Examination of Witnesses (Questions 440-459)
31 MARCH 2004
MS PENNY
BOYS, MR
ALAN WILLIAMS,
MR BOB
GADDES AND
MR COLIN
FARTHING
Q440 Mr Breed: We accepted earlier on
there has been a significant shift in the market for liquid milk,
in particular from the doorstep deliveries, to the supermarkets
through one stop shopping and such. Is there any evidence which
you can point to where you think the major supermarkets may be
using that increased market share, which they have actually got
over quite a relatively short period of time, to improve their
margins on liquid milk by applying pressure to their suppliers
in order to decrease the prices they are paying for milk?
Ms Boys: I do not think we have
got any evidence that that is so. I do not know if there was anything
which came out of your more recent examination of milk or supermarkets.
Mr Farthing: One of the things
the people who carried out the inquiry into Arla and Express looked
at was the relationship between the cost of the milk when it left
the processors, Arla and Express, and the evidence they received
from the two companies, both for Express and for Arla UK (the
operation in this country), was that the average selling price
of fresh milk to the national multiples (the supermarkets) has
been fairly stable over the last five years. Also, for each of
them the difference between the average selling price of milk
to the national multiples and the average variable cost incurred
in producing this milk has also been quite stable. So there is
no evidence of much of a change. Although this is based very much
on what they were told by the two companies, the summary they
reached is that although it is difficult to form firm conclusions
from reported profit levels we note that there does not appear
to be any evidence to suggest that processors earned excessive
profits from fresh processed milk which they supplied to the national
multiples.
Q441 Mr Breed: Through evidence we have
received so far we have been able to identify reasonably accurately
the margins which have been available to the producers and to
the processors. It is somewhat more difficult in terms of the
retailers. Do you think that the retailers in a sense ought to
be more transparent in respect of the figures they can supply
for the margins they are getting?
Mr Farthing: Well, as I said,
the last time we looked at that these figures were relating to
1997 to 1999 and during that period we saw a certain amount of
an improvement in margins and the explanation we were given was
that there had been more competition either in the early part
of that period or—
Q442 Mr Breed: When you say "improvement
in margins" do you mean margins of the supermarkets were
increasing?
Mr Farthing: The supermarkets
were increasing their margins, yes.
Q443 Mr Breed: So they were increasing
their margins in 1999?
Mr Farthing: In the period between
1997 and 1999, yes.
Q444 Mr Breed: So do you think that then,
and perhaps even more so now, the supermarkets were using liquid
milk as a so-called loss leader or as a known value item (as I
think they like to call it)?
Mr Farthing: As I say, we do not
have any evidence of what has happened since then so I cannot
comment on that. In terms of a known value item, I think the answer
is yes. During the supermarkets inquiry this was one of the issues
they looked at and although there is no official, agreed definition
of what a known value item is, almost all of the supermarkets
would put milk in that category. So I think the answer is, yes.
Q445 Mr Breed: Remarkably enough they
are all virtually the same?
Mr Farthing: Yes. Well, it varies
over time, I think. There are periods when they are very similar
and there are periods when one will open up a gap one way or the
other and then it will close again. So it is a dynamic market.
Q446 Mr Breed: Just on the code, when
the Competition Commission finished its rather lengthy report,
rather expensive report as well, the end bit came to not particularly
substantive conclusions and the only basic recommendation was
the introduction of the voluntary code, which many of us thought
was a total and utter waste of time. Here we are two years later
and you are carrying out your own review into that, the initial
findings of which seem to endorse more of what we thought two
years ago than perhaps what you thought two years ago. Would you
like to comment upon the initial findings?
Mr Farthing: The only comment
I will make is that it is not a voluntary code, it is a statutory
one. But the person who has been looking at it is Penny rather
than me.
Ms Boys: We did the review of
the supermarket code.
Q447 Mr Breed: It is not a statutory
code?
Ms Boys: Yes, because it derives
from the Competition Commission's findings so it has the force
of law.
Q448 Mr Breed: That is quite interesting
because we were asking the people who came before us about whether
they felt it ought to be statutory or not and they said, "Yes.
It isn't at the moment but we wouldn't mind it being statutory."
So the British Retail Consortium, who were here on behalf of all
of the supermarkets, were certainly not under the impression that
it was statutory.
Ms Boys: Well, that is a misunderstanding
on their part. It is not statutory in that there is not a Supermarkets
Code Act but it derives from findings made by the Competition
Commission, which have been put into effect through an order.
Q449 Mr Breed: But for supermarkets it
was voluntary as to whether they participated or not?
Ms Boys: No, it is mandatory for
those supermarkets who were the subject of the adverse findings
in the Competition Commission's report, which was the big four
at the time.
Q450 Mr Breed: So the voluntary aspect
was more to do with the supply?
Ms Boys: No, the voluntary aspect,
I interpret that view (and I have heard it said) as all the supermarkets,
not just the big four (Waitrose, the co-ops and so on) should
be covered by that code and not just those against whom the Competition
Commission reached their adverse finding.
Q451 Mr Breed: So how effective do you
consider the code is in regulating the actions of the supermarkets
and in terms of the imbalance of power in the whole dairy supply
chain? Do you think it is now better or worse since the introduction
of the code?
Ms Boys: It is an open question.
We have had the review. We did it after a year, as asked. If something
has been operating for a year you generally expect to have some
hard evidence. You expect to say, "My God, X, Y and Z breached
the code. Look at this." There is an arbitration mechanism
to resolve disputes. You expect to see that mechanism used. Now,
we conducted the widest possible consultation on how people had
experienced the code in operation. We talked to individuals, we
encouraged them to let us know, we talked to trade associations,
we talked to farming bodies and no one came forward with any evidence
that we could take up and pursue in an enforcement sense to show
it was not working. I suppose we could have just signed off and
said, "Well, it must be fine," but of course we knew
there was very great unhappiness amongst suppliers and people
were saying, "Well, you know, the code is there but we don't
like to complain. We're frightened. Can we please make anonymous
complaints?" Obviously we have got the anonymous complaints.
They will be guiding what we decide to do next because it was
a dilemma. We could have said, "Well, the code is working
okay," or we could have said, "Well, everybody's unhappy
so it's quite clear the code hasn't worked. Let's scrap it and
start all over again," or do as we decided, which was to
commission a compliance audit where a firm to be appointed by
us will go in and examine a sample of transactions and look at
the paper chain for those transactions, explore with the parties
involved whether the code was complied with in reality or not.
We have been able to use the anonymous complaints as a sort of
rough guide of the areas to look at in the compliance audit because
obviously you cannot look at absolutely everything.
Q452 Mr Jack: How many former supermarket
buyers have you got on your staff?
Ms Boys: What a good idea. To
my knowledge we have got a very talented and diverse staff but
I do not think we have got any supermarket buyers.
Q453 Mr Jack: When you look into this
area who do you get your information from? What level of management
in Sainsbury's or Tesco supplies the answers to the questions
you ask about how this area operates?
Ms Boys: Well, we have gone first
to the suppliers and to their trade association bodies to say,
"This code was put in for your benefit. How has it operated?"
Then when we asked the supermarkets, yes, I guess it is their
procurement side which has furnished the replies -
Q454 Mr Jack: I do not want you to guess,
I want you to tell me who, at what management level—I do
not necessarily want names and addresses but at what level do
you actually get this information about what really goes on?
Ms Boys: I will have to provide
you with a note of the specifics on that.
Q455 Mr Jack: I say that as somebody
who a very long time ago was both a supplier to supermarkets and
also in charge of procurement. I have seen both sides on this.
But when I look at the prices and payments section in this I think
that whoever drew this up it is like dealing with the horse after
it has bolted because everything talks about what you must not
do once prices have been agreed. But coming back to this inquiry,
the absolutely essential issue is the process by which the price
is agreed.
Ms Boys: Ah! Well, in that case
you are quite right, the code applies to trading practices; it
does not apply to price setting. We could not make up a code which
did that because there was not an adverse finding—
Mr Jack: But if you want to understand,
as I am sure you do, the interplay of the forces of supply and
demand and relative strengths then you really ought to sit in
on what goes on when prices are negotiated because to be quite
frank, as somebody who used to do this for a living—I will
not insult you by saying it is a joke but the key thing is how
you actually set the price, what is the interplay, how are the
forces of big versus small in the supply chain actually exercised.
One of the points which I understand the Competition Commission
found in their report on the various bits for Safeway, and I will
quote the information that we have in our notes on this, "that
there remained a fundamental imbalance of negotiating strength
between supermarkets and most of their suppliers and that the
balance of responses to its surveys indicated that suppliers'
negotiating strength across all sectors had weakened since the
2000 [Competition Commission's] monopoly report. In its surveys
of suppliers 79% to 94% reported that the code had not changed
their dealings with the supermarkets and 6% to 15% said matters
had worsened." I would put it to you that that reflects the
point at which the commercial decisions are made and what does
not seem to be weighed in terms of either the way the code of
practice operates or your view of competition is the operation
of this collective buying power of the supermarkets. I can assure
you that if you are at the end of the telephone and you are speaking
to Mr Tesco or Mr Sainsbury, (a) you will be deeply respectful,
(b) you will be very mindful in a perishable commodity that you
do not have an awful lot of bargaining power but the big buyer
has an awful lot of clout if he decides to de-list you or decides
that this week he is not going to buy from you. You are very respectful
and it is hardly surprising people do not complain too loudly
when the entire survival of their business can depend on that
weekly telephone call which determines the prices that are going
to be paid. As Mr Breed indicated, all of this is conducted in
a less than transparent set of arrangements and the impression
we have gained from talking both to individual farmers and their
representatives, and indeed the trade associations, is that the
idea that this collective group of suppliers has any leverage
on the supermarkets is for the birds. Yet I do not hear that being
reflected in the way you are looking at the situation. Do you
not think you ought to, if you like, get real and get to understand
how this process works so that when you adjudicate on this it
can be from the position of talking to people with knowledge who
actually do it, as opposed to the purveyors of information from
supermarkets who will give you whatever view they want to give
you?
Q456 Chairman: To summarise Mr Jack,
what he is saying is that you effectively set the Queensbury rules
and you are dealing with people who are bare-knuckle prize-fighters
out there and it is not being reflected.
Ms Boys: It would certainly be
common ground, as we have said at various points this afternoon,
the supermarkets have market power. I would not deny that at all.
I think the set of issues of what process, if any, we can put
in place, we can only in the code go back to the Competition Commission's
report and its findings and the code was put in place very specifically
to address those findings. I take your point. I take away from
today in our compliance audit we must ensure that on the supermarkets
side we are getting a realistic picture of what is happening but
I think for us to imagine that the code would govern effectively
a negotiating process between people with market power and people
without market power in thousands, if not millions of pricing
transactions, I doubt whether any regulation could be effective.
Q457 Mr Jack: No, and I would concur
with that. But the point is if you have got better equivalents
between the strength of the supply side and the strength of the
buying side, if they are much more on a point of parity then you
can have a proper interplay of competitive forces. We have talked
about vertical integration and we have talked about potential
increase and if I look, for example, at the structure of the co-ops,
First Milk 2.5 billion litres, Dairy Farmers of Great Britain
2 billion litres, Milk Link 1.4 billion litres. That is just about
6 billion litres, roughly speaking half of the UK milk market.
Now, hypothetically if they decided to join forces we are talking
about a group who are controlling half of the liquid market in
the United Kingdom and when you look at the power of the supermarkets
they are buyers of effectively more than that by definition. Supermarkets
respect strength, not necessarily weakness. Weakness can be taken
advantage of. I do not get the sense that in terms of what the
dairy industry may do to strengthen its position the power of
the buyer is weighed with sufficient weight in your deliberations
in determining what this sector may or may not do to strengthen
its position in negotiation with the supermarkets. Maybe I am
wrong and I look to you to put me right.
Ms Boys: Well, I can only point
you again to the clearance decision we made on the First Milk
and three co-operatives acquisition of Westbury where indeed the
existence of buyer power at the retail level was one of the factors
we took into account which led us to the conclusion that there
were no competition problems there. There is another point I think
I should make too for clarity and that is that actually of course
when the supermarkets are purchasing milk they are not purchasing
from the 25,000 dairy producers, 98% of their milk is purchased
from three dairy producers.
Q458 Mr Breed: On all the other sectors
you look at there are similar situations where relatively small
suppliers actually supply to very large plc international companies,
whether it is aerospace or car, whatever it is. The thing which
actually stops the abuse very often is what is called a contract.
Did it ever occur to you that in this particular area of course
the understanding of a contract does not exist. Virtually nobody
has a contract with the supermarkets. It is done in an informal
sense and therefore has all the weaknesses and everything else.
That must have actually struck you as being somewhat strange that
we have in all the other industries, all the other things that
we investigate, all the other sectors and such the piece of paper
which regulates and assists in the balance of the relationship
is an enforceable legal contract which the supermarkets steadfastly
refuse to enter into. In that sense before you even start to look
at it the bells would ring, with respect?
Ms Boys: It is a question I would
ask the dairy companies first before the supermarkets.
Mr Breed: But that is only a response
to the major side. I think once someone has got away with it everyone
is going to because if you do not actually have to operate in
a contractual relationship then obviously it is going to be very
beneficial for those who are the more dominant. Whether they abuse
that dominance, which is the bit I accept you have to prove—it
cannot be a guess, it cannot be a feeling, it cannot be a perception,
it has to be evidential—but many of us would say that if
we looked hard enough and searched long enough there ought to
be clear evidence of the abuse of dominance in the sector.
Q459 Chairman: Could I just pick up one
point because where we come into this, and I accept this is not
at the start of the story, but in the way, inadequate as it was,
that Milk Marque set the price—not the total price but in
a sense the minimum price—there was a mechanism there. There
was a mechanism whereby buyers and suppliers pitched in on the
basis of what they thought was a realistic expectation on both
sides and eventually some market equilibrium arose. When effectively
you bust that up you have now got lots more suppliers incapable
of accessing the market in any organised way because even though
they work through co-ops those co-ops, from all the evidence we
have seen, are very weak. So in a sense by trying to push towards
this goal of competition in a sense we have ended up in a much
more dysfunctional, much more disorganised and much more unfair
market. How would you respond? I think both of you need to respond
because you were both involved implicitly or explicitly with the
demise of Milk Marque. How would you respond to that?
Mr Farthing: Well, the decision
we took, as I explained, about Milk Marque was really on the basis
of two elements. One was that the share it had in the market was
very large, as I say almost 50%, and the other was that it was
conducting practices which abused that share. So it had both a
very strong market position and it was abusing that position.
The decision that we took was that no remedy which left Milk Marque
untouched would actually deal with those concerns and therefore
the only way in which the competitive problems that we identified
at the time could be addressed was by splitting up Milk Marque
into smaller entities. As I said earlier on, we were very relaxed
about whether those smaller entities were vertically integrated
or not. That was not the issue. The issue was Milk Marque's size
and the anti-competitive practices it was engaging in. So what
we have moved to is a range now of successor bodies who do not
have that size individually and who do not engage in those anti-competitive
practices.
| 
