A hive of rent-seeking and villainy

I spent too much of the past couple weeks listening in to the Commerce Commission hearings on grocery retail. Ok, it was only a couple days of it. But even that was too much. 

Tex Edwards was pushing the Commission to force the two supermarket chains to sell a pile of stores, while wanting a host of restrictions on who could buy them. Foreigners shouldn't be able to buy them, anyone who does would have to have some commitment to healthy food provision and some kind of climate change commitment (supermarkets' emissions are in the ETS but whatever) and some commitment to serving regional New Zealand. It was hard to get a precise read on what he was after with all the restrictions. But narrow the field enough and Tex might be the only person allowed to buy the supermarkets that the Commerce Commission would force the current players to sell. I wonder whether that's a coincidence.

Tex got an awful lot of the Commission's time. The Commission seemed very keen on drawing out these kinds of suggestions. 

In the other corner was Sarah Balle, from online supermarket Supie. She repeatedly suggested that the government provide some giant capital support for her company. If only Supie had some $160 million (I can't remember the number but it was something like this. Maybe it was $120m. Maybe it was $180m. I can't remember. It was an offensively large amount.) dollars from some new KiwiEquity scheme, Supie could scale up to provide real competition. 

But despite supermarkets being alleged to be a giant profit-making duopoly, some capital market failure means nobody with their own money on the line would give Supie $160 million to hoover up those excess returns. You might think that when global markets are awash in capital seeking positive returns, the only real problem here would be overseas investment restrictions that make life tough if you have more than 25% foreign ownership. But Supie suggested foreign entry and foreign money should be banned because foreign retailers keep costs down by bringing in low-quality product. I'd not heard that critique of Aldi before. I bet that the incumbents said the same thing about the need to maintain a ban on parallel imports to keep options like The Warehouse from emerging. 

Supie also got an awful lot of the Commission's time. The Commission seemed very interested in hearing how excellent it would be to have government making giant investments in an online grocer. 

Kate MacNamara sums things up:

On the Commission's recommendation, the Government could ultimately provide financial backing to a new (or small) competitor in the sector, likely through a contestable process.

It could invest in a joint venture partner with a view to selling its stake once the partner was established. Or it could retain that mixed ownership model over the long term.

All three options were delineated in the Commission's draft report on the state of competition in the grocery sector published in July. Its preliminary findings were that competition in grocery retailing is weak, prices to consumers are inordinately high, and supermarket profits are uncommonly fat (the supermarkets contest this).

But just one party has used the conference - running over the last several weeks - to plump for Government investment in the sector by way of remedy.

Sarah Balle, founder of Supie, a new online supermarket, has repeatedly suggested her business, which she says is limited by access to capital and the power of the supermarket incumbents, could better grow and compete with the help of Government funds.

In contrast, Tex (Simon) Edwards, representing both the recently incorporated company, Northelia, and the lobbying entity, Monopoly Watch, has pushed for the forced divestment of existing retail stores, the sale or separation of which could help constitute a third major player.

Edwards has said he already has significant capital backing (should mandated store divestment take place) and he was uncharacteristically silent on Tuesday on the question of how the Government might improve competition by actively entering the market itself.

...

The last word in the forum didn't go to New Zealand Initiative chief economist Eric Crampton but his puckish suggestion was among the most memorable.

In considering ways to facilitate new competitors' entry in the grocery market, Crampton said, the Government could simply resolve to dismantle the barriers to entry of its own making.

The Commission, he suggested, could then write to international grocers with the following invitation: "Hello international grocer, New Zealand might not have featured in any plans you might have had for international expansion. Small markets at the far end of the world beset by regulatory impossibilities that make it hard for new entrants to set up shop are not the most enticing proposition. We at the Commerce Commission are writing you today to ask you to reconsider New Zealand or that you think about us for the first time…"

The letter would promise waving the cumbersome Overseas Investment Office approval process for foreigners buying land purchases for grocery stores, and easing council zoning and consenting rules to allow for the speedy building of stores.

Because I thought it was fun, and because it's the only thing that addresses the real problem and isn't a bunch of evil rent-seeking, I wrote up the letter that I think the Commission should send. Make a list of the big international players and even niche ones. Aldi. Lidl. Kroger. Sobeys. Loblaw. Trader Joe's. Whole Foods. 

Then send them this letter, after making sure that everything in it is true. This isn't hyperbole. This is what I actually want the Commerce Commission to do. This is a market study. It has broad remit. It can get to the source of the lack of competition and address it. It could tell the relevant parts of government what needs to be done to enable entry if government is serious about wanting more competition in grocery retail and lower prices. And then it could send this letter, after making the necessary changes. 

“Hello international grocer,

New Zealand may not have featured in any plans you may have had for international expansion. Small markets at the far end of the world beset by regulatory impossibilities that make it hard for new entrants to set up shop are not the most enticing proposition. 

We at the NZ Commerce Commission are writing you today to ask that you reconsider New Zealand, or to think about us for the first time.

Our market study into grocery retail concluded that a new entrant would be in the national interest. Consequently, the Government has instructed the Overseas Investment Office that no application for OIO approval is necessary for overseas persons purchasing land for grocery stores. This waiver is broad. If a new-entrant grocer proposes an apartment or commercial tower above their new supermarket, that is also allowed.

We have also instructed councils that they must issue zoning variations and consents for new grocers, and that grocers have recourse to the Commerce Commission if zoning or consenting processes are hindering the establishment of a new entrant in grocery retail.

New Zealand is open for business. For too long, regulatory impediments stood in the way of new entry. Those impediments are now gone. Please consider New Zealand in any plans for future expansion.”

The whole thing is depressing. There is a potentially very real and substantial problem here. Government has made it very difficult for a new international entrant to enter. 

A set of hearings on this, in a market study framework with wide remit, would have run very differently if the Commerce Commission cared about competition rather than about protecting Supie, or Tex, or just about punishing the existing grocers. 

The hearings might have heard from planning officers from Auckland, Wellington, Christchurch and others to point out on their maps where any new grocery entrant would be allowed by zoning to set up shop. It would have asked pointed questions about whether Council would actually allow grocers to set up shop in those spaces, or whether Council would pull its more usual kind of tricks: "Yes, it's zoned for grocery. But grocery uses a lot of water. And the wastewater pipes here would need to be upgraded to handle it. Ok, it's really decades of deferred maintenance and the things have to be replaced anyway, but we're going to pretend it's an upgrade so we can make you pay for it instead. Still interested?" 

It could have asked council planners whether competition ever enters into their considerations when setting plans, and if not why not, and whether reform of legislation to bring council planning into the criminal cartels regime would be appropriate. Like, if they're going to ask the head of each supermarket "Hey, if we were to order you to sell half your stores, even if they're actually owner-operator setups, how should we go about making that order?", they could at least ask Council Planners how best to apply criminal cartel provisions to council planning decisions. Could have heard from the folks doing up the new NBA on regional planning to ask them how they're planning to embed competition into regional plans. 

It could have heard from people from the Overseas Investment Office to ask them about barriers to grocery entry. And it wouldn't put up with their usual dissembling about high approval rates that ignores applications deterred by their processes. Has Aldi ever gotten in touch with them asking about coming here? Has anybody else? What would they do with an application from a grocer that had them buying some land currently zoned residential to package together into a new retail site? There's a ban on foreigners buying residential land. What about land that's adjacent to a reserve or stream? Lots of stuff can make land sensitive. 

The most glaring omission from the hearings? Potential international entrants. I understand that Aldi gave the place a serious look six years ago or thereabouts. What happened? Why didn't they enter? What barriers did they see as material? Do they still see those as material? Did the Commission even bother to ask the Aldis, the Lidls, or anyone like that about why they aren't here? 

Fix the underlying problem, then see what happens. If nobody enters, is it really likely that there are $20 bills all over the sidewalks here in grocery retail? Or is it more likely that we're just a small market at the far end of the world that is actually expensive to supply and there aren't really supernormal profits to be had? Let's find out!

Addendum: This is the list of questions that ComCom sent out on Friday afternoon signaling what they wanted to get into on Monday morning. I do not envy anybody who had to deal with this mess over that weekend. Think about the set of impossibilities that government has set in front of any potential entrant, then look at this set of questions. It's all about busting up existing supermarkets. I interjected briefly on entry facilitation to remind that real entry facilitation isn't subsidising Supie or destroying an existing supermarket to give to Tex. It instead should be about getting rid of legislated and regulated barriers to entry. 

This whole thing is destined to fail in exactly the same way that KiwiBuild failed. And ComCom just doesn't want to see it. They've got this fancy new market study provision, and they risk wasting it. 

Session 9:  Divestment and sponsorship of entry

A. Operational and structural separation

Topic 1:  Is Operational and Structural Separation appropriate?

• When should more significant interventions like operational or structural separation be considered?

• Would operational separation be technically possible?

• What would the costs of separation be?

• If structural separation occurred, could the business be run on an arms-length basis, without requiring divestment? For example, it could have the same shareholders but separate boards and management incentives aligned with the narrow interests of the separated entities.

• Would an independent wholesaler or wholesalers have market power that might require further regulatory intervention? 

B. Divestment

Topic 2:  What general principles should be applied when considering divestments

• In what circumstances might it be appropriate for the Commission to recommend a divestment remedy in the context of a market study?  What, if any, preconditions or criteria should be satisfied before the Commission recommends a divestment remedy?

• What criteria or framework should the Commission use in framing a recommended  divestment remedy in the context of a market study?  For example, is the framework for divestments set out in the Commission’s Merger Guidelines (Attachment F) suitable in this context?

• What are the potential negative consequences of government intervention of this type? What can be done to minimise any adverse impact on investment incentives or reputational risk for New Zealand?

Topic 3:  In what circumstances might a retail divestment be effective?

• What is the minimum efficient scale required or minimum number of stores which would need to be divested to create a viable and effective competitor to the major grocery retailers?

• What should be the process or criteria for selection of stores to be divested?

• What other assets would need to be divested or other arrangements put in place (possibly on a transitional basis) to ensure the acquiring entity would be viable and would operate as an effective competitive constraint on the major grocery retailers?

• How should a divestment process be conducted?

• Would a contestable sale process ensure a fair return to the divesting party or parties for the assets divested?  Or might some additional minimum price requirement or compensation mechanism be required to ensure the divesting party or parties are appropriately compensated for the divested assets?

• What are the likely potential challenges which would need to be overcome in implementing a retail divestment?

• What are the potential risks or unintended consequences associated with such a divestment?

Topic 4:  What would be required for the effective divestment of a wholesale business?

• If it were thought that adequate competition in the sector could be generated by establishing a stand-alone wholesaler, what assets would need to be divested to enable the establishment of a viable standalone wholesaler?

• What would the risks or potential unintended consequences be of a divestment designed to establish a stand-alone wholesaler?

Topic 5:  Would a divestment of an integrated wholesale and retail business or the assets necessary to establish an integraged wholesale and retail business be more effective than simply a retail divestment?

• Would the divestment of an integrated wholesale and retail business or the assets necessary to establish an integrated wholesale and retail business give a greater likelihood of successfully establishing a viable and effective competitor than simply the divestment of a selection of retail assets?

• What assets would need to be divested in order to establish a new integrated wholesale and retail business?

• What other arrangements would need to be put in place (possibly on a transitional basis) to ensure the acquiring entity would be viable and would operate effectively as a competitive constraint on the major grocery retailers?

• What are the likely potential challenges which would need to be overcome in implementing an integrated wholesale and retail divestment?

• What are the potential risks or unintended consequences associated with such a divestment?

C. Facilitation of entry and expansion

Topic 6:  What general principles should be applied when considering recommending facilitation of entry or expansion?

• In what circumstances might it be appropriate for the Commission to recommend to the Government that it considers the possibility of taking steps to facilitate entry or expansion in the grocery sector?  Would this require the same pre-conditions or criterial to be met as for a divestment or might some lower threshold or different criteria be appropriate?

• Are there barriers to entry or expansion that the Government is better able to overcome than private enterprise?

• What principles or framework should the Commission apply when considering whether to recommend facilitation of entry or expansion?

Topic 7:  Might a recommendation of facilitation of entry or expansion be appropriate in this case?

• What would it take for facilitation of entry or expansion to be effective?

• What is the minimum extent of facilitation of entry or expansion which would be required to make a meaningful difference to the competitive landscape?

• Might facilitation of entry or expansion occur in conjunction with a divestment remedy?

Session 10:  Reserved for overruns

• Topic 1:  Any overflow from Session 9

• Topic 2:  Is there any other strategic behaviour that may restrict new entry and access and how might it be redressed?