Forget the headlines - the industry's margins and returns are too low to justify a price war, says Dr Clive Black


Andy cuts 5,000 prices and the papers respond with front-page headlines about the price war up and down Britain's aisles. Tel responds with £250m of new low prices . Marc weighs in with a bone-crunching all-you-can-eat BBQ for £4 .

In the midst of recession , Britain's food retail industry is gripped by a price war - yes? Er, well, no . The reality of the trading environment is not quite what headline writers portray. So what do we mean by a price war and why do we think we're not only not in one but that the industry won't see one soon?

First of all, there is no definition of a price war. We define it as 1%+ gross margin investment over a full year. Such an amount would be a massive 'investment' for the British industry, which works on cost of goods ratios of 20% to 30%. After labour, its biggest operating cost, distribution, store overheads and meeting the price of maintenance cap-ex and financing, the industry works on low-to-mid single digit pre-tax margins. This capital-intensive industry is also not especially stellar from a return on capital basis; Tesco, with world-leading capability, delivers capital returns of circa 10% to 11%, hardly super-normal.

Here lies the biggest reason why we do not believe there will be a real price war. Margins and returns are simply too low to justify such action. We struggle to see how anyone can materially win from a dash for share growth through aggressive gross margin investment with the industry structured as it now is.

Fifteen years ago there was arguably more rationale for a surgical strike with a substantial soft underbelly for Asda and Tesco to attack. Today, there are four big players with nearly 75% of the market. Operationally they are all in good shape while technological developments (the net, EPoS, digital TV) mean holding a price advantage is short-lived - most retailers can react to movements in KVI prices in hours. So the rationale is just not there.

We also believe the supply side and political environment work against a price war. From the supply side, there is more balance between capacity and demand today, reducing the retailers' leverage with manufacturers. Evidence for this is abundant through the success of cost recovery from rising commodity prices over the past two years. While it would be wrong to say that structures cannot improve further, better balance means that retailers are increasingly funding their own discounting and deep promotions rather than 'screwing suppliers'.

As for the political environment, three competition inquiries later there is a quite remarkably bureaucratic network governing this industry and one of the consequences is that agricultural commodity markets may not now be as efficient as they used to be because farmers' interests are supported through political and bureaucratic interest, working against price cutting.

So, there we have it. Normal cut and thrust yes. Price war, no. Low margins and capital returns, technological and organisational advancement and the vagaries of competition policy lead us to reach a point where we struggle to see an industry price war. Where we do harbour a concern is if the British economy collapses to the point that consumers say... 'I just can't afford that'. That is not a price war, but an end to things as we know them.


Dr Clive Black is head of research at Shore Capital stockbrokers.