PC News - August 2014

Costs of doing business - Retail trade and dairy product manufacturing

In recent interim reports, the Commission examined the costs of doing business in two Australian industries — retail trade and dairy product manufacturing.

As part of a broader study on the relative costs of doing business in Australia, the Productivity Commission was requested to undertake case studies of the costs facing businesses in the Australian retail trade and dairy product manufacturing industries. The Commission's interim reports were released in June 2014, and final reports will be sent to Government in October.

The Commission found that the costs of doing business in the retail sector are inflated by unnecessary regulations, and governments' progress to address costly anti-competitive provisions has generally been slow and patchy.
In relation to dairy product manufacturing, the Commission found that Australian dairy manufacturers face some cost disadvantages relative to their international competitors, but also some relative advantages, including lower raw milk costs. Some cost disadvantages arise from inefficient policies where corrective action by governments could be warranted, but others simply reflect market conditions where policy interventions are not warranted.

Retail trade

Retailers are facing increasing cost pressures

Over recent years, prices of labour, rent and energy have risen by more than the consumer price index for retail goods (figure 1). Notwithstanding the significant diversity of cost structures across different types of retail businesses, labour costs are the single largest area of expense for most retail businesses. Occupancy costs, including rent, also account for a substantial share of many retailers' costs of doing business.

Retail businesses are responding …

The Commission's preliminary view is that the Australian retail sector as a whole appears to be managing these cost pressures effectively.

The evidence suggests that retailers' net margins have been relatively stable over the past two decades
There has been continued growth in investment and employment, notwithstanding a short term decline after the global financial crisis.
An increasing number of high profile international players are investing in a 'bricks and mortar' presence in the Australian retail market.
Retailers are innovating and adopting a range of strategies to reduce their costs of doing business through the use of technologies such as self-assisted checkouts, a shift from casual to permanent staff, better supply chain management, the use of private label merchandise, energy efficiency measures and a move to online operations.

… within an environment that remains encumbered by unnecessary and costly regulations

The Commission last examined the retail industry in a 2011 inquiry report. Many of the recommendations in that report related to governments removing unnecessary impediments to competition.

Since then, the retail environment has continued to evolve, with retailers operating in an increasingly dynamic and globalised environment and consumers looking for better value for money and more convenient shopping options. Despite the growing cost pressures on retailers progress against the 2011 recommendations has been slow. While all jurisdictions have initiated reform processes, few have achieved substantial reform, and the pace of reform differs markedly across jurisdictions.

Figure 1 Retail labour and intermediate input prices have increased relative to capital prices and final retail prices

Labour and intermediate cost shares from multifactor productivity estimates
Retail input price indexes and the Consumer Price Index, 1997-98 = 100

For data sources and notes see Productivity Commission 2014, Relative Costs of Doing Business in Australia: Retail Trade Industry, Interim Report

Restrictions on trading hours

These impediments include, for example, restrictions on trading hours across and within jurisdictions, and restrictions on what can be sold at particular times. At a time when e-commerce and lifestyle considerations are changing shopping patterns considerably, these restrictions are increasingly out of step with community expectations.

Beyond the costs to consumers, regulations on trading hours also have efficiency costs for retailers. A retailer forced to close earlier than desired suffers from excess capacity, since capital investment (for example, plant and equipment) is not fully utilised. Moreover, being forced to close on Sundays, for example, prevents retailers from managing their stocks better, especially those of highly perishable goods like fruit and vegetables. More produce is wasted and last minute sales are more frequent. There are also additional compliance and operational costs to retailers who trade in all states. These costs become more acute around the time of gazetted public holidays, when retailers have to interrupt 'normal' trading arrangements and put in place different arrangements to comply with the diverse public holiday trading arrangements set down in different states, different regions and different local trading precincts across Australia.

While some gains have been made across Australia in the deregulation of retail trading hours, inconsistencies remain across and within jurisdictions. Trading hours are effectively deregulated in Victoria, Tasmania, the Northern Territory and the Australian Capital Territory and are largely unrestricted in New South Wales. However, they are most restricted in South Australia, Western Australia and Queensland, and are inconsistent within these jurisdictions.

Dairy product manufacturing

Australian dairy product manufacturing businesses are diverse

There is significant variation in the scale and product mix of dairy manufacturing businesses (figure 2). While the industry has a national footprint, most manufacturing activity occurs in south eastern Australia, where about 80 per cent of Australia's raw milk is produced.

This diversity has direct implications for cost structures and prices. For example, while raw milk costs averaged 29 per cent of industry output in 2009-10 (denoted by 'agricultural products', column 1, figure 3), this share varies across dairy products, and some participants reported much higher cost shares for raw milk.

Scale is important but not the whole story

The decline in raw milk volumes, and seasonal variability, may be limiting Australian dairy manufacturers' ability to achieve scale efficiencies and better asset utilisation. However, the commerciality of increasing milk production is primarily a matter for manufacturers and dairy farmers.

A competitive global dairy market

Dairy product markets are global, highly competitive and reasonably mature. About 40 per cent of Australia's dairy output (in milk equivalent terms) is exported, with China and Japan the largest markets. The integration of Australian dairy manufacturers into world markets means that domestic dairy product prices (and farmgate milk prices) are strongly influenced by international markets and prices.

Figure 2 Raw milk utilisation by state, 2012-13
Figure 3 Country comparison of overall cost structures
Per cent of industry output, various years

Faced with fierce competition for export markets and for domestic resources (such as land, capital and skilled labour), dairy product manufacturers will need to continue to innovate and improve the efficiency of their cost structures.

Foreign direct investment in the dairy industry can assist in improving and extending supply chains, help gain access to foreign markets, bring know-how and promote innovation.
Research and development is an important contributor to improvements in efficiency and productivity.

Removing inefficient policies would have community-wide benefits

Policies that advantage particular firms or industries at the expense of the rest of the economy — including dairy product manufacturers and dairy farmers — should be removed (for example, distortionary forms of drought assistance and inefficient environmental and climate change policies).

Reforms to utilities regulations that promote efficient pricing and ensure reliability requirements reflect consumers' willingness to pay could benefit the economy and reduce costs for dairy product manufacturers and dairy farmers.

Relative Costs of Doing Business in Australia:

Read the Retail Trade Industry Interim Report released June 2014
Read the Dairy Product Manufacturing Interim Report released June 2014