Suppliers of essential items should weigh price increases carefully

The recent civil unrest created unfortunate scenes of consumers queuing for basic foods. In such a crisis, competition authorities are mindful that suppliers may be able to take advantage of vulnerable consumers by charging significantly higher prices, despite the underlying costs not changing to the same extent.

In SA, consumer protection regulations were promulgated at the beginning of the Covid-19 pandemic. These have shaped how section 8 of the Competition Act is to be applied in this time of crisis, and specifically prevent certain suppliers of basic foods, medicine and cleanup products and services from applying price increases that are not equivalent to the increase in the cost of providing the goods or service, or that increase the net margin or mark-up above the mark-up or average net margin in the three months before March 1 2020.

The government recently issued a further notice stating that firms in the supply chain for essential goods remain subject to the same regulations in the wake of the unrest and shortages that ensued. These measures are aimed at preventing price gouging and the exploitation of vulnerable consumers. They are well intentioned, and there is merit in protecting vulnerable consumers from significant price spikes of essential products in a crisis.

However, some economists have questioned these interventions given the effect they may have on the demand and supply of essential goods. In circumstances where there is a short-term but significant supply-demand imbalance, it is argued that consumer welfare may be enhanced if prices are allowed to increase, because this encourages more supply and moderates consumption so that essential goods become available to everyone and not just those first in line.

Though such criticism may hold true in some instances, it should not be accepted without scrutiny. It is not always the case that allowing prices to increase will result in a sufficient and timely supply response. It is also not true that higher prices are necessarily required to trigger a supply response, because supply can also increase on the back of expected future changes in demand. In the short term, the appropriate level of rationalisation is not guaranteed in the face of higher prices because wealthier consumers are in a better position to hoard scarce essential goods.

Face masks

In light of the government’s aim to maintain the affordability of essential goods during a crisis, it is worth reassessing 2020’s judgments of the Competition Tribunal and Competition Appeals Court regarding the prices of goods that were deemed essential for consumers during the Covid-19 pandemic.

The cases against Dis-Chem Pharmacy and Babelegi Workwear & Industrial Supplies involved the sale of face masks, which both firms increased in price after a significant rise in demand. In both cases, the tribunal and appeals court departed from the traditional approach in adjudicating excessive-pricing cases. The approach to establishing the existence of market dominance resulted in defining narrower markets than otherwise would have been the case. In addition, a comparison of realised prices to economic costs over an extended period (at least five years) was not undertaken. Rather, in both cases:

• An inferential approach was adopted for the determination of market power. The authorities used the evidence of substantial increases in prices as evidence of the firms’ market power. This was despite both firms holding significantly less than the market-share thresholds for presumed dominance.
• It was concluded that in the context of essential goods in a crisis or national disaster, a firm that increased its prices significantly without a corresponding increase in costs established a prima facie case of prices being unreasonably excessive.
• The authorities argued that there should be no allowance for price increases without changes to underlying costs at all when concerned with the pricing of an item considered to be essential in the fight against the pandemic of Covid-19, and crucial to public health.

The competition authorities’ approach in these cases, and the commission’s general application of the regulations, raise questions for excessive pricing matters. The behaviour in these cases occurred before the promulgation of the regulations and was prosecuted under the traditional excessive-pricing framework [section 8(1)(a) of the Competition Amendment Act]. This raises questions about the extent to which the principles set out in these decisions are a precedent for cases beyond the national disaster, and the implications, more broadly, for excessive-pricing cases in more traditional settings where the concern has centred on dominant firms pricing significantly above economic value over an extended period.

Uncertainty remains

When are demand-driven price increases by dominant firms acceptable, even outside a crisis or a national disaster? What is the appropriate price response by firms when supply is affected by a crisis? Should a retailer always be required to continue selling scarce essential goods at original economic cost when replacement stock is likely to be significantly more expensive? What is the de minimis (pertaining to minimal things) threshold in terms of time and level of sales that should be applied to assess the pricing conduct of a firm during a crisis?

In Dis-Chem, the tribunal imposed a penalty of R1.2m, based on a multiple of the excess profits earned over the complaint period (about one month). Conversely, in Babelegi, the Competition Appeal Court concluded that though there was a contravention of section 8(1)(a), the minimal harm caused by the small number of sales (76 boxes) and short duration of the complaint period (about one month) did not warrant a penalty. Given these differences in approach, uncertainty remains on the time and scope of sales that a dominant firm prices above economic costs, for a punitive outcome.

These questions create significant ambiguity in how future excessive-pricing cases will be handled.

What is clear is that certain suppliers of basic foods, medicine and cleanup products and services (not just dominant firms in the traditional sense) need to be careful when considering increasing prices.

In the current environment, price increases in the absence of corresponding cost increases pose a material compliance risk.

There is also a significant question of how these recent price-gouging matters may affect, and even confuse, the approach to assessing dominance and traditional excessive-pricing complaints outside the sale of essential goods in a crisis.

• The authors work in the competition & regulatory economics practice at Genesis Analytics.