New regulations on relationships between supermarkets and suppliers highlight the benefits and pitfalls of third party intervention
For a piece of regulation that was meant to improve relations between suppliers and buyers, the UK’s new supermarket supply code of practice did not get off to an auspicious start. Introduced in early February, the Groceries Supply Code of Practice is aimed at eliminating alleged abuses of market power by large retailers in their dealings with small suppliers. The rules are designed to calm often fraught relationships.
And the introduction highlights the problems of regulating the sensitive and sometimes nebulous field of supplier relationships in any sector. Whereas there are clear rules, in the UK and elsewhere, that cover the process of procurement, regulation aimed at directly influencing the ensuing relationship between buyer and supplier is much rarer. This makes the new supermarket code a particularly interesting case in judging how far such rules can go.
It is early days for the deal and they have been anything but smooth. First, the National Farmers Union accused the big supermarkets of using “bully-boy tactics” claiming attempts to drive through price cuts and renegotiate contracts just before the new code came into force. Then the chief executive of the frozen food chain Iceland called the code “a complete waste of time”.
The two sides remain doggedly opposed on one key point: whether there should be an ombudsman to deal with complaints. This question is currently the subject of a 12-week consultation period that is likely to be as lively as the exchanges so far.
The supermarket case is an unusually heated one, with relations between big supermarkets and their smaller suppliers having long been the subject of fierce public discussion. The code is regulated by the Office of Fair Trading (OFT) and covers the 10 biggest grocery retailers in the UK including Tesco, Asda and Sainsbury’s. It outlaws a number of practices used by some big chains such as retrospectively altering supply terms and asking suppliers to fund promotions, and obliges supermarkets to keep written records of negotiations.
The code stems from a finding last year by the Competition Commission that large grocery retailers were passing on unexpected costs and excessive risks to their suppliers. According to these suppliers, the code is a response to a problem with a severe impact on many businesses.
“If you go into a deal with your eyes wide open and you’ve agreed a price, then that’s fine,” says Terry Jones, head of the NFU’s London office. “What isn’t fine is where you see the retrospective techniques coming into play.
“Things that really get people upset are when you do the framework deal for 12 months, and then you get a retrospective demand for sums of money or retrospective changes to conditions. You’ve done the deal but someone comes back and says ‘We’re going to move you to 90 days’, or ‘We need you to retrospectively increase the percentage overriding discount, we’d agreed it at 3.5 per cent, we now need it to move to 5, because we haven’t sold as much of your gear as we’d hoped to, the volumes haven’t been quite up to scratch, and we need to maintain the margins.’
£10k to millions
Jones adds: “Or it’s as blatant as ‘We need to ask you now for a sum of x’ – and that can be anywhere from £10,000 to millions of pounds, depending on the size of the supplier – ‘We need you to provide us with that money, which in return will give you the opportunity to trade with us next year.’”
Jones says such demands tend to be made at retailer year-ends when margin and volume expectations have not been met and targeting suppliers is seen as an easy way out. The effect, he says, can be to drive good suppliers out of the market.
“Because of increasing concentration of power in retail, if a retailer started to behave unreasonably, suppliers found themselves in a Catch-22 situation where complaining and being awkward could mean that they could lose the contract.”
But swallowing the retailer’s demand may have ultimately contributed to the demise of the supplier. Jones adds: “The risks of retail supply were beginning to outweigh the rewards, and people would simply throw in the towel.”
In general, the supermarkets publicly welcome the new code although they draw the line at the need for an ombudsman to arbitrate and levy penalties for non-compliance. “It’s a very rigorous code,” says Richard Dodd, head of media and campaigns at the British Retail Consortium.
“It’s overseen by the OFT and introduces a whole new range of safeguards, including the right to go to arbitration, initially at the retailer’s expense, for any supplier that is dissatisfied.
“Given all of that, it’s even less justifiable to suggest that we need a costly ombudsman on top. But now that the code is in, we’ve recognised that it could play a useful part in strengthening relationships between suppliers and retailers.”
There appear to be no directly equivalent measures by which to judge the likely effect of the new code on relationships within the supply chain. France’s Galland Law of 1996 and Ireland’s Groceries Order of 1987 were both introduced with the aim of protecting producers against the power of large retailers.
However, the mechanism they used was to prohibit the sale of goods at below cost price, which the new supermarket code does not do. The effect of both measures was to raise prices and reduce competition, with arguably negative effects on supplier relationships, and both laws were abandoned in 2005.
Rare interventions
Although regulations aimed directly at governing relations between buyers and suppliers are rare, regulatory bodies do occasionally step in and issue direct instructions on how particular relationships are to be conducted.
In 2008, the UK’s Office of Rail Regulation (ORR) censured Network Rail – the organisation that looks after Britain’s railway infrastructure – for failures in its supplier relationships after repair works overran massively.
The operator was fined £14 million and told to improve its supplier partnerships. Network Rail said at the time it wanted to improve its supplier relations and, according to the group representing rail industry suppliers, the ORR’s action helped to bring about more partnership in the industry.
“In general terms, it focused Network Rail’s attention,” says Graham Coombs of the Rail Industry Association. “Network Rail was certainly moving in the right direction, but probably not fast enough, and it certainly spurred the organisation on to actually achieve things.
“A lot of it related to the culture of [Network Rail’s predecessor] Railtrack, which was very adversarial. Relationships are much improved now. There’s increasing partnership. We developed a supply chain initiative, which developed a code that was later fully adopted by Network Rail, basically about mutual respect and improving communications.”
Another regulatory pressure that Coombs believes has improved relations has been the strict efficiency targets set for the industry by the ORR as part of its financial settlement.
“Network Rail has fully understood that the only way it’s going to reach those efficiencies is by working with its suppliers, not only by trying to cut costs. That has probably been the biggest spur to improved relationships.”
Regulations directed at other areas also affect how supplier relationships are managed. Key among these are the procurement regulations under the Official Journal of the European Union (OJEU), which cover organisations that spend public money or quasi-public money, such as utilities. Designed to ensure the widest range of eligible bidders for these organisations’ contracts, the OJEU regulations also influence the relationship between buyer and supplier after the initial procurement.
Leah Fry, supplier development manager for global procurement at utility company National Grid, says the obligations under the OJEU process are good for supplier relationships even if the purchaser has a good relationship with an existing supplier that they’re likely to want to keep.
“If all you’re doing is renewing an incumbent, you might think you’ve got a strong relationship and that you’re getting the best value, but you do need to benchmark that,” she says.
“Within National Grid, there are suppliers that we’ve had very long relationships with. That’s not because we keep renewing a contract with them. Each time they’ve gone through a competitive process and that gives us an assurance that we are still getting the best.”
No scope for expansion
The only limit is in dealing with a company that provides you with a specific good or service, Fry says, and from its portfolio of companies it says it can offer extra services. The regulations prevent the likes of National Grid from increasing the scope of the deal to something that wasn’t part of the original deal.
“Another aspect where regulation affects us is that we have a number of different regulated utilities and we have Chinese walls between some of those utilities,” Fry adds. “So if a supplier is giving us lots of good ideas and information for one of those regulated entities, we can’t share that best practice automatically.”
However, some observers believe that being obliged to go out to competitive tender, regardless of the level of your relationship with a supplier, can be damaging.
“It can hinder the long-term supplier relationship to some degree,” says James Cunningham, manager at procurement consultancy Efficio.
“If you’re trying to work with a supplier, and you’ve been with it for three or four years and you’re looking at joint process improvements and all those kinds of good things, you could end up being forced back into a competitive tender, where you go back out and destroy that relationship. In the private sector you can maintain that supplier for as long as you like.”
The financial services and insurance industries is another field where regulation can indirectly affect supplier relationships. Nick Smith, head of supply chain strategy for Europe, the Middle East and Africa at insurance services group Crawford & Company, says the regulations applied by the Financial Services Authority in the UK and the Sarbanes-Oxley Act in the US rule some suppliers out of working with the industry entirely.
“Compliance with regulation is costly,” he says. “Some very good but smaller suppliers do not have the margin or resource to comply, so they have had to either be dropped as a supplier or withdraw from the market. Regulation does create additional work but it ensures best practice at all times.”
Paul Howe, supply chain assurance manager at Aviva, agrees that the effect of regulation on relations with suppliers in the insurance industry is generally positive. “Regulation definitely affects the types of measurements that we use to manage our suppliers,” he says. “But most, if not all, of the regulation is end customer-focused, and most of it is really about good practice. There isn’t anything there that is onerous or illogical or not good for our business or the supplier’s business.”
Beyond the G20
Outside the more developed economies, however, it’s a different story. Ray Carter, director of procurement consultancy DPSS, says that in countries outside the G20, the effect of local government regulation on relationships can be largely negative.
“We have a lot of government-imposed regulation on our overseas relationships and sometimes it’s very heavy handed,” he says. “In lots of these countries the contractor is there to run around and do as it’s told. Its opinion is not really sought and its job is to jump.”
So is there a case for direct regulation aimed at improving supply chain relationships? The answer appears to be no.
“Would legislation alone make a better supplier relationship?” says Alan Day, managing director of procurement consultancy State of Flux. “I’m a bit sceptical. So much of this is orientated towards behaviour and trust. I think you’d struggle to frame legislation around ‘You must behave in the following manner.’
“But I would like to see more on aspects such as the generally accepted practice for measuring the benefits of a relationship. In the way accountancy has accounting practices, and each year the generally accepted practices are published, I think we should have something like that. But legislation? No.”
