Inflation has remained persistently high. While inflation has fallen in most countries, it remains above central banks’ target rates. The US PCE deflator is 2.4% and core PCE deflator is 2.8%. US CPI inflation sits at 3.1% and core CPI inflation at 3.9%. Australian CPI inflation is 3.4%, in the latest monthly reading.
This is an issue for politicians because the public has become sick of intransigent inflation. Politicians are under pressure to ‘do something’ about prices. However, as is sadly often the case, politicians have taken the easy solution: scapegoating.
Politicians have consistently blamed corporations for inflation, suggesting that it is due to corporate greed, price gouging, and profiteering. This has focused on supermarkets. There is no doubt that supermarkets have treated farmers and suppliers harshly.
But, are supermarkets really ripping off consumers?
In September 2023, President Biden said he would “crack down on junk fees”, implying that hidden fees were the cause of high prices
.
In February 2024, President Biden took aim at grocery stores for “ripping people off”, stating:
“”Inflation is coming down. It’s now lower in America than any other major economy in the world,”… “The cost of eggs, milk, chicken, gas, and so many other essential items have come down.”… “But for all we’ve done to bring prices down, there are still too many corporations in America ripping people off: price gouging, junk fees, greedflation, shrinkflation,”… “Well, it’s going to stop. Americans, we’re tired of being played for suckers”.
Elizabeth Warren has also gotten in on the act, blaming “greedy corporations” for high prices and accusing grocery chains of “price gouging”
.
Australia has been similar. In 2024, Australia’s prime minister, Anthony Albanese, pursued an inquiry into supermarket pricing. The insinuation being that grocery stores were price gouging and exploiting market power to increase prices and harm consumers.
Are supermarkets profiteering?
The question is whether these insinuations are accurate. The answer is that it depends on the circumstances. But, in many cases, they are merely political scapegoating and attempts to distract from the government’s own failures.
Let’s focus on supermarkets. Market conditions differ across countries. There is no one-size-fits-all answer to supermarket pricing decisions. However, in Australia, there is little-to-no evidence that supermarkets are price gouging.
Much of the reporting focuses on gross margins, which are variously reported as earnings before interest and tax (EBIT) relative to sales. Sometimes, the reporting is earnings before interest, tax, depreciation, and amortization (EBITDA) to sales. However, as the name suggests, such earnings ignore interest, tax, and depreciation costs. Warren Buffett has remarked how misleading this is, so much so that Charlie Munger facetiously referred to EBITDA as ‘bulls*** earnings’.
Profit margins are low when we factor in all costs. Coles’s and Woolworths’s net profit margins have remained relatively stagnant at around 2.5% to 2.75% for the past five years. They have not increased. That is, revenue has increased but so have expenses
.
This is even more stark when we look at net income. Looking at fiscal years, Coles’s net income fell in the last year even when excluding discontinued businesses. It was lower than in 2019, whether or not discontinued businesses are included. Woolworths is similar, with net income being only $13 million higher than reported in 2019 and lower than reported in 2020
.
The supermarkets’ income statements do not point towards abnormally high profits or supermarkets using inflation as an excuse to gouge consumers.
Why are supermarkets’ profits stagnant?
The question is then: But don’t we have a concentrated supermarket duopoly? Why are supermarkets’ net margins are stagnant, and why is net income is increasing less than inflation?
The answer to supermarkets’ stagnating earnings is likely several fold:
Own goals and inefficiency: First, supermarkets have suffered own goals, which have harmed earnings. These include ill-fated excursions into other product lines and the costs of managing the aftermath. They also include unnecessary spending on political campaigning, such as Woolworths committing at least $1.55 million to the Voice Referendum, which both alienated customers and increased SG&A in the latter half of Calendar Year 2023. This might imply agency conflicts, which could suggest inefficiency.
Consumer habits: Second, many consumers are price sensitive and attempt to limit grocery spending. Thus, while grocery prices increase, people will downshift to cheaper alternatives and/or buy less. This hurts total margins as supermarkets still have fixed costs and labor costs.
Competition: Third, in many areas there is competition. Supermarket pricing tends to homogenize across markets within a given chain. Thus, the price of milk is standard across NSW. Similarly, the price of Pepsi or other products. Therefore, supermarkets must set prices so they can operate in competitive markets even if some locations are highly concentrated.
Salience effects: Fourth, there are significant salience effects. Supermarkets have attempted to keep prices low for staple goods and fresh food, such as fruit and milk. This is clear from the Dairy Wars of 2011-2019, where milk prices hovered at $1 per litre. However, the net effect is that this harms supply chains. Dairy farms shut, and supply reduced to the extent that milk prices eventually had to rise. When, the prices increased, the one-off hike looked extreme even if the increase over the decade was not. Further, keeping produce prices low forces supermarkets to raise prices for other items by even more in order to offset that effect and cover expenses.
Costs: Supermarkets have significant costs. Food inflation has been high. However, it has been below that of some rents, and of utilities and fuel.
There is nuance and we do not have the supermarkets’ full books. Supermarkets’ lease liabilities fluctuate: commercial rents are not the same as residential rents and supermarkets are often anchor tenants. A weak Australian dollar has impacted costs, including hedging expenses. Employee expenses have increased, including the costs of remediating historic underpayment and the need to avoid repeating it. Utilities have increased for supermarket operators, as they have done for all Australians.
The net picture is that supermarkets do not appear to be earning abnormally high profits. A profit margin of 2.5% is not significant relative to other companies and leaves limited margin to absorb higher expenses.
The accusation that supermarkets are ‘price gouging’ or ‘ripping off’ customers simply does not hold up.