Economic Analysis of Oligopoly Essay

This has been extended and they are now looking to expand their hold on the Australian market by moving into the liquor industry. Julian Lee (2008) highlights Coles and Woolworths move into the industry, by trying to build on their previous acquisitions of liquor outlets to challenge the major brands for a share of the $6 billion per year Australian beer market. The article reveals that Coles and Woolworths plan to ‘give more space to their own beers and promote the beers in their hotels’. The beer market has so far been resistant and has retained a strong brand loyalty. Coles and Woolworths are competing against each other and relying heavily on price discounting and forming supplier contracts to attain exclusive supply. The article questions whether or not these oligopolies will be as successful as previously in attaining their complete dominance because ‘home or exclusive brands’ are currently only a small component of the market. b Justification of the topic ‘Supermarkets brew up a crate full of profits’ is an article that clearly describes the workings on an oligopolistic market. The fact that the market is governed by two powerful firms that have the ability to influence price shows that the market more closely resembles a duopolistic structure. The beer and liquor industry comprises a differentiated oligopoly of which Woolworths and Coles are the main controllers. Woolworths and Coles control between 78 and 80. per cent of the national grocery market according to two 2008 retail surveys (Lenaghan, 2008), indicating a very high seller concentration ratio, and this figure points out the two giants’ share of the supermarket industry, including their diversification into liquor. It is clear that the competitors hope to extend this duopoly in the beer market where they have been less successful. Coles and Woolworths can be justified as a competitive duopoly as they are interdependent. They rely on each other o judge pricing of products and it has been suggested (Moynihan, 2007) that the two powers collude to maximize their profits. Significant barriers to entry for independent competitors have been created including large start up costs. The sheer size of their companies allows them to influence legislation, the fact that they encompass large economies of scale, and their control of raw materials helps these two firms to retain the staggering market share ‘to an extent unparalleled in other countries. ’(Jones, 2005) 2. Economic Analysis It is quite evident that Coles and Woolworths began their crusade of the Australian liquor industry early. Estimates of the ‘take out sales figure would be somewhat over $9 billion of a total liquor market of about $17 billon’ (Jones, 2005). Over the years the rises in productivity and efficiency have enabled the companies to sell at a discounted price. ‘Woolworths has long been engaged in a project to reduce costs through improvements in supply chain logistics’ (Jones 2005). Coles and Woolworths are well aware that this efficiency leads to increasing returns to scale. They hold economies of scale and scope that their nearest rivals cannot compete with and therefore their long run average costs continue to decline whist their output quantities are more than doubling. The long run average cost curve (1) is produced when economies of scale are many and diseconomies of scale are few. 1. 2. It is very clear that Coles and Woolworths association of groceries and liquor retailing is a classic example of oligopolistic firms attempting to further enhance their market. ‘In the mid 80’s Coles bought the Liquorland group signalling its entry into liquor retailing. Coles bought Vintage Cellars in 1992, the Australian Liquor Group in 2001, and the sizeable Theo’s business in 2003. Woolworths bought Victoria’s Dan Murphy in 1999, Tooheys Bros in Sydney in 2000, the Liberty Liquor group (including Harry’s Liquor) in 2001, the Booze Brothers Chain in South Australia in 2000, the Super Cellar group in South Australia in 2003, Bailey & Bailey in South Australia in 2003, and ALH in late 2004. Woolworths also acquired 18 licenses from the purchase of Franklins’ grocery chain in 2001’. (Jones 2005) This shows the industry power that the duopoly own, although as Lee rites they have found that ‘beer has remained resistant’ to the takeover of private home brand labels. Home brand labels have relied on a discounted price to capture the market’s attention, a strategy that will have little success with beer. The beer industry is already dominated by premium, boutique, imported and Aussie favourite beers t hat the chance of finding a large market share is unlikely. At the moment the in-house brands make up ‘just 2%’ of the beer market, most of which is taken up by Sol, a Woolworths brand. The beer industry is unlike the grocery industry where a discounted price is favourable. The Australian brewing duopoly of Fosters and Lion Nathan both believe that ‘branded beer will win out’ and are not worried that the products being forced into the market by Coles and Woolworths ‘will eat into (their) market share’. Coles and Woolworths envisions that the low priced private label brands will increase their demanded quantity from Q1 to Q2 (2) and this in turn will increase their market share and their profits. In the long run they will also be able to force more small independent brewers and sellers out of business because these retailers do not encompass the specialisation skills or labour to be able to price lower than the oligopolists or even match their prices. Although matching any price reduction for the oligopolist who retains significant economies of scale can be treated with simplicity. This can be shown by a downward movement in the marginal cost curve. (3) The prices for the consumer would decrease and the average total cost for the producer also decreases. The local liquor retailer could more often than not, have no success in moving their marginal cost curve to match that of the oligopolists. These independents’ market share and profitability will in effect reduce dramatically. This can then cause possible reductions in the industry shifting the supply curve to the left. For the consumer this is ultimately a negative scenario as the oligopolists who charge a cheaper price at present, will be able to increase their prices once the other competition has been eliminated (4). (3)(4) The article gives light onto the fact that the two giants’ are ‘creating exclusive contracts for (their) retail outlets’ and this restricts competitors selling their brands. ‘Woolworths already distributes Bitburger, Lowenbrau and Amsterdam Mariner, while Coles sells Hollandia, Cantina Cerveza, Bavaria, Estrella Damm, Harviestoun, La Trappe and Konig Pilsner. It also contracts Boag’s – now owned by Lion Nathan – to make Tasman Bitter, Tasman Gold and Hammer ‘n’ Tongs for the chain’. It is clear that already Coles and Woolworths dominates much of the beer market by owning the outlets and the contracts to sell the beer itself. They anticipate that loyal customers will have to come to their outlet when shopping for their regular branded beer. It is also highlighted that ‘imported premium beer sales have grown by 20%’ from January 2007, a figure which is likely to increase. Coles and Woolworths are furthermore using their oligopolist power to create barriers and retaliate at competitors. In 2002 Fosters had no choice but to decide against branching into the retailer market as Coles had began to reduce the stocking of Fosters’ lines in its outlets (Jones, 2005). It had become clear that Coles and Woolworths were not going to let their market be penetrated by other competitors and that notion of collusion seems to be a regular and probable occurrence. Although oligopolists frequently collude, within the beer industry collusion is not yet possible as they are still trying to dominate the existing market. If the two firms were to succeed in their strategy to dominate the market and collude to set higher prices for the consumer their profit margins would be very high and the industry would resemble that of a pure monopoly (5). . Conclusion The $6 billion Australian beer market has proved to be resilient to attempts by the two giants to capture the industry. Ultimately the oligopolists plan to attempt to take hold of the beer market as they have done with groceries and petrol. In the short run, the economies of scale and the continuous logistics improvements provides the consumer with cheaper prices that the independents may not be able to provid e and consequently when the independents are run out of the market the competition and prices of the industry may increase dramatically. Coles and Woolworths are aiming to ‘target the value shopper, and that’s where private label and control labels are playing. ’ The potential success of this is questioned in the article, as within the beer industry the value shopper makes up a ‘small component of the market’. Only time will tell if Coles and Woolworths can continue to extend their previous successes.