Supermarkets' ‘low-cost’ squeezes out mid-sized farmers

In January 2015, supermarkets were at it again causing a stir with loss leader promotions on products originating from the farm sector. This time they were spruiking Australia’s cheapest sausages at 29 cents each (equivalent of $3.85/kg). The head of trading meat at one of the major supermarkets was reported  (1) as saying:

Aussies love a snag especially over the summer so whether it’s on the barbie in the backyard or something quick and easy for dinner we know our customers will love the great price.

Furthermore, the head of trading meat plugged their business’s consumer catchphrase by saying ‘it’s part of our ongoing commitment to give families great quality food at unbeatably low prices.’

The loss leader marketing strategy for sausages has brought back memories of the $1 per litre milk wars which started in January 2011 and the 85c sliced bread promotion which occurred in September last year. The loss leader marketing strategy generally aims at selling goods at the cheapest price to entice more consumers to the seller’s stores. Ultimately, as the number of consumers enticed to their stores increases the potential for these additional consumers to buy other goods that enjoy higher retail margins also increases.

Although the low-cost concept for the supermarket business may appear healthy from a consumer perspective, it is not necessarily healthy from a farm sector perspective. Some observers may think that low-cost consumer products such as milk would lead to increasing consumption of the low-cost product per capita. However, a limited analysis of retail milk prices (in real terms) and market milk consumption in Australia shows that milk consumption only increased slightly (up 2%) after the loss leader promotion for milk which commenced in early 2011 (see Figure 1).

Figure 1: Retail milk price and milk consumption in Australia.

* Indicative Melbourne based prices for a 2 litre carton. e = estimate

Source:  ABARES, dairy manufacturers and Dairy Australia, and AFI analysis.

It is also difficult to determine whether lower retail prices for milk have been the major driver behind the slight increase in market milk consumption. Dairy Australia have highlighted other factors for the increase in milk consumption such as the relentless expansion of the coffee culture in Australia.

Industry experts have highlighted how low-cost marketing strategies for supermarket products originating from the farm sector can have negative impacts on mid-sized farm businesses. Major supermarkets are increasingly negotiating long-term supply contracts with fixed profit margins to consistently offer low-cost products like milk, bread and sausages to consumers. Industry expert – Dr David McKinna – argues that for farm businesses to meet the market specifications for these type of long-term supply contracts they generally need to have economies of scale (large-sized farms) and a typical corporate business model. (2) According to McKinna, the major supermarkets long-term supply contracts leave small-sized and mid-sized farm businesses with three options.

Firstly, the small- and mid-sized farmers could increase their scale to improve their chances of meeting the market specifications of the major supermarket consistently. However, scaling-up these types of farm businesses usually requires a lot of capital funding and risk management. Considering that most small- and mid-sized farm businesses are family owned and operated, the opportunity to obtain capital funding efficiently and manage risk affordably is generally low.

Secondly, the small- and mid-sized farm businesses could establish a niche marketing strategy and supply a premium product to consumers. However, this option may not be that suitable for mid-sized farmers, as the premium market category is tiny in comparison to the mainstream categories and is much more suited for small-sized farmers that are agile and generally supported by other off-farm income.

Lastly, the small- and mid-sized farmers could continue with business as usual and operate in fear that they will eventually be squeezed out. The major supermarkets, which are increasingly adopting a low-cost marketing strategy, control up to 80% of the supermarket business in some regions. The market power of the major supermarkets leaves these farmers – particularly the mid-sized ones – with no other option but to continually eat into their own profits to keep their businesses alive.  

Footnotes

1. ‘Woolies’ cheap shot at Aussie meat’, Farm Weekly (16/01/2015).

2. ‘The snag in Woolies’ 29c sausage’, Matthew Cawood, Farm Online (23/01/2015).

Back to February 2015 Insights contents page.

Images: Dairy Australia