Maths show supermarkets not to blame for cost-of-living crisis

Supermarkets have clearly become the poster children for alleged ‘price gouging’ behaviour in the cost-of-living saga. Not all supermarkets, but specifically Woolworths and Coles; while their smaller competitors happily fly under the radar.

Sticker shock has become a common experience over the last couple of years and we have all at times wondered what cost increases could have justified observed price hikes. This is not confined to supermarkets.

The Governor of the Reserve Bank recently said some businesses are using general inflation as a cover for lifting prices to increase profit margins. That’s certainly a possibility, and economists should not be so wedded to models of competition as to rule out such practices.

But is this really what is happening in supermarkets? The ACCC is committing its considerable resources for a year to produce an answer, and other inquiries are under way. But a much easier and quicker way to arrive at a broad-brush answer is to do a simple desk-top analysis of Woolworths’ and Coles’ financial results for the latest half-year as announced in recent days.

The two putative villains generated earnings before interest and tax (EBIT) of $2,577 million in the half-year — which sounds like a huge sum only until it is put into perspective. It came from sales of $45,677 million, hence an average profit margin of 5.6%.

If Woolies and Coles were to turn themselves into not-for-profit charities and reduce prices to forego all EBIT, the benefit to consumers would represent less than half a cent in the dollar of total household consumption expenditure in the period, and about four cents in the dollar of expenditure on food alone.

As the Prime Minister explained last week, we have a market economy in which businesses are expected to make a profit. So, eliminating all profit is out of the question; but how much of it represents the alleged ‘gouging’?

If it is half, then the benefit to consumers from stopping the gouging would be two cents in the dollar of food expenditure. If it is a quarter, the benefit is one cent in the dollar. Is this what the supermarkets’ critics have in mind?

These calculations are based on the total amount of EBIT. The increase over the two years since the corresponding period of 2021 was $464 million, which is a better indicator of the contribution to the increase in prices (inflation). The increase in total household food expenditure over that period was around $7.5 billion, so supermarket EBIT contributed about six cents in the dollar.

As these calculations suggest, average EBIT margins did increase over those two years: from 5.1% to 5.6%. Thus, whereas in the second half of 2021 shoppers were contributing $5.10 in profit for every $100 spent, in 2023 this had risen to $5.60. The ACCC inquiry will shed light on the reasons for this modest increase.

But whichever way one looks at the arithmetic, there is no prima facie case that supermarket profits have been a major contributor to cost-of-living pressures.

That is not to deny that some products in supermarkets may be exceptionally profitable for the retailers. But if that is the case, then they must be offset by other products with exceptionally skinny margins for the average to be what it is.

It is also not to deny that suppliers to supermarkets may have increased their margins — not farmers, but suppliers with pricing power such as the long list of (mostly despised multinational) manufacturers whose packaged products fill supermarket shelves. If so, it is for them to explain.

Another possibility is that the supermarket industry is so uncompetitive that firms cannot be bothered reducing costs and passing at least some of the benefit on to consumers. However,  this seems unlikely in view of sizeable cost-cutting investments over the years in distribution, inventory management and self-service.

The ferocity of the political campaign against the big two tells us more about politics than about nefarious supermarket pricing. It is a populist romp designed to distract attention from the government’s own policy contributions to inflation.

The previous government was also complicit by excessively stoking aggregate demand for two years. Now in opposition, they are happy to join in the populist campaign — especially the Coalition’s rural and regional wing.

But it is the lot of oppositions to huff and puff. It is for governments to steady the ship and steer debate in a more rational direction; not fan the flames of populism.

It may be that the political circus soon moves on to something else and the supermarkets leave the ring unscathed.

But if the inquiries currently under way lead to a significant tightening of regulation, it will be another blow to the free market economy we all benefit from.

Robert Carling is a Senior Fellow at the Centre for Independent Studies and a former IMF, World Bank and federal and state Treasury economist.

Photo by GOWTHAM AGM