A closer look at what the Commerce Commission’s often-quoted figure actually means
Most New Zealanders have probably heard the claim that our major supermarkets make around $1 million a day in “excess profits.”
It’s a powerful statistic. It has been widely used in discussions about grocery prices and supermarket competition.
But what does it actually mean?
The figure originated from the Commerce Commission’s 2022 market study into New Zealand’s grocery sector. The Commission undertook extensive work and ultimately concluded that competition in the grocery market was not working as well as it should.
There is good reason to take those concerns seriously. New Zealand’s grocery market is highly concentrated, entering the market at scale is difficult, and the two major supermarket groups have significant advantages in areas such as purchasing, distribution and access to suitable sites.
However, the often-repeated $1 million per day figure deserves a little more explanation. Because it doesn’t mean quite what many people might reasonably assume.
Where did the $1 million come from?
The Commerce Commission calculated that the major supermarket businesses were earning an average return on the capital invested in their businesses of approximately 12.9%. It then estimated what it cost those businesses to obtain the money invested in them.
This is known as the Weighted Average Cost of Capital, or WACC.
You don’t need to understand the finance terminology. Think of WACC simply as the minimum return investors would generally require for putting their money into a business of that risk.The Commission’s central estimate was around 5.5%, with a higher estimate of approximately 6.6%.
The calculation was therefore broadly:
Supermarket return: 12.9% less Required return on capital: 6.6%
Equals 6.3% above the cost of capital.
When that difference was applied to the approximately $5.8 billion of capital employed in the supermarket businesses, it came to roughly $365 million per year or almost exactly $1 million per day.
The arithmetic is perfectly reasonable. The important question is what that $1 million should be called.
“Economic profit” is not necessarily “excessive profit”
This distinction is important. Imagine you own a business in which you have invested $1 million. After allowing for tax, the business produces a return of $130,000 a year or approximately 13%. Now imagine that, given the risks involved, you could reasonably expect a 6.5% return elsewhere. Your business is therefore generating considerably more than your cost of capital.
An economist might describe that difference as an economic profit. But as a business owner, you probably wouldn’t automatically describe the difference as an excessive profit.
You might be earning the additional return because you have built a strong brand, developed better systems, employed excellent people, negotiated better purchasing arrangements, invested wisely or simply operate more efficiently than your competitors.
Of course, there is another possibility.
You might be earning those returns because competitors have difficulty entering your market and that is where the supermarket question becomes interesting.
What do supermarkets overseas actually earn?
One useful reality check is to look at supermarket businesses operating elsewhere. The Commerce Commission did exactly that. Interestingly, its own study found that the New Zealand supermarkets’ approximately 12.9% return on capital was only slightly higher than, and broadly similar to, the international supermarkets it examined, which averaged around 11.8%. More recent results from major international supermarket groups also demonstrate that returns substantially above 5–7% are not unusual.
Depending on the company and how return on capital is calculated, major international grocery businesses have recently reported returns ranging from roughly 9% to well above 15%.
If supermarkets operating internationally commonly earn returns of 10%, 12%, 14% or more, should every dollar earned by a New Zealand supermarket above a 6.6% cost of capital automatically be regarded as an excess profit caused by inadequate competition?
I don’t think the numbers alone answer that question.
The difference is substantial
Consider what happens if we change the assumed “normal” return. Using approximately $5.8 billion of supermarket capital and the Commission’s 12.9% return:
- At a normal return of 6%, the calculated excess is approximately $365 million a year — $1 million per day.
- If a normal return were 10%, it falls to approximately $168 million a year.
- At 11%, it falls to approximately $110 million.
- And if we use the Commission’s own international supermarket comparison of approximately 8%, the difference falls to roughly $64 million per year — around $175,000 per day.
That is around 80% less than the headline $1 million figure. The point isn’t that $64 million is necessarily the correct number either. The point is that the answer changes dramatically depending upon what we regard as a reasonable return for a competitive supermarket business.
Why not simply use the international average?
Unfortunately, that isn’t perfect either. Supermarkets operate differently between countries. Some own their stores and distribution centres while others lease them. Property values differ. Labour costs differ. Tax systems differ. Geography and transport costs differ.
New Zealand’s relatively small population spread over two long islands also creates particular distribution challenges. Accounting treatments can make a surprisingly large difference as well. In fact, during the Commerce Commission’s own investigation, changes to the way supermarket assets and leases were treated resulted in significant changes to the calculated returns. So simply saying overseas supermarkets earn 11.8%, therefore New Zealand supermarkets should earn 11.8%, would be too simplistic.
Where I think the Commission has a stronger argument
There is another side to this issue that shouldn’t be ignored. If businesses can consistently earn substantially more than their cost of capital, competitors should notice. Imagine an industry where businesses consistently earn 13% on their money while investors only require 6–7%.
That’s attractive!
Normally other businesses would enter the market to capture some of those returns. More competition would follow. Prices might fall. Businesses would invest more. Returns would eventually come under pressure. So if unusually attractive returns continue year after year and new competitors still don’t arrive, an obvious question arises:
What is stopping them?
This is where the Commerce Commission’s broader investigation becomes important. It identified significant barriers facing potential supermarket competitors, including the enormous scale required, access to appropriately located sites, wholesale supply and the established operators’ significant scale advantages.
The Commission’s case for improving supermarket competition therefore goes well beyond the $1 million-a-day calculation. And in my view, that is actually the stronger argument.
What does this mean for grocery prices?
There is another useful way to put the $1 million figure into perspective. Suppose the entire $365 million identified as excess profit disappeared and every dollar was passed directly to consumers through lower prices. Against an approximately $22 billion grocery market, that represents roughly 1.7% of sales. For someone spending $250 a week on groceries, the theoretical saving would therefore be around $4 per week.
Even completely eliminating the Commission’s calculated $1 million per day wouldn’t suddenly make a $250 grocery bill become $200.
New Zealand’s grocery prices are also influenced by supplier costs, wages, freight, property costs, energy, taxation, exchange rates, agricultural prices, productivity and the cost of bringing goods to a relatively small and geographically isolated market.
Competition matters. But so do all those other things.
So, do supermarkets really make $1 million a day in excess profits?
The technically accurate answer is more complicated than the headline. The Commerce Commission estimated that New Zealand’s major supermarkets were generating approximately $1 million per day more than they would have earned if their return on capital had been limited to around 6.6%.
This isn’t quite the same as demonstrating that:
“New Zealanders are paying $1 million every day in additional grocery prices because supermarkets are making excessive profits.”
To demonstrate that, we would need to know what return these businesses would earn in a genuinely competitive New Zealand supermarket market. International supermarket returns suggest that a competitive supermarket business can legitimately earn considerably more than its cost of capital.
On the other hand, New Zealand’s persistent market concentration and barriers to new entrants provide legitimate reasons to question whether competition is delivering everything it should.
New Zealand may need stronger supermarket competition without every dollar of supermarket profit above WACC necessarily being an “excess profit.”
That distinction matters.
Good public policy should ultimately focus less on producing a compelling headline about how much profit is “too much” and more on creating the conditions in which genuine competitors can enter the market, compete effectively and give consumers meaningful choice.
If new competitors can enter freely, obtain sites, access wholesale supply and compete on reasonably equal terms, the market itself becomes a much better judge of what constitutes a reasonable supermarket profit.
