Supermarkets are squeezing SMEs

COMMENT

The procurement practices of the big four supermarkets — Pick n Pay, Shoprite Checkers, Woolworths and Spar — have a significant negative effect on the ability of new small and medium enterprise (SME) suppliers to enter the market and to create jobs.

It is their practices of charging suppliers a substantial “rebate commission” and requiring suppliers to comply with private, rather than public, production and health standards, that are particularly harmful.

According to the National Development Plan (NDP), in the short to medium term, about 90% of the projected semi- and low-skilled jobs are most likely to be created by “small and expanding firms” that service the domestic market.

A question is whether product lines that are not dominated by large suppliers could be a source of employment creation. One possibility is high-value foodstuffs such as special oils and pre-prepared foods.

A recent study shows that automation, as well as quality and hygiene standards, can have a decisive effect on the competitiveness, viability and job-creation potential of small suppliers.

The study surveyed 28 suppliers to the four supermarkets, two senior executives from two of the supermarkets, an ex-buyer from one of the supermarkets (now a consultant to SME suppliers), a packaging company, and a driver for one of the suppliers.

The SME suppliers of high-value foodstuffs had the following profile:

• About 85% of the SMEs were older than five years. Most of them had started as an informal enterprise that operated from a garage or kitchen. This makes the study relevant for assessing the potential for informal-sector suppliers to expand and develop linkages to formal-sector supermarkets;

• Their annual turnover ranged from below R1-million to more than R20-million; and

• Generally, the larger the supplier firm in terms of turnover, the more employees it has. The average employment was about 40. Eight firms employed fewer than 20 workers. Almost half the firms had between 21 and 60 employees.

Only four suppliers employed more than 60 workers, the largest having 285 employees. The firms that employed fewer than 10 people tended to be either highly automated or involved only in packaging and distribution. Surprisingly, no casual, seasonal or temporary workers were employed.

Interviewees reported that Spar is an important entry point to test the market. Because Spar operates as a franchise, franchisees of stores have some discretion in procurement and can decide to stock a particular product and contract directly with a supplier. Thus SME suppliers can produce small quantities and supply just one store.

Given that Spar has a relatively small market share, growth beyond a certain size depends on SMEs supplying other supermarkets too.

Shoprite Checkers is a favourite because its shelf prices are lower than those of other supermarkets, thus products sell quicker. But, because its primary market is a lower-income segment, the market for high-value products has a ceiling.

Woolworths has the largest scope, but it is difficult to become a supplier because most of its products are “private label” — that is, suppliers’ products are sold under the Woolworths brand.

This means supplying Pick n Pay is critical to the growth of emerging small suppliers, but this research suggests that Pick n Pay abuses this market power when contracting with SME suppliers that do not have a strong, independent brand.

Retailers use two legal mechanisms to exercise control over production and supply by SME firms that are legally autonomous: supply contracts and production and hygiene standards.

The typical supply contract between the supermarkets and their SME suppliers outlines the basis on which the supermarket places orders. The supermarket and the supplier agree on a supply price and the supermarket’s mark-up for each product, which determines the selling (or shelf) price. Few suppliers take issue with this process.

The complicating factor is that, although the supplier nominally receives payment based on the agreed supply price, all four supermarkets charge their SME suppliers a “rebate commission” — a percentage ranging between 6% and 16% of every order.

Pick n Pay’s rebate comprises several different fees:

• An “incentive fee”, usually about 5% of the value of an order, is a fee that the supplier pays to the supermarket simply for the privilege of having the supermarket stock its product. 

• An advertising fee, which is notionally charged for advertising, but without a legal obligation on the supermarket to advertise the supplier’s product.

• A settlement fee, which is to ensure that the supermarket pays the supplier within 30 days of receipt of goods.

• A “swell allowance”, charged only by Pick n Pay, for it to carry the risk of over-ordering stock and damage to the stock after delivery, even if the damage is caused by Pick n Pay.

There is little variation among the supermarkets in the rebate commissions, but there appears to be a huge variation in the charges paid by different SMEs and the service received from the supermarket

For example, some suppliers did not pay a rebate commission and were paid for a delivery within seven days.

Other suppliers paid a 10% rebate commission, but were only paid within 30 days. All except two suppliers were unaware that they had been contracted on different terms to those that applied to their competitors.

In addition to the rebate commission, Pick n Pay’s terms of trade include the following:

• An obligation on the part of the supplier to contribute about R1 500 a store for the refurbishment of existing stores or the building or acquisition of new stores. Technically, suppliers are meant to pay only if the relevant store will stock its products, but suppliers reported that they had to contribute to stores that don’t stock their products;

• A stipulation that promotion costs (such as offering discounts or two for the price of one) are borne by the supplier, yet Pick n Pay decides unilaterally which products are to be promoted; and

• A penalty is triggered if a supplier fails to deliver a certain percentage, usually 95%, of orders over a year, irrespective of the reason for nondelivery — even when nondelivery is caused by Pick n Pay’s faulty refrigeration facilities or because the products are not in season.

The basis for the penalties levied by Pick n Pay seems a clear example of the supermarket abusing its market power. Although the penalty clause is based on a year’s supply and penalises the supplier for its failure to deliver over that period, the supplier has no corresponding claim that the supermarket has to take delivery of ordered supplies and pay according to agreed terms for the year.

Suppliers say Pick n Pay claims it is contracting afresh for each order it places — and thus can decide to place an order or not as it wishes, without suppliers having any recourse.

Suppliers generally report that they are unable to contest their contract terms, because they will be “blacklisted” and their products “de-listed” (no longer stocked).

Pick n Pay’s penalty practice and the threat of being “delisted” for even noncommercial reasons (such as questioning decisions) creates a profound insecurity of contract and a huge risk for suppliers. It limits a supplier’s incentive to invest in new capacity to expand output and create more, or better-paid, jobs.

Three government departments — health, agriculture, forestry and fisheries, and trade and industry — regulate and enforce food safety. Six Acts govern the production, manufacture, transport and labelling of food. In addition, the international Hazard Analysis Critical Control Point system has been gazetted as part of the Foodstuffs, Cosmetics and Disinfectants Act. But no sector is legally obliged to implement the system.

All four supermarkets have historically required compliance with these public health and safety standards. But, in recent years, Woolworths, Pick n Pay and Shoprite Checkers have required compliance with stringent private production and hygiene standards, arguing that compliance with these are necessary for consumer protection. One has to question this assertion, as Spar’s products comply with public standards and consumers are safe.

C Dolan and J Humphrey, in their article Governance and Trade in Fresh Vegetables: The Impact of UK Supermarkets on the African Horticulture Industry in the Journal of Development Studies, argue that standards are often a manifestation of relative power rather than a desire to protect consumers.

For example, UK supermarkets demand compliance from African suppliers but not from Spanish suppliers, which undermines their justification that the private standards are there to protect consumers.

Interviewees said that, if it wasn’t for Spar, the compliance costs would prevent new SME suppliers that do not have considerable capital from starting up. All interviewees favoured a mandatory period of grace for start-up businesses to attain gradual compliance (which Woolworths does with its private-label suppliers).

The key findings are that the opportunities for SMEs to grow are circumscribed by the SME supplier’s bargaining power relative to a supermarket. The majority are without a powerful brand and have little to no bargaining power.

The fact that supermarkets centralise their procurement, that they impose contracts on their SME suppliers and often abuse their market power undermines the growth and job creation potential of SMEs.

Because their contracts are insecure and supermarkets’ proclivity to pass risks to suppliers through rebate commissions, suppliers choose to automate rather than to employ more people or improve the skills of their staff.

Finally, the rise of private production and hygiene standards, and the costs of compliance have a chilling effect on SME entrants.

These procurement practices have profound implications for the viability and growth of small businesses in the food industry, which affects job creation. These practices will have to be addressed, for example by the Competition Commission, if the NDP’s vision is to be realised.

Policy interventions are needed in four areas.

First, the state should regulate the contracts between supermarkets and small suppliers as it does other relationships marked by unequal power relations, for example contracts between retailers and consumers, employers and employees, and franchisers and franchisees.

Second, the government must regulate how private standards may be enforced, including provision for gradual compliance over a period of three to five years, and ensure that uncompetitive practices are eliminated.

Third, the practice of rebate commissions has to be scrutinised.

Finally, SME suppliers should enjoy representation, as supermarkets do, on the South African Bureau of Standards, the retail committee of the National Empowerment Fund, and the National Economic Development and Labour Council, which make policy decisions.

Marlese von Broembsen is a visiting researcher at the Centre for Global Law and Policy, Harvard Law School, and previously taught at the University of Cape Town’s law faculty. This is an edited and shortened version of an article that first appeared on the Econ3x3 website