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Fighting the food fight

2 October 2014 By Edward Hadas

British supermarkets are doing something unusual. They are following the rules of textbook economics: responding to competition by cutting prices. Such behaviour is rare. While business bosses often say they admire free enterprise, we actually live in a restrained enterprise economy. Everyone should be grateful.

J Sainsbury, the No. 2 in the British grocery market, is the latest established competitor to suggest that its profit is sliding. Its admission follows grim announcements from market leader Tesco and Wm Morrison. Tesco has already cut its interim dividend by 75 percent, and Sainsbury is likely to follow.

The big problem for the established UK chains is the advent of so-called hard discounters, most notably German chains Aldi and Lidl. They have lower costs so can charge less and still earn good profits. The main response from the market leaders has been to cut prices. The battle is an excellent example of how capitalism spawns creative destruction. Shareholders of the losing companies suffer, but the overall economy benefits.

Creative destruction, though, is usually much more civilised than this British food fight. In most industries, price competition is limited and all but the weakest companies stay in reasonable financial health. Prices do decline in times of overcapacity, but not ruinously. As a consequence, companies can earn reasonable profits and can therefore afford to re-invest in their businesses.

Even when faced with disruptive new technologies or innovative new formats, struggling large companies rarely engage in ruinous price wars. The standard practice is to keep prices fairly high and hope for an improvement, or a takeover.

For example, Motorola, Nokia, BlackBerry and other winners-turned-losers in the mobile phone business, have faded into insignificance without doing any noticeable damage to the higher returns garnered by more successful peers. In the U.S. car industry, a huge recession did briefly kill profits but prices soon settled at levels high enough to provide almost all the big producers with reasonably high returns, despite theoretically intense competition and global oversupply.

Airlines in the United States used to be notable outsiders in the restrained enterprise economy. From the advent of fare deregulation in 1978 until very recently, large and small carriers repeatedly priced their way into bankruptcy. It looked like the industry had not captured the true, oligopolistic spirit of modern capitalism.

Now, though, there are only four U.S. national airlines, and they seem to have caught on. While old habits die hard, it would be unsurprising if the next cyclical downturn saw the number of available flights decline while fares stayed high.

The prevalence of restrained enterprise can make the political blood boil on both the right and the left. It looks like markets are rigged markets and crony capitalism is endemic. All-powerful companies, it may seem, make a mockery of both free market capitalism and democratic values.

The appearance is largely deceptive. In the almost infinitely interconnected contemporary economy, blind competition does more harm than good. Excessive price pressure reduces the funds available for investments in long-term projects. Too-easy failure of established companies destroys jobs, which are typically in short supply, and reduces the willingness to invest in risky ventures.

Most important, cooperation often does more good than competition. Whole industries are far better than individual companies at many important tasks. Competitors gain when they come together to work with regulators, lobby governments, guide universities and research institutions, set quality and technological standards, and deal with public worries and hostility.

When the restrained enterprise economy works well, industries are dominated by a small group of large and basically responsible companies. They compete enough to ward off stagnation and complacency, but not to the point of mutual harm. By getting along, they minimise unnecessary disruptions, work better with stakeholders and invest ambitiously.

When this economy works badly, however, the companies are irresponsible and collude against the common good. Their profits do become unnecessarily high. They use their power against workers, customers and other groups which should be partners, not enemies. They stifle useful competition. They resist helpful innovations such as lower cost structures in food distribution. They give superstar pay to humdrum captains of industry.

Economies cannot stay successful unless those gains from competition are kept under control. That requires enough economic and political freedom to allow outsiders – not only new competitors but governments, civic campaigners and customer groups – to challenge excesses and shake up complacent industries.

In most developing economies, these challengers are hamstrung. The situation is better in the United States and Europe, although the prevalent level of executive pay is a clear sign of excessive corporate cooperation. Still, all is not lost. In the UK food retailing business, new competitors are doing the rough work needed to keep the economy strong.



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