A lucrative source of income for Coles and Woolworths could come under threat from a proposed grocery code of conduct and the competition watchdog’s crackdown on profit gouging in the $111 billion food and grocery trade.
At risk is the $20 billion-plus in rebates, discounts and promotional allowances that food and grocery suppliers pay Coles, Woolworths, Metcash and other retailers in “trade spend” each year.
Trade spend has grown by at least 4 per cent a year over the past four years, from an average 22 per cent of sales in 2010 to 25.6 per cent in 2013, squeezing supplier margins while underpinning profits for the major retailers.
According to a KPMG report on the sustainability and competitiveness of the food and grocery sector, trade spend by 17 major food and grocery industry suppliers rose from $3.8 billion in 2010 to $4.3 billion in 2013.
However, these suppliers accounted for just 16 per cent of the market. Industry players believe total trade spend could be more than $20 billion.
The Australian Food and Grocery Council believes the competition and consumer commission’s latest allegations of unconscionable conduct against Coles could help suppliers resist pressure from retailers to plug profit gaps, pay for better positions on supermarket shelves or fund promotions.
At the same time, the proposed grocery code of conduct signed between Coles, Woolworths and grocery suppliers last year would restrict retailers’ ability to force suppliers to pay 100 per cent of the cost of wastage and theft in stores, as Coles is alleged to have done.
“If you look at the code and look at the ACCC’s actions they’re squarely related to trade spend, (including) demands for additional payments and offsetting claims against remittances, payments to make up profit projections and so forth,” said Australian Food and Grocery Council chief executive Gary Dawson.
“Strengthening the ability of suppliers to push back on these sorts of demands should help to at least moderate the increase in trade spend and hopefully we’ll see it plateau,” Mr Dawson said.
“When you look at the decline in profitability in suppliers and the correlation between that and rising trade spend it suggests a significant profit transfer [to the retailers],” Mr Dawson said.
“There’s only so much profit in the pool and this has to top out at some point.”
KPMG estimated that trade spend now accounted for $1 of every $4 in supplier sales and now exceeded the cost of goods sold for many suppliers.
However, increased trade spending had failed to boost suppliers’ sales, which have fallen 1.2 per cent a year over the past four years while volumes have risen only 0.1 per cent.
For major domestic and multinational suppliers trade spend represented as much as 37.5 per cent of gross sales and trade spend with Woolworths and Coles accounted for 28.7 per cent of gross sales.
Coles and Woolworths previously reported income from rebates, discounts and promotional allowances in their annual accounts. But after a change in accounting standards under IFRS, trade spend is now netted off against their cost of goods sold.
Analysts say income from rebates, discounts and allowances remains a “big pot of money” for the retailers.
However, as the major retailers come under increasing scrutiny over their treatment of suppliers and as suppliers’ profits are squeezed, extracting more trade spend may prove increasingly difficult.
“Trade spend as a source of earnings growth is getting harder for the retailers to extract because of ACCC scrutiny and lower supply profitability,” said Citigroup analyst Craig Woolford.
According to the KPMG report, suppliers’ earnings before interest and tax to sales have fallen from 9.6 per cent in 2010 to 6.9 per cent in 2013 and are now well below those of their international peers, despite retailers’ claims that some multinational suppliers are “over-earning” in Australia.
“Overall, trade spend was the key driver for the declining gross and EBIT margins,” the KPMG report said.
Mr Dawson said the grocery code of conduct, which is expected to be introduced late this year or early next year, was founded on a reasonable sharing of risk and reward between retailers and suppliers.
Under the code retailers would no longer be able to charge suppliers for products stolen from supermarkets or pay 100 per cent of wastage, over which they have little or no control.
Retailers will also be banned from varying supply agreements retrospectively and demanding payments for better shelf space.
‘It’s untenable to think they can transfer 100 per cent of the risk and none of the reward to suppliers,” Mr Dawson said.
Last week the ACCC accused Coles of unconscionable conduct against five grocery suppliers in 2011 by forcing them to plug gaps in its profits, pay for wastage in stores and pay fines for late deliveries.
Coles has rejected the allegations, describing its communications with suppliers as “normal topics for business discussions” between grocery suppliers and retailers around the world.