As I mentioned in my last post, there’s been a lot of consolidation in the grocery markets, and the players in that consolidation – Coles Myer Limited (CML), Woolworths (WOW) and Metcash (IGA) – are starting to expand in to other market segments. I’ve recently come across ideal firm size theory, which suggests there are limits to that expansion, so in this post I want to look at some of the factors that encourage and constrain that growth.
Factors promoting consolidation
Branding & Advertising
People like to buy brands they know about. The way to get a brand message to stick in peoples heads is keep repeating it over and over and over again. So the more money a brand can spend on advertising, the more popular that brand will be.
Purchasing & Distribution
Any product that has high capital costs in production and distribution will show economies of scale. So the more of a particular good a single retailer buys from a wholesaler, the lower the price that retailer has to pay to get those goods on to their shelves. Bigger retailers can even cut out the middle man, buy straight from producers and develop their own private labels.
Not everyone can hire only above average employees. A good operating system (manuals, POS systems, training materials) can get consistent (although not brilliant) results with workers who are neither interested or intelligent (one POS developer told me "our target user is a 16 year old high school dropout telling her friend what happened last night on Neighbours "). A good system costs a lot of money to develop, but that cost can be amortised across all the stores applying that system.
problems with consolidation
The battle between large and small business is not totally one-sided – large companies are subject to diseconomies of scale. Smaller businesses have much lower management overheads and are able to respond much faster to new threats and opportunities that appear in the market. Smaller businesses are also less prone to conflicts of interest between owners, managers, and employees (the limit case here is self employed workers, where one person fills all three roles).
models of consolidation
Some markets consolidate through one or two retailers expanding by acquiring or undercutting their rivals. These retailers have the benefits of centralised branding, purchasing and systems, and the disadvantage of centralised ownership.
In markets for low value, fast moving goods, where there’s a lot of competition and branding has a big influence on consumer behaviour, franchises can prosper. Franchises have the advantage of centralised branding, purchasing and systems, and also the advantage of decentralised ownership. The franchise model dominates in areas where branding is important and the startup cost for each outlet is low enough that anyone with a bit of industry experience and a house to mortgage can be their own boss. The canonical example here is the fast food industry.
In some markets one or more open platforms can take hold. These give smaller businesses (who have the advantage of decentralised ownership) some of the advantages of centralised systems, and are especially prominent in services markets, where purchasing & distribution is not relevant, and personal relationships are more important than brands. E.g. the SABRE network gives independent travel agents the ability to sell tickets on any airline. Since all market participants have equal access to that system, there is no pricing or operational advantage for large players. Note that this benefits suppliers even more than buyers – if there was no open platform, then there would be huge benefits in centralising ownership of travel agents, which would lead to the emergence of one or two giants dominating the market, these giants would then be able to exert pricing leverage over the airlines. It’s not surprising then that SABRE was actually created by an airline. The real estate market can also be considered to have an ‘open platform’ since cheap newspaper advertising and websites like domain lets an independent agent advertise to the same number of potential buyers as any of their competition. Again, if these media weren’t open to all, then the market would consolidate around the handful of giant firms that could fund the production and distribution of their own advertising, and then those firms would be able to extract much larger commissions from sellers.
Not really sure what to make of all this just yet. Ben Barren asked what impact will technology have? Somewhere in all this WOW vs CML froth & bubble there’s an open platform waiting to get built, something that will keep the independents and franchises in the game once POS systems with supply chain integretion and the ability to sell financial products start to become competitive weapons. I’ll ponder a bit longer and see if I can discern it’s shape.