Reference no: EM132408641

Read the following article, which appeared in the Sydney Morning Herald on September 10, 2011, and answer the following questions.

a) How do oligopolies such as the Coles/Woolies form?

b) Explain how Coles and Woolies are mutually interdependent using the Prisoner's Dilemma and the information in the article.

c) Explain what Coles and Woolies are really trying to do here using concepts of oligopoly behaviour, collusion, and entry barriers.

d) While they argue it is good for consumers, how do oligopolies such as this one affect economic efficiency and ultimately consumers?

"High price to pay as Coles, Woolies wage war with discounts" by Ian Verrender

If Noah was an economist, Australia would have been his dream destination when he set forth in the ark. Check out our corporate landscape and you'll understand why.

We seem to love our businesses in pairs. There's a couple of airlines, a pair of brewers, two steel makers, a handful of banks that would do almost anything to cosy down to two and, of course, our two big retailers.

It never starts off like that, of course. But over time, smaller players join forces and others are bought out until there's just two left facing off at either end of the street.

The rationale for the constant round of takeovers and rationalisation is that bigger is better and far more efficient. And anyway, two big well-resourced players is enough to provide competition for consumers.

If you've noticed the war between our two big retailers of late, it would be difficult to disagree.

Coles and Woolies have been slugging it out for months now, discounting like mad on everything from foodstuffs to bog roll (the entire food chain, as it were) and the hostilities show no sign of letting up.

The picture both are painting is that this has been terrific for consumers with Coles boasting that its aggressive discounting strategy on staples such as milk has contributed significantly to keeping national inflation in check.

But a quick look at the latest earnings results from the two grocery giants indicates they've been travelling quite nicely, too, and during one of the toughest retailing climates in decades.

After years of underperformance, Coles has been bouncing back with revenue up almost 7 per cent and earnings before interest and tax up a whopping 21.2 per cent.

Given there is no magic pudding in business, someone somewhere must be losing out. As we witnessed during the early days of the two retailers' expansion into alcohol, it was the smaller chains and the independents that bore the brunt of the onslaught.

Because they don't have the purchasing power of the majors, many independent bottle shops now find they can buy a bottle of decent branded wine cheaper at Dan Murphy's than they can directly source from the producer.

But there has been a new element to the latest round of discounting, and it now has become apparent that not only smaller retailing rivals are suffering, but the pain has begun creeping back up the supply chain to the producers.

A fortnight ago, Australasia's biggest bakery, Goodman Fielder, announced a $167 million loss and sheeted the blame home squarely to the retailing bunfight. Just a year before, the company announced a profit of about the same level, and the sudden turnaround wasn't because people had stopped eating bread.

On the very same day, the American boss of Heinz told analysts that Australia was ''one of the most difficult'' markets in the world.

Back in March, Foster's suspended supplies of Victoria Bitter, Pure Blonde and Carlton Draught to the two retailers after it learned the pair planned to sell cases of the amber fluid for $28 - well below cost.

All this activity has raised fears that, while consumers may benefit in the short term from keener prices, putting the squeeze on producers may have a serious long-term impact on supplies, which may end up biting consumers.

And it appears our competition laws are a little like Singapore's guns in 1942, which were not equipped to repel a land invasion from the Japanese.

This week, the Senate economics committee began taking a closer look at the impact of the recent heavy discounting on milk.

Both majors, led by Coles, have been selling milk for way below the cost of producing it, to the point where it is cheaper now than bottled water.

Clearly a windfall for consumers, the strategy, however, masks some serious issues about the way in which the two giants exert their power to lure in customers at the expense of rivals and producers.

Neither the government nor the opposition are prepared to take on the retailers alone. Trying to lift the price of a necessity such as milk doesn't win votes. And that is the card both Woolies and Coles are playing.

But their renewed focus on home brands and the heavy discounting on staples has involved a subtle shift in pricing policy. Once upon a time, there was a promise of low prices on all goods, every day. That's no longer the case. Now, it is lower prices on some goods, every day.

Both retailers admit they are selling home-brand milk (which, incidentally, is exactly the same product as branded milk) for far less than it costs to produce.

You don't have to be a mathematical whiz to figure out that if both companies are increasing their profits, then the discounting on staples has been more than compensated by lifting prices on other goods.

The idea is to lure in customers to buy milk, and then make up the loss and add some more income with extra profits on other goods.

It may be a basic commodity but getting your head around milk supply and pricing is no easy task. Thousands of producers, a handful of processors and a myriad retailers - most of them corner stores and non-grocery chains like petrol stations - make the market extraordinarily complex.

Milk is a driver of foot traffic in stores. As expected, the heavy discounting has attracted a great deal of foot traffic away from small retailers and into the majors. Corner shops are hurting big time.

But it has had some other impacts as well. Milk consumption has declined alarmingly, more than 15 per cent, since the cheap milk hit the shelves. It was already in decline before the price war began and, theoretically, cheaper milk should spur on demand.

Instead, it seems while far more milk is being sold through the big two under their cheap home brands, overall consumption is down perhaps because some smaller retailers have already pulled out of the market.

That, in turn, has squeezed the already slim margins of the processors such as Dairy Farmers, which are looking at ways to cut costs. That may mean not delivering to outlying country areas and smaller retailers.

And the sharply lower volumes being sold eventually will have an impact on dairy farmers. Victorian producers are more efficient than NSW producers, essentially because of climate. Even though supply prices are locked in for now, at some stage it is conceivable that northern producers will no longer be viable.

So what's to be done about all this? Our competition laws are focused on protecting consumers, not producers further up the chain, so the two big retailers have little reason to fear they are doing anything wrong.

Consumers are enjoying the luxury of a short term win as the two retailers go head to head with each other. But the two retailers are knocking the stuffing out of suppliers. Even Noah would have second thoughts about that.