Purchasing power and retail chains in Mexico

16/11/2020

The purchasing power of retail chains could benefit consumers. For one thing, it offsets the market power of big players in the food and beverage industry. Next, retailers get the best prices, the discounts of which they can then pass on to consumers. Ultimately, the individual product standards and the consistent quality and safety-related norms set by retailers result in superior quality goods for consumers.

Purchasing power is the ability of retail chains to obtain from their suppliers more favorable terms than those available to other buyers or that would be expected on competitive terms. This power is determined by the relationship between the ability to buy companies to substitute suppliers, and that of suppliers to substitute buyers.

The purchasing power of retail chains could benefit consumers. First, it counteracts the market power of large food and beverage producers. Second, retailers get better prices, the rebates from which can be passed on to consumers. Finally, product specifications and quality and safety standards set by retailers translate into higher quality products for consumers.

However, the exercise of purchasing power can also have anti-competitive effects and harm consumers. A retailer may condition some of its suppliers not to sell to other retail chains, in order to prevent their entry or force their exit. They may also put pressure on their suppliers to match or improve the price at which they sell to other chains, making it more costly for suppliers to give discounts to potential new buyers and resulting in less competition in the final market.

The exercise of buying power could also lead to a "waterbed effect", where the supplier compensates for discounts to the dominant buyer by increasing the price to competitors of the dominant buyer, a behavior that could result in higher prices on average for the final consumers. Another practice is that the buyer may unilaterally change the terms of the contract, for example by imposing discounts or delays in payments to suppliers, which may eventually affect the financial viability and innovation of the latter.

Damage to the dynamic efficiency of markets can be generated when retail chains impose conditions that are favorable to them, but that reduce suppliers' profits and, in the extreme, reduce their availability of resources to invest and innovate, which could even force out of the market those suppliers that cannot withstand the retail chains' purchasing conditions. The loss of dynamic efficiency caused by the abuse of purchasing power has concerned competition authorities such as those of Germany, Australia, Colombia, Portugal, and the United Kingdom.

Relationship between retailers and their suppliers

The literature shows that the effects of purchasing power are clearly different when it is a buyer with monopoly power that is imposed on small suppliers, than when it is opposed to suppliers who also hold market power (referred to in the economic literature as a bilateral monopoly where both have bargaining power). In the latter case, purchasing power translates into greater welfare for consumers if retail chains shift some of the profits extracted from suppliers to consumers.

The more concentrated an industry is, the more likely it is that larger companies will operate under well-known brands; then, the commercial chains have less power to negotiate lower prices with better-positioned suppliers, since it is more difficult to substitute them. As a result, retailers' marketing margins will be lower.

The empirical exercise conducted in this study shows that, indeed, the marketing margins of major retailers tend to be lower when the food and beverage supply industry is more concentrated.

In contrast, it is not clear that this happens when the food industry is less concentrated, as both high and low margins are recorded. This is an indication that large commercial chains have a certain degree of purchasing power at least with the small suppliers in some industries.

With respect to the commercial practices that some of the large chains carry out and that could affect suppliers, mainly the smaller ones, we find the application of discounts to supplier payments according to the date of payment of their invoices (the sooner the store pays, the greater the discount they impose on the supplier), as well as the application of discounts for the use of their logistics network and for the so-called "portage" -a service that consists of the delivery of goods in a distribution center different from the one in which a store is aligned- if required.

Although these types of discounts are previously agreed upon with suppliers, it could be that unilateral discount practices are carried out. For this study, for example, the Mexican Council of the Consumer Products Industry (ConMéxico) reported two cases of disputes between suppliers and retail chains over unilateral discounts and another case of payment differences. 

Likewise, a specialized consulting firm stated for the study that retail chains often incur in practices such as not paying the established amount or paying outside the agreed period, in addition to applying non-negotiated charges with suppliers or returning merchandise without prior agreement.

The effect of these practices is that they create uncertainty for small suppliers, in addition to transferring to them the risk of not selling the products that the retailer has already purchased. This has a negative impact on suppliers' finances and on their incentives to innovate, in addition to putting their permanence in the market at risk. In sum, these practices imply damage to the dynamic efficiency of markets, which reduces the well-being of consumers in the long term.

Best international practices

To moderate the asymmetry in bargaining power between suppliers and retailers, some countries have adopted generally self-regulatory and voluntary codes of conduct. Some of these codes have characteristics that make them effective, such as the obligation to specify in contracts the minimum elements agreed upon; recognition of situations and conditions under which chains could charge suppliers; inclusion of rules for removing a product from a retailer's shopping list; display on shelves; delivery and receipt in the distribution chain; transfer of intellectual property rights; and inclusion of monetary penalties.

Burch, Lawrence, and Hattersley (2012) state that self-regulatory codes have been insufficient to solve problems related to purchasing power that negatively affect suppliers and that, in contrast, a mandatory approach to contain it has shown better results.

In the United Kingdom, the Grocery Supply Code of Practice (GSCOP) is mandatory for all retailers with annual sales in excess of £1 billion, and the Grocery Code Adjudicator (GCA) is responsible for monitoring and enforcing it. Enforcement was not immediate. The SuperMarket Code of Practice, which preceded the GSCOP from 2002 to 2009, was a self-regulatory scheme, but in the absence of results new rules were introduced specifying participants to comply with the GSCOP and, in 2013, the GCA began operations. This new institutional arrangement has improved the perception of suppliers about self-service stores' compliance with the code.

Agreement of good practices

In Mexico, there is also an agreement to resolve conflicts between suppliers and self-service chains: the "Agreement of Concertation for the Continuous Improvement of Competitive Commercial Practices" (Agreement), which contains as one of its annexes the "Code of Competitive Commercial Practices" (Code).

The Agreement was signed in 2009 (with updates in 2012 and 2014) by the Confederation of Industrial Chambers of the United Mexican States (Concamin), the National Chamber of the Transformation Industry (Canacintra), the National Agricultural Council (CNA) and ConMexico, on behalf of the producers, and the National Association of Self-Service and Department Stores (ANTAD), on behalf of the buyers. The SE, which acts as a technical secretary, the Federal Consumer Protection Agency (Profeco), and the Mexican Institute of Industrial Property (IMPI) also signed.

Adherence to the Agreement is voluntary, but compliance with it is mandatory for those who adhere to it.

The governing body of the Convention is the Permanent Executive Committee (PEC), made up of representatives of both parties, whose function is to update and promote compliance with the Code. The SE supervises and assists the parties in compliance with the Agreement and the Code; it has a voice, but not a vote.

In the event of a dispute, the Agreement obliges its members to use one of the resolution mechanisms provided for therein before resorting to judicial instances. It has instruments for its own evaluation and to validate the compliance with the conditions that must be observed in the transactions between members.

The Code contains 16 commercial practices that must be complied with in the relationship between suppliers and buyers.

In general, the Code is not widely used, mainly because it is not well known by the member companies. The mechanism of mass adhesion through business bodies led to the registration of companies that are unaware that they are part of this instrument. Although the SE provided COFECE with a list of 560 adhering companies and business groups, at least two of the commercial companies on the list with which COFECE had contact for this study are unaware of their affiliation.

Four companies learned of their affiliation up to the time they were asked for this study, and two business groups were unable to indicate which of the companies they represent were affiliated. The agreement has not been promoted among the members of the business bodies. The SE describes specific dissemination actions, although not a systematic mechanism, and the business organizations required for this study did not accredit constant dissemination actions.

The members of the Convention have low levels of compliance with obligations and exercise of rights. On the one hand, the Agreement is used more by larger economic agents such as those affiliated with ConMéxico, who would have the least need to use it, because they are suppliers with bargaining power. On the other hand, Canacintra stated that it does not use the Agreement, although its affiliates are mainly small and medium-sized companies.

In five years of operation of the 2014 update of the Agreement, 45 non-compliances have been resolved, the most recurrent being those related to payments, price changes, and means of pressure. In none of the above cases was any sanction imposed and only in two cases did the agents receive a warning from the SE.

The mechanisms established in the Convention to resolve disputes are not used. ANTAD and Concamin pointed out that they resolved various complaints submitted informally by suppliers or business bodies, without requiring formal submission to the CEP. The SE reports that it has not integrated any case to assist any SME before the same or any other authority.

Moreover, the practices included in the Code are not enforced or are insufficient to cover the nature of business relationships. For example, self-service chains request "contributions" from suppliers when they do not meet their profitability or sales goals, which are "subsequently compensated", although this does not always happen. This practice is not included in the Agreement.

In the same context, a retail marketing consulting firm was required to indicate how well the commercial relationships between modern channel retail chains and their suppliers conform to the practices contemplated in the Code. It pointed out that of the 16 practices contemplated, the following are mainly not complied with:

Price changes (make only the changes agreed between the parties).

Conditional purchases/sales (to condition these operations to buy or sell another good, or to restrict the possibility of negotiating with other agents).

Means of pressure (not to use unilateral practices to resolve differences).

Purchase order (include in this document the price and a minimum period of three days to reject the order).

Promoter of good practices (the designation of a person for this task).

Finally, the tools provided in the Agreement itself have not been used to evaluate and enforce it. Although it establishes a biannual satisfaction survey for members on their perception and effectiveness, the ES only reported the one for 2015. The survey showed that 29% of those surveyed were familiar with dispute resolution mechanisms and 46% had little information about the role of the promoter of good practices.

In order to mitigate the asymmetry in negotiating power between suppliers and supply chains, it is necessary to promote the Agreement, improve the application of the Code and correct some of its omissions. Specifically:

To promote the Agreement among the members of the business organizations, with specific and systematic actions of diffusion by the SE and the business organizations. In particular, to promote the participation of small and medium-sized companies.

The Code should prohibit retail chains from charging their suppliers for waste attributable to the chains, loss of items after delivery, errors in forecasts or consumer complaints, and other situations in which the chains could charge suppliers abusively. Codes in Australia, Spain, Italy, and the United Kingdom, among others, provide for the prohibition of such charges.

The Mexican Code already indicates prohibitions on charging the supplier to cover marketing costs, purchase or delivery suspensions, and promotional fees, when one possibility would be to allow them and regulate the circumstances in which they can be done. However, this Code should indicate more precisely the concepts that retail chains may charge suppliers and include the conditions under which these charges are permissible.

The Australian and UK codes also specify the conditions under which such charges are permissible, for example, whether they are included in the supply agreements or whether the charge will cover the financing of a new advertising campaign. In Spain, it is permitted for the supplier to contribute to the marketing expenses of retail chains, as long as such payment is reasonable in terms of the supplier's profits and the retailer's profits and costs.

Use the dispute resolution mechanisms provided for in the Agreement, establishing means of protection from possible retaliation by the retail chains in the event that suppliers or business bodies formally lodge complaints.

That the SE and Profeco proactively monitor the verification of the conditions of the Agreement. In case of non-compliance, the mechanisms for imposing sanctions provided for in the Agreement should be used.