The Commerce Commission released its long-awaited draft market study into the grocery sector today. As the New Zealand Herald reported:
Supermarkets could be forced to sell their wholesale businesses or some sites to boost competition, after the Commerce Commission warned competition in the $22 billion grocery sector "is not working well for consumers".
While the Commerce Commission's draft market study into supermarkets did not say how much cheaper groceries should be, it said it would expect consumers to pay less if competition was better.
"If competition was more effective, retailers would face stronger pressures to deliver the right prices, quality and range to satisfy a diverse range of consumer preferences," Commerce Commission chair Anna Rawlings said...
"The major retailers appear to avoid competing strongly with each other, particularly on price. Meanwhile, competitors wanting to enter the market or expand face significant challenges, including a lack of competitively priced wholesale supply and a lack of suitable sites for large scale stores," Rawlings said.
The report, which you can read here (all 517 pages of it, but don't worry, there is a shorter executive summary as well), goes into the upstream (supermarkets' dealings with their suppliers) side of the market as well as the downstream (how consumers are affected). On the latter point, the New Zealand Herald article reports:
Rawlings said the pricing and loyalty programmes were so complex as to be confusing, making it difficult to make informed decisions. Consumers often did not appear to know how much personal data they were giving to the supermarkets when they signed up, or how it was used.
The rewards also require high levels of spend for a relatively low return. In one prominent loyalty scheme, shoppers are required to spend as much as $2000 to receive a $15 voucher in return.
I made a modest contribution to this report, conducting some experimental research with my colleague Steven Tucker into consumer decision-making under uncertainty. Our report is also available on the Commerce Commission website (see here). Specifically, we looked into how consumers' purchasing decisions are affected by having multiple pricing schemes to choose from simultaneously, and whether consumer welfare (measured by consumer surplus) was affected by having more complexity (in the form of more pricing schemes and more complicated schemes to choose from). We also looked into whether displaying unit prices induced consumers to make more optimal decisions.
We ran a number of experimental sessions in the Waikato Experimental Economics Laboratory earlier this year, where students participated in experiments and could earn real money based on their decisions. Each experimental session consisted of several decision rounds, in each of four stages. In each decision round, the research participants chose how much (if any) of a fictitious good they wanted to buy, faced with one or more pricing schemes and with a known schedule of 'buy-back values' (essentially, we offered to buy back any units of the good that the research participants bought, and gave them a schedule of the amounts they would be paid for different quantities). The use of buy-back values means that we know what the underlying demand curve is, and can calculate the optimal quantity that the research participants should purchase in order to maximise their consumer surplus. The four stages of the experiment were: (1) a single pricing scheme (of which there were several); (2) multiple pricing schemes, but participants could choose to buy only from one scheme; (3) multiple pricing schemes, and participants could buy from one or more of the schemes (this was the most complex); and (4) the same as stage 2, but with unit prices displayed for each pricing scheme.
There is a lot more methodological detail and the full results in our report. The Commerce Commission has picked out the bits that they felt were most relevant, and included those in their own report. In short, we found that:
...multiple discounting schemes do induce suboptimal decision making on the part of consumers. They are less likely to choose the optimal consumption bundle when faced with multiple pricing schemes, and the average welfare loss (loss of consumer surplus) is higher than when faced with no discounting and a single simple pricing scheme... Finally, we find weak statistical evidence that displaying unit prices mitigates the effects of multiple discounting schemes on the optimality of consumer decision-making.
The takeaway message is that complexity makes it difficult for consumers to optimise. It is attractive to believe that, when faced with a variety of different prices, consumers can easily identify the optimal consumption bundle. However, the real world isn't like an idealised model of rational utility-maximising consumers. When faced with multiple pricing schemes, some as part of loyalty programmes and some not, and some involving quantity discounts and others not, consumers can easily stray from the optimal decision. And if you layer on top of that a multiplicity of brands, different styles of promotions, packaging differences, and more, it is easy to see that this complexity can make a consumer worse off. Rather than optimising, consumers may respond to this complexity by satisficing (as Nobel Prize winner Herbert Simon termed it) - choosing an option that is 'good enough'. Moreover, having a multiplicity of pricing and promotional schemes can create the illusion of consumers getting a good deal, when in practice it makes it more difficult for them to do so.
The Commerce Commission is recommending mandatory unit pricing and that the supermarkets simplify their promotional practices and make the terms and conditions of their loyalty schemes clearer and more transparent. It will be interesting to see how those recommendations are received.
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