Every year, the supermarkets hire substantial batches of high-flying graduates to work in their buying departments. The urban mythology is that these expensively-educated young people are paid to shout down the phone, browbeating suppliers to offer yet more discounts.
This hectoring seems to be at the heart of the recent decision of the Groceries Code Adjudicator to investigate Tesco, following allegations that the company delayed payments to suppliers and unfairly handled payments for shelf promotions. These particular complaints may prove groundless. Yet they don’t exactly serve to diminish sentiment that Britain’s large firms can act as ruthless short-term profit maximisers, squeezing their supply chain for every penny. Of course, even if that is the case, we could simply see it as being part of the workings of the free market, in which the most efficient survive. But given the relative sizes of our corporate giants and most of their suppliers, there is an inherent imbalance of power at play.
So how else could these supply chains be managed? Milk is a topical example, in which the much-maligned Tesco, along with Marks and Spencer and Waitrose, is cast as the good guy. It established long-term contracts with suppliers, in which the dairy farmers are probably getting around 30p a litre for milk. Amid allegations that supermarkets are using milk as a loss leader in price wars, other farmers are believed to be receiving as little as 20p a litre – below the cost of production. The National Farmers Union warns that many will be driven out of business; over the past decade, nearly 10,000 dairy farmers have left the industry.
Another answer can be found in many extant markets that function in more sophisticated ways, flying in the face of the simple economic textbook injunction of “slash costs and maximise profit”.
A 2012 paper by Alan Kirman of the University of Marseilles and Nick Vriend of Queen Mary, London, demonstrated this by studying Marseilles’ wholesale fish market. They obtained a data set documenting every single transaction that took place in the market, across a number of years. At the time, there were about 40 registered sellers, and around 400 regular buyers. The prospective buyer approaches a seller and says what he or she wants, and is quoted a price – crucially, no prices are advertised. The price quoted is on a take it or leave it basis, and there is no bargaining.
You would be forgiven for wondering how these non-conventional features translate into business. But for every type of fish, and across the market as a whole, the classic downward sloping demand curve is seen. A higher average price means less is bought. And in a reciprocal process, buyers become loyal to the sellers who offer them the highest utility. In turn, sellers tailor their products and services to these loyal buyers, who prompt higher gross revenues.
There is a lesson here for larger companies. Developing such longer term relationships may enable value to be created in the supply chain – in contrast to the conventional model, in which it is well and truly squeezed out.
Paul Ormerod is an economist at Volterra Partners LLP, a visiting professor at the UCL Centre for Decision Making Uncertainty, and author of Positive Linking: How Networks Can Transform the World.