplier to lower prices or face smaller shelf space — or even no shelf space. If a supplier sees a break-even proposition from the chain, it usually has to accept that proposition, hoping for a profitable opportunity elsewhere or later.
While this sounds “evil,” taking advantage of a stronger bargaining position is a part of any business. The suppliers know the chains have the upper hand, so the suppliers have to be more clever to stay solvent. My free-enterprise nature says if the suppliers don’t like the heat, they can get out of the kitchen. If a few suppliers decide to quit the business, then the other suppliers will have more bargaining power.
I see no need for government intervention here, even if the Commission made some noise to justify why it was making noise.
Conclusion
The Commission was mostly a waste of taxpayer’s money.
The grocery store industry is robust and competitive in Canada.
And if western Canadians don’t believe me, then they should join the Federated Co-op. This co-op has more than 100 grocery stores from Port Alberni to Kenora. These stores are quite robust and compete well against the publicly-held grocery store chains. If the Co-op has excess profits, those profits go back to the consumer. Western Canadians have no grounds to complain of monopoly collusion.
We need more co-ops, especially in the food sector.
But better than co-ops, we need spolus. It’s time to think about a new way of commerce.
Published in 2024
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