Questioning the UK Competition Commission Ombudsman Plan

Josh Wright —  12 August 2009

In April 2008, the UK Competition Commission issued its Final Report culminating from its grocery sector inquiry.  Along with supermarket concentration, the concern that emerges out of that Report is that supermarkets will use their power to negotiate sharp deals with suppliers.  For example:

In emails from store buyers seized during its investigation, the Commission found evidence of foul language towards suppliers together with demands for retrospective discounts and payment for stock lost or damaged after delivery.  Business Secretary Peter Mandelson will decide whether to implement the recommendation, which came in the face of steadfast opposition by the Big Four store chains, Tesco, Asda, Sainsbury’s and Morrisons.  The British Retail Consortium, which represents the chains, accused the watchdog of imposing a £5m a year scheme that was likely to lead to higher costs for shoppers.  Groups representing suppliers, including the National Farmers Union, welcomed the recommendations and called for their swift implementation.

The Competition Commission now has a new recommendation to arbitrate disputes in vertical contractual relationships between manufacturers and retailers, presumably over things like product allocation, pricing and shelf space decisions to alleviate fears of the exercise of buyer power in these relationships (again from the Independent):

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A key recommendation was to establish an ombudsman to police relations between the big grocers and suppliers, in an effort to stamp out alleged cases of bullying or the supermarkets allegedly abusing their immense buying power. The commission, which does not have the power to introduce an ombudsman itself, sought the agreement of supermarkets for this. But most have vehemently opposed the idea, arguing it would add red tape and costs, which would be passed on to customers.

Yesterday, the commission bared its teeth and formally recommended to Lord Mandelson’s Department for Business, Innovation and Skills (BIS) that it should establish an ombudsman to arbitrate on disputes between grocers and suppliers, under the terms of the new Groceries Supply Code of Practice (GSCOP). The new code will come into effect on 4 February 2010, replacing the hitherto voluntary code that the big four grocers signed up to. The ombudsman and GSCOP applies to the 10 grocers with annual turnover of more than £1bn: Tesco, Asda, Morrisons, Sainsbury’s, Aldi, Lidl, Waitrose, The Co-operative Group, Iceland and Marks & Spencer.

The Ombudsman seems like quite an odd remedy to me for solving so-called “problems” believed to arise from vertical contractual relationships.  Of course, “problems” arise whenever two sides to a negotiation would like a greater share of the pie.  Sometimes negotiations are fierce.  Sometimes the contractual instruments that arise out of these negotations are complex and involve sharing of rents in exchange for promotional activity, monitoring, and self-enforcement mechanisms.  Monitoring and maintenance of these relationships can be fluid, complex, profitable, and good for consumers.

The Final Report recognizes the benefits that arise from the negotiations between suppliers and retailers such as extraction of discounts that are passed on to consumers (though in my view does not sufficiently appreciate the benefits of that retail exclusivity can have in terms of intensifying competition for distribution — nor the economic benefits of promotion more generally) but articulates a concern that these negotations will result in the passing on of “excessive risks” or “excessive costs” to suppliers.  Why an Ombudsman is well situated to determine what is an excessive allocation of risk or costs to suppliers in this setting, which generates complex distribution arrangements such as slotting contracts and category management arrangements, escapes me.  It seems to be the most likely outcome of this portion of the plan is to raise costs to consumers by encouraging both sides of the negotation to lobby the Ombudsman in favor of their respective positions and affect the terms of trade rather than than engage in the sometimes tough (and yes, sometimes even involving foul language!) negotations with collaborators in the supply chain.