Suppliers at a huge disadvantage when dealing with supermarkets

Big four food retailers control most of the market and determine who is able to enter the product supply chain

For the past two months, the Competition Commission has been investigating the retail grocery industry. The big four supermarkets — Pick n Pay, Shoprite Checkers, Woolworths and Spar — control almost the entire grocery retail market. The investigation focused on the effect of this monopoly on smaller retailers. But there are other casualties too: their small and medium-sized suppliers.

Over the past 15 years, the big four’s total market share of food retail has increased from about 60% to more than 90%. It is unclear whether this monopoly benefits consumers, but one thing is clear: black- and white-owned small suppliers are subjected to egregious contractual terms, which has implications for their survival, for entrants to the sector and for job creation. A survey and in-depth interviews with 26 small and medium-sized suppliers shows that unless suppliers have a strong independent brand, they are simply competing with other suppliers for shelf space and are dispensable. As one put it: “If you take issue with a buyer you get blacklisted [your product will be no longer be stocked], so you need to remain grateful for whatever shelf space you can get. They know it and you know it.”

The National Development Plan estimates that 90% of SA’s semiskilled and unskilled jobs are likely to be created by small and medium-sized enterprises (SMEs).

But a study on SMEs in the fine-food supply sector illustrates the negative implications of the four supermarkets’ monopoly of food retail for SMEs and for job creation.

The study was done for the Research Project on Employment, Inclusive Growth and Income Distribution, an independent national research project initiated and supported by the Treasury and based at the University of Cape Town. The aim of the project is to provide policy makers with empirical evidence to combat unemployment, poverty and inequality.

The suppliers interviewed were black- and white-owned and most had started producing from a kitchen or garage. Their turnover ranged between R800,000 and R30m and most supplied more than one supermarket — 23 supplied Pick n Pay, 21 supplied Spar; 15 supplied Shoprite-Checkers and eight supplied Woolworths. On average, they manufactured 48 product lines and employed 34 unskilled people and five skilled. We found significant positive correlation between turnover and the number of jobs created.

Suppliers noted that Spar’s franchise model was an important entry point to test the market. Store owners can contract directly with their SME suppliers, suppliers can produce just enough for one store and deliver goods directly to it rather than waiting for hours behind the big trucks delivering to Pick n Pay. But Spar has a small market share and business growth necessitates supplying other supermarkets too.

Shoprite Checkers’ market for high-value products has a ceiling and most Woolworths products are “private label” (sold under the Woolworths brand). Supplying Pick n Pay is therefore critical to the growth of emerging small suppliers.

Typically, the supermarket and the supplier agree on a supply price and the supermarket’s mark-up for each product, which determines the selling (or shelf) price. Few suppliers take issue with this process.

However, all four supermarkets also charge their SME suppliers a “rebate commission” — ranging between 6% and 16% of every order, which comprises various fees. A significant part of the commission is known as an “incentive fee”, which suppliers pay supermarkets for the privilege of having their stock on the shelf.

On average, Pick n Pay’s incentive fee is 5.8% of each order, which does not create any right for the products to remain on the shelf until sold or until their sell-by date. As one distributor said: “If a product is not performing in certain stores, Pick n Pay can delist you in all stores. One of the most frustrating aspects is that they delist products without informing you. The next time you visit the store, there are items that you have to take back, otherwise they will not place any more orders with you. If it were still on the shelf you could save the products for reselling, but in most cases it is just removed and dumped into return bins with broken items. It is normally such a mess that you cannot save anything and it is your loss.”

Pick n Pay’s rebate commission also includes a 2% “advertising” fee, although there is no obligation by the supermarket to advertise the supplier’s product (advertising in its broadsheets is an additional charge); a “settlement fee”, to ensure payment within 30 days; and a “swell allowance”, charged for the supermarket to carry the risk of over-ordering stock and damage to stock after delivery, even if caused by its own employees.

Different suppliers are charged different percentages, with no discernable pattern. For example, some suppliers did not pay any rebate commission yet were paid within seven days. Other suppliers paid a 10% rebate commission and were paid within 30 days. Most suppliers were unaware that they had been contracted on different terms from their competitors.

Pick n Pay’s terms of trade also include an obligation to contribute to stores’ refurbishment and the acquisition of new stores. Suppliers reported that they made contributions to stores that did not stock their products. There is a stipulation that promotion costs are borne by the supplier. A penalty is triggered if a supplier fails to deliver a certain percentage, usually 95%, of orders over a year — even when nondelivery is caused by a distribution centre’s faulty refrigeration facilities or because the products are not in season.

Suppliers reported they could not contest their contract terms because they would be blacklisted and their products delisted.

Similar procurement practices by UK supermarkets have been investigated by the UK Competition Commission, which argued: “The transfer or excessive risks or unexpected costs by grocery retailers to their suppliers is likely to lessen suppliers’ incentives to invest in new capacity, products and production processes. If unchecked, these practices would ultimately have a detrimental effect on consumers.”

The South African study illustrates that supermarkets’ supply chain practices (with the exception of Spar franchises) transfer “excessive risk” to its SME suppliers.

The greatest risk for Pick n Pay’s suppliers is that each new order constitutes a new contract and there is a constant threat of being delisted. Suppliers said these practices discouraged them from employing additional people.

Despite comprehensive government food and safety standards, Woolworths, Pick n Pay and Shoprite Checkers demand compliance with their own stringent production and hygiene standards, arguing this is necessary for consumer protection.

Requirements include an air-locked bathroom, a basin with handles that can be manipulated with an elbow and specifications for windows and tiles. The cost of fulfilling the specifications and of annual audits is considerable. For its private label suppliers, Woolworths carries the audit costs.

Catherine Dolan and John Humphrey write in the Journal of Development Studies that standards are often a manifestation of relative power. For example, UK supermarkets demand compliance from African suppliers but not from their Spanish counterparts, undermining the justification that the standards protect consumers. Similarly, Spar’s products comply with public standards but compliance with private standards is not enforced.

Through these procurement practices and private standards, supermarkets are effectively determining who enters the food supply chains and who is excluded, and the terms of their participation. Their procurement practices have profound public policy implications — for the viability and growth of SMEs in the food industry and for their potential to create jobs.

Policy interventions are needed. The state should regulate the contracts between supermarkets and small suppliers as it does other relationships marked by unequal power relations — for example, contracts between retailers and consumers, employers and employees, and franchisers and franchisees.

The government must regulate how private standards may be enforced, including provision for gradual compliance, and ensure that uncompetitive practices are eliminated. The practice of rebate commissions has to be scrutinised by the Competition Commission. And SME suppliers should enjoy representation, as supermarkets do, on the South African Bureau of Standards, the retail committee of the National Empowerment Fund and the National Economic Development and Labour Council, which make policy decisions.