Grocers face price check: Are supermarkets abusing their immense buying power

In April 2008, after a gruelling two-year inquiry, the UK Competition Commission unveiled its eagerly anticipated final report on the £110bn grocery sector.

A key recommendation was to establish an ombudsman to police relations between the big grocers and suppliers, in an effort to stamp out alleged cases of bullying or the supermarkets allegedly abusing their immense buying power. The commission, which does not have the power to introduce an ombudsman itself, sought the agreement of supermarkets for this. But most have vehemently opposed the idea, arguing it would add red tape and costs, which would be passed on to customers.

Yesterday, the commission bared its teeth and formally recommended to Lord Mandelson's Department for Business, Innovation and Skills (BIS) that it should establish an ombudsman to arbitrate on disputes between grocers and suppliers, under the terms of the new Groceries Supply Code of Practice (GSCOP). The new code will come into effect on 4 February 2010, replacing the hitherto voluntary code that the big four grocers signed up to. The ombudsman and GSCOP applies to the 10 grocers with annual turnover of more than £1bn: Tesco, Asda, Morrisons, Sainsbury's, Aldi, Lidl, Waitrose, The Co-operative Group, Iceland and Marks & Spencer.

Peter Freeman, the Competition Commission's chairman, said: "Our inquiry clearly revealed problems that require action and which, if left unchecked, would damage the consumer. We continue to believe that everyone's interests – and that includes retailers – would be served by tackling a problem that has clouded the industry for many years now." He added that "The current economic difficulties if anything reinforce rather than reduce the need for action."

While industry observers have welcomed the introduction of an ombudsman, some remain sceptical that the body would be able to rein in any activities of the big supermarkets. Bryan Roberts, the global research director at Planet Retail, says: "It is welcome in practice, but I think it will be a paper tiger. It will probably not amount to much."

Grocery suppliers certainly feel that the current system favours the supermarkets. At present, the Office of Fair Trading is responsible for monitoring relationships between suppliers and supermarkets under the voluntary Supermarkets Code of Practice.

However since the code came into effect in 2002, the OFT has never moved against a supermarket after receiving a complaint from a supplier, although the grocers assert this is because the existing code works.

In reality, suppliers have little confidence in the regulator to deal with grievances and – given the enormous buying power of the big grocers – are petrified of having their contracts terminated if they stick their head above the parapet to complain. More specifically, suppliers feel they lack protection against practices that can include retrospective changes to contracts agreed, or being charged for wastage or shrinkage when products break or get stolen in the supply chain. Duncan Swift, the joint head of food at the accountancy firm Grant Thornton, which advises financially distressed food businesses, says: "Having seen the lack of effectiveness of the [voluntary] code since 2002, you effectively need a regulator that has the appetite and the industry teeth that are seen to make a difference." He added: "All the supply-chain risk continues to be borne by the suppliers."

The ombudsman's overriding role will be to undertake investigations and to act as an arbitrator between retailers and suppliers in disputes arising under the terms of newly introduced GSCOP.

In certain circumstances, it is envisaged that the ombudsman will be able to investigate "proactively" areas of complaints regarding a particular retailer, while maintaining the anonymity of the supplier.

Fear of losing a supermarket's business is a key reason why so few suppliers come forward.

However, if a supplier wants to get a complaint formally resolved, it will almost certainly have to be named to enable a thorough investigation and arbitration. A supplier that wins a dispute could be reimbursed for lost business and incurred costs in bringing the action – although this has not yet been decided.

A decision is likewise pending on whether fines will also be issued, but the Competition Commission said yesterday that "The ombudsman would be more effective if it had more comprehensive powers to investigate and penalise retailers for non-compliance with the GSCOP."

Over recent years, the highest- profile case referred to the OFT involved Ferndale Foods and Asda. But in 2005, the OFT dismissed the ready-meal supplier's claim that Asda has failed to give it the full 90 days notice before terminating its contract. Mr Swift said: "The OFT has done nothing of note in regulating the supermarkets over the last seven years."

Only a few of the big grocers, including Waitrose and Aldi, are in favour of the ombudsman. While the big four supermarkets broadly welcome the strengthened GSCOP and it being extended to their six rivals, Tesco, Asda and Sainsbury's are firmly against the introduction of an ombudsman.

They argue that it represents unnecessary red tape, will lead to higher costs for consumers and will provide additional protection for some of the world's most powerful consumer goods companies, such as Unilever and Procter & Gamble.

Lucy Neville-Rolfe, Tesco's executive director, said: "We believe that, perversely, the ombudsman would mainly benefit large successful suppliers who are well able to look after their own interests.

"It's a highly competitive industry and if our ability to negotiate with such suppliers is reduced, the inevitable result will be higher prices to consumers at a difficult time."

An Asda spokeswoman said: "An ombudsman is bad news for consumers – it will effectively be a one-sided pressure group for price rises from big multinational suppliers, allowing inflation in through the back door." Sainsbury's said: "We consider that the OFT is well placed to continue in its current role of regulating the code and that there is no need to establish new powers."

However, Mr Swift says the idea that the ombudsman will hit consumers is "scaremongering". The Commission forecasts that the cost of the ombudsman, including set-up costs borne by the grocers, will be about £5m a year, compared to the £70bn of grocery supplies to retailers in the UK.

In fact, Grant Thornton estimates the ombudsman will only add 1.25p to the average family weekly grocery bill. However, the British Retail Consortium said: "Lord Mandelson must reject the Competition Commission's recommendation."

In fact, some are sceptical that the the department will want to bring in the ombudsman any time soon. For those in favour of an ombudsman, the worst-case scenario is that BIS will not want to introduce the necessary legislation to establish the ombudsman and will refer it back to the OFT.

Mr Swift said: "BIS is highly unlikely to do anything before the next general election. That means that it will be left to the OFT, to take on responsibilities which an ombudsman would have had."