Pricing behaviour in British supermarkets: obfuscation and leadership?

1. Pricing behaviour in British supermarkets: obfuscation and leadership? Michael Waterson University of Warwick Reporting on work in part done jointly with RatulaChakraborty, Paul Dobson, Jon Seaton Presentation OFT- July 2012 Preliminary- please do not quote

2. Plan • To analyse the behaviour of the “big 4” GB grocery retailers in response to competition and cost pressures- focus on inflationary period in 2008- essentially empirical exploration • The nature of our data • Some theoretical considerations • Empirical exploration, examining the detail of pricing behaviour • Revealing and exploring puzzles in the data • Implications for theoretical models • Examining price leadership • Complementary to Griffith et al. analyses of consumer behaviour in food purchasing (eg J E Perspectives, 2009)

3. Shopper Spending in Grocery Retailers: 2008 (source, Nielsen, 2009)

4. Data • Tesco Pricecheck website, then subsequently mysupermarket.co.uk website, for data on firms’ prices by week across a large number of products • Prices gathered manually in Tesco exercise • Recall that all four firms set national prices across all their superstores • Coverage varies over time • Our aim is to get a consistent set of • products where prices for all • players are available over the whole • of the period- two subsamples • None of the players have complained • about the methodology or quality of • basic data gathered • Supplemented with information from • a variety of other places TP600 M370

5. Theoretical considerations (1) • Concerning their main shopping trip, consumers purchase a “basket” of food on a (broadly) weekly basis- within this there will be both regular items and occasional purchases • The price of the basket will differ across the main suppliers, although the products will be similar/ identical • The consumer’s decision is (a) which supermarket to patronise (assume too expensive to go to 2 or more), (b) what additional goods to purchase • Chen et al (J Monetary, 2008) probably closest to our work- using Dominick data they find “small price increases occur more frequently than small price decreases for price changes of up to 10¢.” (in inflationary and non-inflationary periods).- “rational inattention”. Also other “macro” papers.

6. Empirical investigation • A number of hypotheses that can be examined with our data • To preview results, we do not find much in accord with the comparative statics arguments • Rational inattention may have a part to play, but not in the way hypothesised by Chen et al. • We focus on an inflationary period in 2008

7. The background: Cost pressures

9. Is our sample representative? TP600 data

10. Common Patterns As the graph shows, although there is no weighting in the indexes constructed for Tesco etc, the experience aggregating across prices is very similar. This is confirmed by the correlations across the series M370 Product sample

11. Conclusion so far • There was an inflationary episode of unusual proportions in grocery prices in the first 6-8 months of 2008 (presumably as a result of the significant increase in commodity prices in the early months of that year). Followed by slump in output from September. • This episode is apparent in the CPI and equally in the set of prices we have collected from the major supermarket chains- our set of prices follows closely the official index • Hence, our set of prices appears representative of the baskets collected for the CPI from these chains plus other outlets

12. Pricing behaviour in the inflationary period of 2008 • So the question becomes: How did these firms manage to raise prices to consumers to such an extent whilst maintaining position? • In part a question of the mechanics • But more deeply a question of what consumers “see” • Initially, this puzzle deepens • Because there are more price falls than rises in 2008, particularly during the period of most rapid inflation!

13. There are more falls than rises overall (true other periods also) Source: TP600

15. What is the answer?

16. Pencechange Note remarkable concordance of views on this

17. 2008 versus previous years- some findings • There are around 4 times as many price falls per year in 2008 than there were in the previous years • But only about 2.5 times as many price rises • Tesco, the most active price changer that year, keeps a very similar proportion of both the price rises and the price falls across 2008 as it was in the previous periods • As well as price changes intensifying, the distribution of price changes across particular values is massively (statistically significantly) different between 2008 and the earlier years; the price movements are very asymmetric • Features include many more price falls than expected in the 1p- 6p range, fewer than expected above that • There are fewer than expected small price rises, but more than expected larger ones, except for round number values, 10p, 20p.

18. Implications • The “trick” reconciling more prices falling, with overall basket price rising, is that the falls tend to be associated most closely with penny falls, although there are also substantial numbers of larger price reductions • Price rises tend to be concentrated on rather larger values, with 10p popular, but other higher values also • All four firms have similar views as to popular price movements- Psychology rather than Economics? • These conclusions on rises v. falls are completely different from those of Chen et al., both in and out of inflationary times • This is consistent with obfuscation and inattention, more broadly: clear attempts to confuse the consumer about price trends

19. Basket prices and obfuscation What is the nature of the obfuscation? • Consumer buy baskets, not individual products, in these stores, although prices are what are observed • What sorts of prices are changed? • Test the hypothesis that one chain is cheaper than another

20. Examining the variance of “basket” prices • If the variance of the basket price is large across baskets, they may find it difficult to determine whether their basket is actually cheaper at one store or the other • We selected baskets of 30 and of 50 items, items randomly chosen with weights according to importance in expenditure, and generated a 100 samples (with replacement) of this size from our data, retrieving the mean and variance of the basket price. • Results:

21. Testing whether one supermarket chain is cheaper than another

22. Basket prices and obfuscation (continued) • What sorts of prices are changed? • Descriptive regressions • Four hypotheses: • Price cuts may be loaded onto branded products and promoted • the consumer may recall less accurately the price of an infrequently purchased item, so load price rises onto them • the consumer notices price rises less on high value goods than on low value goods • Prices more likely to rise when costs rising

23. Descriptive regressions

24. Effects seem more “random” in 2008- adding noise to the basket

25. Conclusions on obfuscation • The big commodities costs increases in early 2008 led to a problem for UK supermarkets in dealing with the cost pressures • They raised the price of the consumer’s “basket” of products • The way they appear to have tackled the problem was through obscuring the basket price rise through a massive excess of small price falls, obscuring the price rises that were occurring. • Is there a leader in all this?

26. What is price leadership? • OECD definition: “Price leadership refers to a situation where prices and price changes established by a dominant firm, or a firm are accepted by others as the leader, and which other firms in the industry adopt and follow” • Scherer and Ross: Dominant firm, Collusive and Barometric Barometric: “occasional changes in the identity of the price leader … the absence of leader power to coerce others into accepting its price; a tendency for the leader formally to validate price reductions that other sellers have already initiated” (1990, p. 249) • These definitions strike me as tautological. • So, we devise a definition that is testable- PL may not exist, and use it to examine UK supermarket behaviour.

27. Plan • Define price leadership in a testable way • Explain usefulness of British supermarket industry for this • Devise the sample of products, etc. • Characterise pricing behaviour • Examine leadership incidence, significance and impact- an empirically-based examination • Next steps

28. Our definition of price leadership • Price leadership occurs when one firm makes a change in its Regular Price (Nakamura 2008) that is followed within the next two weeks by the other (another) firm making a Regular Price change of exactly the same monetary amount in the same direction on the same product. • This excludes: • temporary price changes, • simultaneous price changes, • those followed with a long lag, • price changes of similar monetary amounts, • Price changes on a similar but not the same product • So it is testable- it may not occur.

29. Our data sample • Weekly prices for 370 precisely defined products over 7 years (late 2003- late 2010) for Tesco and Asda. • Note: These are National prices, applied uniformly across all large supermarkets within their chains (in Asda’s case, this is virtually all their stores nationwide; in Tesco’s case, their most important stores). • Product examples: Nescafe Gold Blend Coffee 200g; Own label fresh single cream, 568ml • Products determined by completeness of data • Note: Price leadership (under our or other definitions) leaves open the issue of a suitable starting point • We analyse pricing behaviour for 331 of our 370 products, for which prices are identical/ become identical across firms within 6 weeks of the start of the sample period. • Types: Upward/ downward; Tesco/ Asda • Prices very flexible

30. Findings on price leadership (1- Incidence)

31. Findings on price leadership (2- Temporal variation)

32. Is this behaviour random? • No Evidence: null hypotheses (i) that behaviour is random across the years in terms of upwards versus downwards movements, (ii) that the share of upwards movements by Tesco versus Asda is randomly distributed across the years, (iii) the same for downwards movements, (iv) that upwards and downwards movements are a random proportion of total price changes • All these are tested (chi-sq) and the null is rejected. • Plus further test (next slide)

33. Are the price changes caused by cost changes? • No • At least, this is not the sole or main driver • Casual evidence: • Rapid pace of price changes • The very large number of penny price falls • The large number of price falls more generally • The diversity in experience across products • Comparison with simultaneous price changes (otherwise defined in the same way)- explain idea Significant “excess” of leadership incidents

34. Effects relating to particular product types • What proportion of our products is led up by one or other firm? • Own brand products are (slightly) more likely to be led up • Does leadership lead to greater overall price rises? • Difficult because • We don’t have cost data • Most products complex (e.g. not just price of wheat) • But: within the largest category within our sample, Bread and Cereals, the mean price increase across the seven products with five or six instances of Tesco leadership was 68.6%, whereas for those 16 with zero instances it was 34.4% (significant difference)

35. Next steps and reflections • No particular theory of why the price leadership as defined takes place- is there an encompassing theory? • How much do we need to have before we call it leadership- is every instance leadership? • We proposed a tight definition of price leadership, yet found extensive (and possibly growing) leadership behaviour, by both main players • However, there is no direct evidence of intent • That is, the definition does not lead to a causal explanation • How to capture this issue?

36. Key stylised facts on prices in British supermarkets

37. This intensification is particularly true of the number of penny falls

38. Theoretical considerations (2) • There are several models showing that obfuscation (here, relevant to bundle) can exist in equilibrium (e.g. Ellison/ Wolitsky) • These have comparative static implications Highest cost firms use obfuscation most Increased competition increases obfuscation • Which prices are most likely to be used in this way? It is possible that price rises will be more likely on infrequently purchased products, where the consumer has poor recall (similar argument to Sorensen, 2000, pharmacy pricing paper) Or they may be on larger items, so smaller percentage rises 10. 11. Large number of “macro” papers exploring the importance of micro price changes

39. Market Shares of Top 4 UK Grocery Retailers (1993-2011) Source: Kantar WorldPanel (based on consumer panel till roll receipts)