I often get questions from friends and media when issues emerge. The Toronto Star published a story last week saying that retailer margins were increasing faster than the rate of inflation suggesting that retailers were profiting from inflation by hiking prices more than is justified by their cost increases. Is that a valid conclusion? It might be but its unlikely to be the only factor if it is. It is hard to tell, particularly given the data that the article uses. There are, however, likely other factors also at play here.
What is a Gross Margin?
Gross margin is simply revenue (prices times quantities sold) minus cost of goods sold (acquisition price times quantities bought) divided by revenue which gives you the percentage margin over cost. This percentage can go up a number of ways. In this case the argument is be that the selling prices are increasing faster than acquisition prices which would suggest that the retailers are taking extra margin and hiding under the cover of inflation.
So Are Retailers Taking Extra Margin?
There are a number of factors which could be at play here. First, it could be that retailers are increasing prices faster than their costs are increasing - the article may be right. If its happening it could be opportunism but it might also reflect higher non-product costs. Cost increases are happening throughout the supply chain. We know many companies are experiencing wage pressure because of labour shortages. We know the cost of fuel is going up. Other real estate costs are also increasing. Grocers may need more margin to maintain returns at previous levels. Inflation is not just limited to the cost of food but transportation and wages are also increasing which means stores might need more gross margin to maintain constant profits.
"likely other factors also at play here"
It is worth noting that grocers have seen profits increase during the pandemic. There have been significant increases in volume because of decreased food service expenditures. Returns will increase based on volume even if gross margin doesn’t change. Some would argue that the grocers should have reduced gross margin given higher volumes because it is easier to cover the fixed overhead even if it is increasing.
There could be quirks of calculation that make it appear that grocer’s have changed their pricing policies when, in fact, this isn’t the case. If product mix changed (perhaps even in response to food price inflation) then high level gross margins could change too. It may be that cheaper items have a higher percentage margin in order to justify shelf space - remember that grocers pay particular attention to return per foot of shelf space. An item that costs $1 dollar makes 12 cents in gross margin at 12%, whereas an item that costs $2 makes 24 cents at the exact same percentage margin. If people are substituting cheaper items to make their food dollar go further, gross margins could look higher without representing a real change in pricing approach. Other product mix factors could also be at play. We know that the products we bought changed during the pandemic. One example is that the demand for flour went up early in the lockdowns as many people baked more. The proportion of online sales is also increasing. One retailer raised the issue of the cost of building online infrastructure and may need margin to offset those costs.
There is a discussion in the article about market concentration and market power. The argument is that because individual retail companies control so much of the market that there is not enough competition and they make higher profits. The grocery market remains highly competitive. Profits are driven by top line sales which are driven by share of the market. If you charge too much people will switch to your competitors. This sensitivity to being higher priced than your competitors (particularly in staples which bring people into the store) is evidenced by the price fixing scandal from a few years ago. Stores were loath to increase bread prices unless everyone did so they conspired to raise them together. I may be making the case about oligopoly power with that example but the point is people are now looking for those agreements. I’d be surprised if they were doing this again and without collusion it is unlikely an individual company would take larger increases than others.
That is not to say that large retailers are not wielding market power. There have been a lot of calls for a grocery code of conduct because of pressure large retailers are putting on their suppliers. A recent dispute between Loblaws and PepsiCo was about the retailer not allowing the supplier to take a price increase. If grocers are wielding market power to reduce price increases they may actually be reducing the rate of price inflation. One might argue that they should pass all of it along to consumers and keep the same margin but it is possible that margin increases even with lower than justified price increases.
The article also highlights that there are larger absolute price increases for grocery products than there were for farmers selling the raw products. One example is that milk increased $0.17 per litre at retail and only $0.09 per litre at the farm. This ignores the fact that there are also cost increases for transportation and processors and is definitively not evidence of price gouging. If the cost to produce milk goes up $0.09 a litre and then the cost to ship it goes up and the cost to process it goes up, we would expect the price of a litre of milk to go up more than $0.09.
The article in the Star may be exactly right about grocers hiding higher margins under the cover of broader inflation but they haven’t provided enough evidence to say so definitively. My guess is that there is more to the change in gross margin than just profiteering. These things are never as straight forward as they seem.
Recommended citation format: von Massow, M. "Are Retailers Driving Food Inflation Through Profiteering?". Food Focus Guelph (129), Department of Food, Agricultural and Resource Economics, University of Guelph, July 24, 2022.