Mike von Massow
Are We Getting Price Gouged at the Grocery Store?
Food inflation has been persistently high and is not coming down as general inflation is. Canadians are looking for answers. Its not a surprise that fingers are getting pointed at grocers. Their profits are up. They are also where we feel the cost of food price inflation. Most Canadians are blissfully unaware of the factors that affect food prices and wonder why food inflation isn’t coming down with general inflation. Politicians and pundits are feeding the dislike of grocers by talking about “greedflation” and price gouging. We’ve had multiple hearings in parliament focused on grocers which feeds the narrative. The appearance recently of the CEO’s of the three biggest grocery chains has received particular attention. I had opined that these hearing are little more than political theatre (for which I was criticized) but having watched the hearing I stand by it. I don’t believe that grocers are contributing substantially to food price inflation.
Are We Being Price Gouged?
There is no evidence of price gouging happening. Notwithstanding the hyperbole and vitriol from politicians and pundits, I have yet to see any evidence. I am not optimistic that the investigation by the Canadian Competition Bureau will find anything but I remain open to whatever they bring forward. It may have been more productive to wait until that investigation was finished – particularly given the grocer companies (minus CEO’s) had already testified. There was no reason to suspect that the companies would suddenly have an epiphany and say “Oh Yes! You’re right. We are screwing Canadian consumers. That pile of paper next to Jagmeet Singh makes all the difference.”
The grocery industry is concentrated. A small group of grocers dominate the market. They do, however, compete significantly with each other for share. We heard the CEO’s testify about expansion and building stores. Galen Weston appears regularly on television to try to convince us to shop at his stores and particularly to buy the store brands (no name, President’s Choice). Walmart advertises extensively. Multiple flyers show up at my house every week. There are app’s that allow you to compare flyers between stores. Share drives profitability. The only way that grocers could raise prices and not lose share is to collude. I hear you saying – “well they did, remember bread price fixing?” True enough. But there is an ongoing investigation and its hard to believe that they would risk this. I expect that there remains a significant amount of distrust and bitterness among Loblaws’ competitors due to bread price fixing (CEO’s of Metro and Sobey’s denied it again in the hearings) that would reduce the likelihood of collusion. Loblaws came forward and said it was happening, throwing the others under the bus and protecting themselves from prosecution. Taking additional prices individually would bring risk of market share loss. It is a delicate balance.
It is small comfort, but food price inflation has been higher in many other jurisdictions. Canada’s food price inflation is among the lowest in the G7 Group of Countries. The rates of food price inflation in developing countries is much higher. This is a global issue with reasons that cut across national borders and differences in domestic policy or market structure.
There are many reasons that food prices are increasing. Extreme weather events and disease, exacerbated by climate change have disrupted production in many areas. Before Christmas lettuce prices skyrocketed due to an insect borne virus disrupted production in Southern California at a time when the majority of North America’s demand was supplied from this area. Prices have come down again as primary supply has moved to other geographies. Flooding in the Salinas Valley in January caused significant damage to vegetable production and generated price increases of almost 10% for products like tomatoes in January alone. European consumers are seeing empty shelves due to drought in Northern Africa and Southern Europe. This matters for Canadians as it makes it more difficult to access alternate sources of product when our primary sources are limited or fail. A lower Canadian dollar and higher transportation costs have put more pressure on higher prices on products coming from the US and other imports.
The war in Ukraine has also created significant inflationary pressure. The Ukraine is a major exporter of wheat and vegetable oil (primarily sunflower oil). Taking that product out of the market has driven prices up and it’s been made worse by countries like Argentina restricting exports in order to protect domestic consumers. This has caused increases in products like pasta, flour, and vegetable oils to increase in the range of 20% in the past year. Other products with flour and/or vegetable oils as ingredients are also affected.
The war and the accompanying sanctions have also increased farm input costs. The Ukraine and Russia export large volumes of fertilizer. Production and export of fertilizer was compromised causing prices to go. up. Russian exports were subject to punitive tariffs. The costs of producing crops went up in Canada and around the world. Canadian farm prices are largely driven by international markets and this cost pressure puts additional pressure on food prices. In the hearings, Conservative members focused on the carbon tax. While the carbon tax is significant, particularly at the farm level, it is not as important as some other factors causing price increases.
Topline inflation numbers have been consistently high but there are many differences at the product level. Pork prices have gone up just 2% in the past year, but flour has gone up 23% (for reasons outlined above). While lettuce prices are up over 35% in the past year, they actually went down in January as seasonal production moved away from the area that experienced the viral disease challenge. The inflation story is more complex than many are presenting.
The parliamentary committee is focused on retailer and may be missing the broader issues on food price inflation. While retailers are making record profits, there is little, if any, evidence that I have seen that they are taking excessive price increases. One might argue that retailers could reduce margins to maintain profits and help Canadians but these profits don’t necessarily mean that they are hiding extra price increases in the food inflation numbers. Profit is not illegal.
Why Are Grocery Profits Up?
There could be many reasons that grocery profits are up. The focus has been on price gouging without any discussion about other potential contributors to larger profits.
The first and most obvious one is volume. If you look at Statistics Canada numbers for sales in food service and drinking places we see they are down dramatically due to both COVID and food price inflation – we eat out less as a strategy to stretch our food dollar. We still need to eat so when sales go down in food service sales go up in grocery. If margins are static and volume goes up, profits will increase. I spoke to one small local grocer who said that “COVID saved my business” after a lot of local construction reduced her traffic and volume.
The grocers said that they weren’t profiting due to price inflation. Others say they are. There is an investigation ongoing by the Competition Bureau (after which you might think would have been a good time to have the CEO’s come in and respond). Grocers said that product mix and sales in pharmacies contributed. Sobey’s has seen less growth than Loblaws and Michael Medline (the CEO of Sobey’s) highlighted that they have a smaller proportion of non-food revenues and less profit growth than some of their competitors. This makes intuitive sense and I believe that it is probable.
One part of product mix that I was surprised that no one on the committee asked is the impact of buying cheaper products in the face of food price inflation. Grocers evaluate shelf space like real estate. They look for a return per linear foot. They charge suppliers for prime retail shelf space (see comments below about supplier relationships ). Prime real estate (eye level shelves) should generate higher returns per foot than less appealing real estate. You generate returns per foot two ways.
1. You make more margin on a product; or
2. You generate more sales (inventory turns) of that product.
I expect that percentage margins are higher on cheaper products than they are on more expensive ones. If you have a can of soup you sell for $2 and make 10% your return is $0.20. If you have another can of soup that sells for $1, the same percentage margin will only generate $0.10. The total dollar margin will depend on the difference in volume. An increase in volume of lower cost items might well change profitability as product mix changes. Grocers can say that individual margins haven’t changed but total margin might change due to product mix. I was very surprised no one thought to ask this question in the committee hearing. Its not a change in pricing approach for grocers but it does sound bad if profit goes up because people are buying cheaper products. I acknowledge that this is complete conjecture, but I did bounce the idea off of a couple of grocery industry veterans and they said it was plausible. According to Statistics Canada, grocery sales are up less than the rate of inflation. That means Canadians are buying less expensive items in the face of price increases.
In my view these arguments for higher profits are stronger than the price gouging one.
Are the Retailers Really Good Citizens?
While I don’t think the retailers are driving food inflation, I by no means think that they are innocent of wielding market power. There is concentration in the industry with a few companies dominating the market which generates market power. I believe that they are wielding that market power on their suppliers and not necessarily their customers. Individual grocers hold access to significant numbers of customers. If suppliers (processors, importers, farmers, and others) want access to those customers they have to meet the demands of the grocers. They have to accept fees, returns, price demands, and other things to sell to them. This is what has led to demands for a grocery code of conduct. The code is being negotiated now with threats from government that if they don’t agree on one, a code will be imposed. A code is intended to set limits on what grocers can ask suppliers for.
The code is being conflated with increases in consumer prices. There is no doubt that pressure on suppliers affects grocer profits. I also believe that this affects consumer prices – but it keeps them lower so large grocers can compete with each other in a highly competitive environment. A code of conduct will mitigate the degree to which grocers can pressure suppliers, but it won’t lower consumer food prices. It will have some combination three potential impacts:
Suppliers will make a bit more money as they face fewer fees and price pressure;
Grocers will make less money as they collect fewer fees and face higher prices; and/or
Consumers will pay more for groceries as grocers face higher costs and fight to keep their same margins.
This is a zero-sum game. If suppliers make more money, then either grocers will make less, or consumers will pay more. It may be a good thing to do from a competition policy perspective but it is not related to the current issue of food price inflation and it is important that we distinguish them. I was surprised and disappointed that no one on the committee asked the CEO’s about this relative to a code of conduct.
I should add at the end that the degree to which grocers undertake this behaviour likely varies but I expect all of the big ones do it to some degree.
Can the Government Do Anything About It?
The truth is, despite protestations and promises from politicians, that there is little that governments can realistically do directly to effectively reduce food prices. There are also issues around the secondary impacts of policy around food prices.
The most obvious one (and one I have seen raised in the media) is the regulation of food prices. In this scenario the government would establish price ceilings for food products. This is virtually unheard of in North America but has happened in other jurisdictions, primarily in developing countries. The first question that arises is where is the price limit set? Is it set at the farm level, at the retail level, or somewhere in between.
On first blush this might seem like a good way to curtail food price increases. The focus could be on staples. The problem arises that this takes money out of the system. If the money isn't replaced (i.e. through a subsidy from the government), products will likely find other markets. That means products will become unavailable. While that does buffer against higher costs for those items, it clearly doesn't achieve cost relief on those products. If these are imported items, they will go to other markets. If they are domestically produced, they will likely leave the country for higher returns. There are some products, like dairy and poultry, that have domestic production controls. Farm prices are set based on a cost of production model (which is contentious for some) so if grocery prices were capped, retailers and processor would have margins squeezed. Milk is already a loss leader in the grocery store. Yogurt and cheese are staples in many households. At the very least, specials would disappear, but it would be much more likely that less product would be available on shelves. This type of regulation is impractical and is unlikely to achieve much. If prices go down it will be at the expense of farmers, processors, or retailers. In the long run that will reduce access to those products and stifle innovation and research investment. If governments make up the difference through a direct subsidy it becomes very expensive.
In some countries, governments have chosen to limit exports as a way of reducing domestic food prices. Argentina did it this year when wheat prices went very high due to the war in Ukraine. the Argentinian government has done it before when commodity prices increased. This means that all domestic production must be sold domestically and this forces prices down. This is great for domestic consumers, especially the urban poor, but it puts a burden on domestic farmers who lose returns and may stop or reduce production in favour of unregulated products.
Some jurisdictions tax food and are now waiving the tax on food. In Canada, most retail food items are not taxed so this is not an option. The Government of Alberta has introduced fuel tax relief as an effort to buffer the rising cost of gasoline. This is an effective way of reducing the cost of transportation. This can't be used for most food products. There are some criticisms of this approach too. The benefits of the tax relief accrue more to those who spend more. Providing tax relief on purchases will provide relief but will provide the greatest benefit to those that spend the most rather than those that need it most.
Another option that pundits highlight is to deal with the root causes of the inflationary pressure. The truth, however, is that many of those factors are beyond the control of our politicians. The war in the Ukraine is causing significant disruptions to world wheat, fertilizer, and fuel trade which will lead to increases in prices. Drought in Western North America and other extreme weather events are putting upward pressure on farm commodity prices which is also inflationary at the consumer level. Renewed COVID related lockdowns in China are worsening already significant supply chain disruptions. All of these are beyond the control of national, provincial, or state governments. Interest rate hikes will not make it easier for prairie farmers to buy expensive fertilizer, grow grass for cattle, or to achieve normal yields in the face of extreme dry conditions. There are some activities designed to achieve other policy objectives which could be making food price inflation worse. Activities at the US/Mexico border, particularly in Texas, that are designed to catch illegal immigrants and other smuggling are slowing border crossings. This leads to lower transportation capacity (each trip takes more time) and also transportation losses (perishable products) which increases costs. The Government of Texas is prioritizing the immigration activity over food cost.
A member of the Parliamentary committee suggested “windfall taxes” of grocery companies. I am not an expert in taxation but it is not clear to me how you would define “windfall” and how you would decide who pays and who doesn’t. Governments could introduce a higher rate of corporate tax across the board but I expect it would be much more difficult to isolate the grocery industry. It would generate revenue that could be used to support families feeling the pinch, but it could also raise prices as companies still try to meet shareholder expectations. It could also reduce investment in the grocery industry and reduce access to food in less profitable locations. The bottom line is that this sort of policy approach is less easy than a glib comment at a committee would suggest.
Another proposal is that we break up the large grocery chains and make them sell off some of their brands. Loblaws has a large number of different stores. The thinking is that this would increase competition and reduce market power. It likely would help reduce the ability of grocers to leverage suppliers as they would control less of the consumer market. That would be a good thing. Given the already fierce competition in the grocery market, it is not clear that this would reduce food prices though. Smaller companies would have fewer economies of scale so there would be fewer efficiencies. There is a real chance that food prices would go up.
I suppose that federal or provincial governments could get into the grocery business. They could create stores for staples with controlled or subsidized prices. This would be a significant endeavour – think about the level of investment in real estate and distribution infrastructure. They could focus on local suppliers and reinforce another policy objective. I am pessimistic about this approach because governments haven’t demonstrated an ability to efficiently manage competitive enterprises. It is also not clear that they could buy from suppliers as cheaply as the larger grocers do. It would likely lose money but it would put pressure on the existing grocers to price match for as long as governments were in the business.
While there are not a lot of things governments can do specifically relative to food prices, there may be some things they can do to provide broader relief. The truth is that those with the lowest incomes will feel the pinch of inflation more than others. They are being squeezed not only by food price increases but by rent increases and fuel price increases. Relieving any of this pressure is helpful. Income support for those with lowest incomes could go a long way to reducing the burden of rising food prices and other costs of living. Broader tax relief could also take the pressure off for the middle class (tax relief is less effective for low income earners). Politicians who criticize incumbent government for rising food prices should be challenged to provide real proposals that would differentiate them. The reality is that we are experiencing generational levels of food price inflation for a variety of reasons that go beyond the factors that affect general inflation. This is not an easy fix and we shouldn't be pretending it is.
Keywords: grocery food retail price tax inflation
Recommended citation format: von Massow, M. "Are We Getting Price Gouged at the Grocery Store?". Food Focus Guelph (132), Department of Food, Agricultural and Resource Economics, University of Guelph, March 13, 2023.