The hidden costs of powerful buyers and cheap prices

Supply chains updates

There is a common thread running through a number of the disruptions and shortages caused by the global pandemic. Some supply chains have become dominated by hugely powerful buyers, who have used their muscle to provide lower prices to consumers. We have enjoyed the benefits of this dynamic for decades, but the crisis has made visible its hidden costs.

In the UK, every step of the food supply chain is suffering from labour shortages triggered by whipsaw demand and migrant workers going home. Employers in the farming, food processing and transport sectors all blame the same root cause. They say they relied on migrant workers because they had to compress labour costs to deliver the low prices demanded by large supermarkets.

The prices paid to UK farms for strawberries, to give one example, barely rose between 2008 and 2018, even as the minimum wage rose 37 per cent. In Germany, farmers are so angry with low prices, they have been blockading supermarkets with their tractors.

“If [the supermarket buyers] walk into the room and say you need to drop your price by say 10 per cent because we’ve been offered your volume by someone else . . . what do you then do when your entire business is geared up to supplying them — it’s very difficult to replace that volume, certainly quickly,” one UK-based farmer told me.

Nick Allen, chief executive of the British Meat Processors Association, says supermarket pressure helped cause consolidation in his sector: small and local abattoirs have been replaced with big ones located in places that are often inconvenient for local workers to reach. The number of pig abattoirs in England has halved since 2000 to 93, according to data from the Agriculture and Horticulture Development Board. The largest 11 kill 92 per cent of the country’s pigs.

Powerful buyers aren’t unique to the food industry. When the pandemic hit, many large clothing retailers pushed the cost of the drop in demand on to suppliers. UK retailer New Look, for example, told suppliers it was suspending outstanding payments owed to them indefinitely. In Bangladesh, a study found that half of garment suppliers had the bulk of their in-process, or already completed, orders cancelled. Of those, 72 per cent of buyers refused to pay for raw materials, such as fabric, that the supplier had already bought.

It’s hard to argue in the case of UK supermarkets that squeezing suppliers has helped them to amass vast profits. Operating margins for listed supermarkets Sainsbury’s, Tesco and Wm Morrison are between 0 and 3 per cent. Their shares have underperformed the FTSE 100 for more than a decade.

In recent decades, antitrust authorities have been relaxed about growing buyer power so long as it doesn’t hurt the consumer. Indeed, when UK supermarkets Asda and Sainsbury’s wanted to merge in 2018, they argued that by becoming an even bigger buyer they could extract lower prices from suppliers to benefit customers (in the end the merger was blocked, but not because of concerns about buyer power).

But policy is beginning to shift. In Germany, the government has clamped down on employment subcontracting in abattoirs which led to miserable conditions for workers and exacerbated Covid-19 outbreaks. “Meat is too cheap,” agriculture minister Julia Klöckner has said. She has also made new rules on how supermarkets can treat suppliers. In the US, Lina Khan, the new chair of the Federal Trade Commission, wants to transform the approach to antitrust regulation. She has argued that “focusing on consumer welfare disregards the host of other ways that excessive concentration can harm us — enabling firms to squeeze suppliers and producers [and] endangering system stability”.

A paper from 2018 on the US economy found that dependence on large buyers lowers the wages paid by suppliers, and accounts for 10 per cent of wage stagnation in non-financial companies since the 1970s. Innovation and investment may have suffered too. A paper on the UK pig industry concluded that relations in the supply chain were too adversarial, disorganised and uncertain to sustain investment by producers and processors.

Finally, there has been a cost to supply chain resilience. A system without slack, where suppliers and workers are stretched to the max by powerful buyers, may be efficient most of the time. But, as we have just discovered, when there is a shock, such a system can quickly fall apart.

Low prices are important for consumers, especially those on low incomes. But in single-minded pursuit of that goal, we traded resilience for efficiency. Now we are paying the price.

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