By Charl van der Merwe
The South African Competition Commission (“SACC”) on Wednesday 29 May 2019 released its interim report on its findings in the Grocery Retail Sector Market Inquiry (“Inquiry”).
The Inquiry’s terms of reference, published in October 2015, mandated the SACC to investigate:
- “The impact of the expansion, diversification and consolidation of national supermarket chains on small and independent retailers in townships, peri-urban and rural areas and the informal economy;
- The impact of long term exclusive lease agreements entered into between property developers and national supermarket chains, and the role of financiers in these agreements on competition in the grocery retail sector;
- The dynamics of competition between local and foreign national operated small and independent retailers in townships, peri-urban areas, rural areas and the informal economy;
- The impact of regulations, including inter alia municipal town planning and by-laws on small and independent retailers in townships, peri-urban areas, rural areas and the informal economy;
- The impact of buyer groups on small and independent retailers in townships, periurban areas, rural areas and the informal economy;
- The impact of certain identified value chains on the operations of small and independent retailers in townships, peri-urban areas, rural areas and the informal economy.”
The Inquiry received extensive submissions from industry stakeholders including large grocery retailers (“larger retailers”), FMCG suppliers, banks, shopping center property developers (“property developers”) and small and independent retailers. The public hearings of the Inquiry were held in all major cities during April 2017 to November 2017 with further ‘informal hearings’ in smaller towns across South Africa. The Interim Report was hailed by SACC Commissioner, Tembinkosi Bonakele (“Commissioner”) at the media briefing on 29 May 2019 as the most comprehensive study into all elements of the grocery retail sector.
Industry stakeholders will have a further opportunity to engage with the SACC on the findings of the interim report and to present further written submissions before Friday 28 June 2019. The Final Report is expected to be released on 30 September 2019.
Long Term Exclusive Lease Agreements and Rental Costs
The Inquire placed great emphasis on the practice of long term exclusive lease agreements entered into between large retailers and property developers apropos new shopping malls and other property developments. The Inquiry found that these exclusive lease agreements range for periods of up to 45 years, constituting what the Inquiry termed unnecessary artificial barriers to entry.
A central focus of the Inquiry was the significant market power of the large retailers which enable large retailers to negotiate long term exclusive lease agreements, lower rental fees and more favorable rebates from suppliers.
The Inquiry found that property developers are reliant on the large retailers’ participation in new property developments (as anchor tenants) as they attract customers to the development and are also required by banks and other financial houses to advance funding to property developers. It is noteworthy that the Inquiry found that contrary to the submissions made by large retailers, finance houses do not demand exclusivity (only a fixed terms commitment from an anchor tenant). The practice of exclusivity was introduced by the large retailers as compensation for risk.
The Inquiry found that the prevalence of the long term exclusive lease agreements had the effect of reinforcing the levels of concentration in the market as the ‘process’ repeats itself which each new development. While this does mean that new competitors are foreclosed from the market, significantly, it also excludes small and independent specialist retailers such as butcheries, bakeries etc, which, according to the Inquiry, deprive consumers of ‘bespoke’ or ‘craft’ products which characterizes the retail sector in other areas of the world.
The Inquiry found the submissions made by the large retailers as ‘not compelling’ and has recommended that:
- Large retailers immediately cease enforcing exclusivity provisions against specialty stores (which was undertaken by the large retailers); and
- Exclusivity clauses be ‘phased out’ within 3 years (and no new lease agreements be entered into that contain exclusivity) in order to allow new entrants into developments.
A second but related finding of the Inquiry is that large retailers are able to use their bargaining power to negotiate lower rental fees in property developments which, according to the findings, causes property developers to increase rental fees for small and independent stores in order to ‘recoup’ the discount offered to the large retailers.
The Inquiry heard evidence from a variety of small retailers and specialty stores (as well as property developers) that the higher rental fees in property developments hinders entrance or leads to the failure of small retailers and specialty stores. Interestingly, the Inquiry did not make any recommendations in this regard and, instead, called for further submissions on the commercial realities and possible remedies.
The Inquiry found that that the large retailers also enjoy significant market power, compared to independent retailers and wholesalers, as they provide a key route to market for suppliers. Accordingly, the Inquiry found that large retailers are able to extract more favorable trading terms than that which wholesalers and/or buying groups are able to negotiate. Interestingly, however, the Inquiry found that large retailers are able to extract larger rebates than buyer groups, despite the larger volumes purchased by buyer groups.
According to the SACC chief economist, James Hodge, the primary concern is not ‘basic rebates’ which are also available to buyer groups and wholesalers but rather the ‘special retail rebates’ (e.g. distribution center rebates, store opening rebates, advertising rebates etc.) which are not available to wholesalers or buying groups.
In this regard, the Inquiry found that the justification for these ‘special retail rebates’ are unconvincing as the knock-on effect is that the independent retailers or specialty stores at the retail level (who purchase stock from wholesalers and buyer group) face higher costs and cannot compete with the large retailers.
The Inquiry recognizes that rebates are not inherently anti-competitive and can often be justified. The Inquiry further found that the current rebate structures cannot be easily changed without commercial disruption. The Inquiry, therefore, did not make any recommendations and, instead, invited industry stakeholders to engage with the Inquiry in order to address the issue.
The Inquiry also recommend intervention, through regulation, by a “single government department”. The department was not specified due to the uncertainty on whether the Economic Development Department (“EDD”) will remain in its current form. The EDD has now been subsumed into the Department of Trade and Industry (“DTI”), which will be headed by former EDD minister, Minister Ebrahim Patel. The DTI is, therefore, likely to be nominated as the relevant governmental department.
As an alternative, the Inquiry recommend an industry code of conduct, which requires buy in from industry stakeholders to agree on and implement policies which would otherwise cause commercial disruption. Industry codes appear to be increasingly finding favour with the SACC as a form of soft enforcement. There is currently a draft Code of Conduct published in relation to the Automotive Aftermarket.
In this regard, the SACC Commissioner noted that the grocery retail sector is a sector which is known around the world for being highly regulated and, according to the Inquiry, is not conducive to the levels of concentration experienced in South Africa. The Commissioner, therefore, remarked that the sector cannot wait for the slow and costly process of regulating conduct through enforcement and should, instead, be remedied through ideally am industry code of conduct and/or regulation.
Asked to comment on the impact of the Code, John Oxenham says that “the timing of the Code is noteworthy in light of the Competition Amendment Act and draft buyer power and price discrimination regulations having been published. Dominant entities involved in the FMCG sector, will likely have to carefully evaluate their trading terms to ensure that they are objectively justifiable not only in light of traditional competition law principles but also public interest related objectives“.
Fellow competition lawyer, Michael-James Currie concurs with Oxenham and suggests that “while rebates can be anti-competitive, there needs to be robust evidence and a clear theory of harm before an anti-competitive finding. This ordinarily requires a case specific assessment based on the facts at hand which may make ‘industry wide’ reforms difficult to monitor and enforce. Likewise, rebates are nor per se anti-competitive and therefore industry wide reforms or blanket thresholds may have unintended consequences and potentially have adverse effects on consumer welfare.”
Oxenham suggests that a “carefully balanced approach must be taken in this regard, although this appears to be recognized by the SACC“.
It is clear from the Report that industry participants will ultimately need to justify and support any alleged pro-competitive effects based on clear and objective evidence.