In mysterious (super) markets we should trust to serve our economic interest – not regulators of prices
A typical supermarket carries many thousands of separate items on its shelves. It may also offer a variety of other services at its tills or counters, including payment or transaction services. The operating profit margins on these different items or services will vary greatly and may even vary from day to day as buyers take advantage of opportunities to buy low and sell high. Their suppliers may also offer discounts for prompt payment or bulk orders or their payment terms may be extended to help add profit margins.
The shopper couldn’t possibly hope to know such details nor should they care to know. All they might be aware of is the price of some KVI (known value item), for example a jar of coffee or a box of tea. And the supermarket will try and make sure that the KVIs are priced competitively. If the tomatoes are a profitable line at the vegetable counter they may well help cross subsidise the cooking oil, but nobody other than the shop managers needs to be well aware of this.
What will matter to the shopper, a matter of which the shopkeeper will be well aware, is not the price of any one item on the menu, but of the cost of a trolley load of groceries and the cost in time and transport of collecting it. Shareholders and managers care whether the selling price of the average shopping trolley or basket will more than cover the average costs of delivering the trolley load – rents and employment costs included. Most important is that these prices on average are high enough to provide a satisfactory return on the capital invested in the chain of shops and distribution centres and trucks needed to keep the shelves well stocked and so the customers coming through the doors. Margins may go down and true profits go up, to the ultimate advantage to both customers and shareholders.
If the realised return on capital is above risk adjusted returns, shoppers and non-shoppers can be assured that the essential service of supplying and delivering goods and services to households will continue to be provided at prices they prove willing to pay for. Indeed, the more profitable the enterprise, the more likely the retail offering will be extended to more locations, with fuller stocked shelves in ever greater variety.
Consumers generally can be assured that the cure for high or “exploitative” prices and margins is high prices themselves. High prices that lead to above normal or required returns on capital encourage more supply, that in due course will reduce prices. In other words, consumers can rely on market forces to supply goods and services and to restrain pricing power.
The owners of profitable firms are well incentivised to expand their offerings. Unprofitable firms who are unable to charge enough (sometimes inconveniently for their loyal customers) will go out of business. Perhaps as consumers we should worry more about unsustainably low prices than unsustainably high prices. High prices bring more goods with greater variety; low prices will mean reduced supplies and less variety and quality.
In the presumed absence of competition, we rely on regulators to determine prices on a cost plus basis; hopefully not too high a return that might mean very high prices not vulnerable to competitive forces. There is a danger that regulation of some prices in an essentially bundled offering may fail to recognize the overarching role played in the economy by return on capital and the important tendency for excess returns to be competed away.
The threats to SA consumers of additional regulation that come to mind are the potential assaults on the menu of charges made by furniture retailers who supply furniture bundled with credit, delivery costs and perhaps personal insurance. Or on the suppliers of chickens bundled with brine, the proportion of which is regulated. Or the services of cell phone companies, who among the services they provide, include connections to other cell phone companies, that are now subject to a lower regulated charge.
The itemised insurance or delivery charges levied by a furniture retailer may look exorbitantly high, seemingly well above observable costs. A regulator may then demand lower charges for them. But such lower charges may well mean a higher price for the separately itemised furniture item. The insurance charges may well have cross subsidised the price of the furniture item. Then lower charges for insurance will mean higher explicit prices for the furniture itself, if the cost of capital is to be recovered. Similarly, by reducing the cell phone interconnection charge – the cost of a bundled pre paid contract – perhaps the subsidized cell phone itself may well will go up. And if it costs less to bulk up a chicken with brine than with mealie meal, the price of chicken will surely reflect this as the chicken producers compete with each other to make extra sales.
Provided furniture retailers, cell phone companies or chicken producers compete with each other, we need not concern ourselves with the charges of the individual items, than we need to concern ourselves with the gross profit margins of all the separate items provided by a supermarket. We can rely on competition rather than regulation to constrain prices and to secure essential supplies.
An easy to recognise feature of regulated markets is insufficient supply and non-price rationing – that is long queues for service or forced sacrifices of quality and variety. Think of the waiting lists for “free housing” or medical services at public hospitals in SA or of power load shedding due to the lack of regulated generating capacity.
The essential problem is that it is hard to understand and appreciate the hidden hand of market forces. It seems easier to think that prices are some simple mark up on costs. The problem is compounded in that students of economics are more easily and taught how markets fail than how they work in what appears to be mysterious ways. History tells us that governments (that is government officials) are much more easily prone to failure to supply essential goods and services than market forces driven by profit seeking companies.
The price regulator is bound to be some university-trained economist. The successful entrepreneur does not need to understand theoretical economics at all – only how to buy low and sell high and the more they succeed the better off we will all be. More important than price competition will be innovation, new products / services or improved methods of production that are introduced to the economy by enterprising companies and risk loving individuals. These companies and individuals will have high prospective margins very much in mind but in turn will be subject to emulation and margin pressure. Regulation can only serve to stifle, not promote, innovation.
Thank you for this informative article. I enjoyed it because it give me some information on how to purchase and sell if I open my own trading company one day and it also helps me to understand super market/markets way of thinking qua prices.
This article helped me to understand a bit more about competition and regulation.The example of tomatoes cross subsidising the cooking oil explain something about how prices are calculated. I understand that competition keeps prices low more than regulation.
What i found most interesting about the article is how price regulation does not necessarily lead to growth and sometimes serves the markets more than the consumer and this may be counter productive based on what the regulations are meant to achieve.
this is such an insightful article, it cleared a lot of things that I had in question and also made me aware of some aspects of the market that I as a consumer did not find interesting enough to be aware of. The articles explanation of competition and regulations and how they operate proved to be very useful as I was not familiar with some of the information mentioned. It made me realise how we as consumers are part of the market but do not really understand how it works but instead are concerned about finding goods and services of good quality at prices that are accommodated by our various incomes.