Shopping not going too well for Sainsbury’s and Asda.

A typical UK family spends approximately 10% on food, with the figure being 4% higher for low income families. Therefore, what happens in the grocery industry is of significance to all consumers in the UK.

The proposed merger of Sainsbury’s and Asda would, if no changes are made in their operation, create a business which has 29% of the grocery market (Sainsbury’s 15% and Asda 14%), employ 343,000 workers (Sainsbury’s 187,000 and Asda 156,000), have 2,104 stores (Sainsbury’s 1,428, Asda 676) and revenue of £50.7bn (Sainsbury’s £28.5bn, Asda £22.2bn). The new business, which joins Britain’s second and third largest supermarkets together, would push Tesco out of first place

The arguments in favour of the merger focus on the economies of scale which the new firm would gain, such as bulk buying and marketing economies. It would allow it to build a stronger on-line presence and counter the competition from the discounters Aldi and Lidl and also from the entry of Amazon into the grocery market. According to the Chief Executive of Sainbury’s, consumers would benefit from price cuts of 10% on “everyday products”.

Elsewhere, there were concerns that the merger would reduce competition. The CMA has identified 694 areas of the country where it would fall because both Sainsbury’s and Asda have stores (either supermarkets or convenience stores) which currently compete. However, Sainsbury’s and Asda argue that the physical presence of stores is increasingly unimportant as more shopping is done on-line. Consumer groups and trade unions fear that the merger would effectively create a duopoly among the supermarkets (Tesco and Sainsbury’s/Asda) which would allow pressure to be placed on suppliers to lower prices, would involve redundancies as the new firm closed stores and sacked staff and lead to lower quality and higher prices.

Although their final report is not due until April, the Competition and Market Authority announced last month that the proposed merger  was likely to be against the public interest, leading to higher prices and a reduction in the range and quality of products. They have the power to block the deal or, if they allow it, to ensure that the two companies sell off a number of stores and allow another company to buy either the Sainsbury’s or Asda brand.

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Natural monopoly and competitive markets

Any economics student who has studied long run cost curves should be familiar with the idea of natural monopoly.  Many utilities, such as telephones, water and electricity supply are natural monopolies.  This creates a problem when it come to privatizing a state monopoly, because a private monopoly can result.

In some cases the British government solved the problem by separating the natural monopoly, the network part of the business, from the supply section.  So we have UK Power Networks and a number of competing gas and electricity firms.  In the case of BT that was not the case and the privatized firm was allowed to keep its network.  However, this may be about to change, as this article shows:

http://www.telegraph.co.uk/finance/newsbysector/mediatechnologyandtelecoms/telecoms/11903239/Taking-Openreach-out-of-BT-could-backfire-warns-Ed-Vaizey.html

There will certainly be advantages and disadvantages to separating the network from the operator, but economic theory suggests it could be a good move.