Price controls on essential food items: consultation paper

Chapter 5: Setting a Price Cap

The Scottish Government considers that any future price cap scheme would involve the setting of prices in an open and transparent way. How prices are set should be clearly understood by both consumers and businesses. Consideration is being given to how best to set the maximum price that would apply to a food item and how that price should change over time.

We recognise that determining the maximum price is not straightforward. There are a number of possible approaches to determining an appropriate level of price cap, and each involves balancing the benefit for consumers, responsiveness to market conditions and impacts on producers, retailers and other parts of the supply chain. The level at which prices for individual items are set may vary between the different models available to us and would need to be considered on a case-by-case basis depending on the food item.

This chapter explores the question of how a price cap ceiling might be set and alternative models that could be used. The relevant illustrative provisions from Annex A are sections 6 and 8 in Part 1.

What is the proposal?

We are proposing an item-level price cap, under which retailers that sell a specified food product would be required to offer at least one qualifying variety at or below a maximum price. It is proposed that the maximum prices be set in Regulations.

Before making any Regulations to set prices, it is proposed that Ministers must have regard to the matters set out in section 8 of the illustrative provisions. These are the same matters that are suggested be taken into account when making Regulations about the items that are to be subject to a cap (see Chapter 3). As a brief reminder these are outlined in section 8 of the illustrative provisions and concern healthy eating policies, nutrition guidance, general affordability, impacts on producers, retailers and other impacted businesses, consumer preferences and food security.

Linked to the question of price, are questions of how price caps should change over time and at what frequency. One option is that Regulations would be laid every time maximum prices are changed. However, the illustrative provisions also include a power for Ministers to set out how maximum prices are calculated in Regulations and to provide that any prices caps set out in legislation automatically increase annually (or at another interval). This would allow Ministers to make provision for price caps to automatically keep pace with inflation or another measure – should that be considered desirable. Regardless of how prices are set, they would be kept under active review to ensure they remain proportionate and effective.

Discussion points relating to setting a price cap

Factors taken into account when setting food prices

We are proposing the factors that Ministers must have regard to when setting the price of specific food items would be the same as those set out in Chapter 3, when selecting the items that would be subject to a cap (see section 8 of draft provisions). However, if you believe that is not the case and that the list of relevant factors should be different, we would like to understand why. The list is not intended to be exhaustive, and all relevant factors would be taken into account.

Dependency on price cap model

The setting of price caps on essential goods is linked directly to how any price cap model is applied to affected retailers. The draft proposal outlined in Chapter 2 proposes applying a cap to individual items which can, for example, be specified by reference to condition, weight, etc.

Chapter 2 also explored and asked for feedback on alternative options such as setting the price of a basket of goods instead, whereby a number of goods are specified and a total price for those goods is set, leaving flexibility for the retailer in setting individual item prices. The choice of price cap model will have a direct bearing on how prices are set.

Current prices and baselining

Prices in supermarkets arise from the ongoing interactions between the consumer and the retailer, largely owing to supply and demand. Prices are set by retailers based on a number of factors including competition, cost of production and supply, target profit margins and other running costs. An individual item price can be set below these levels in order to attract customers – so called “loss leaders”.

Prices are also influenced by the “price elasticity of demand” where consumer purchasing habits vary in the face of increasing prices depending on the type of item they are buying, as well as the price of alternative items. This means for some products consumers will be likely to continue to buy a product or be unwilling to shift to cheaper alternatives even when prices rise sharply, whereas for other products consumers may expect a certain price and will be unwilling to spend more even if the cost of production is increasing.

In fixing any price through a price cap it would be important to develop an understanding of a “baseline price” for each item under consideration, which gives an indication of the average “current price” across the market for a specific food product. Identifying baseline prices for products would help aid decision-making regarding how maximum prices will be determined and the likely impact of setting maximum prices at different levels. This is needed to assess both the affordability and benefit to the consumer of those products and to understand the impact on businesses. The price of a specific item can vary between retailers for a number of reasons, even where an identical product is being sold, and prices clearly vary between lower-end and premium versions of the same product.

We expect that in order to address affordability of food, particularly for low-income households, a baseline price would need to be calculated by observing the recent price history of a product based on the lower end of the market and not for higher end retailers or premium products. Other factors we expect to need to consider when identifying relevant baseline prices for products include:

• Product quality: how can product quality be taken into account when comparing lower-priced products across retailers;
• Brands: How differences between branded and “own-brand” products should be treated, if at all;
• Sizes: whether prices should be assessed on a per-unit basis or by reference to specific product sizes or quantities;
• Reductions: how should temporary promotions, loyalty card discounts and other price reductions be reflected when estimating baseline prices.

Setting prices relative to the baseline

Once a baseline for a specific product is established a price cap could be put in place that is at, below or above this baseline price, which acts as a proxy for the “current price”. Setting the cap below the baseline price clearly delivers immediate benefit to the consumer in terms of the affordability of that specific item. Setting the price at or above the baseline price delivers no immediate benefit but can insulate the consumer from price increases over time.

While the illustrative draft provisions would see a broad ability for a price to be fixed it would be important for Government to be transparent as to how prices are initially set regardless of how they compare with a baseline price. Options for approaches to initial price setting are outlined below and we invite views on the relative merits of these and any other options.

• Market price: This involves setting the price cap at or near the baseline price. The benefit is that it clearly reflects current market conditions when the cap is set. The benefits of the cap would be visible to consumers as prices on non-capped items rise due to inflation. As the baseline is calculated in reference to lower end items there would likely be a smaller number of items already at or below that price and a number of more premium brands above this level.
• Affordability assessment: This approach would see prices initially set through consideration of the desired cost of an “average shop” of essential items for those on low-incomes. Or put another way, the price of capped items would be set at a level that ensures people on low incomes have the option for a selection of items that would allow them to only spend a certain percentage of their income to meet their basic food needs.
• Market plus: Alternatively, an initial price could be set at, for example, some percentage above the baseline rate. While this has no immediate benefit for the consumer it would be intended as a “backstop” to future periods of high inflationary pressures and particularly sharp rises to specified products.
• Cost-based: An alternative methodology to establishing appropriate price levels for a cap would be to link price caps to the underlying costs of producing and supplying food. For example, the price of eggs could be linked to livestock prices, energy prices, feed prices, packaging costs, transport costs and other inputs. This would be unique to each item and would be administratively resource intensive to pursue.
• Averaging: Another approach would be to set the price based on the running average of a product over a fixed period of time (for example a year). The reason this approach would be considered is to, again, insulate consumers from temporary spikes in prices over time.

Uprating

Over time, it is the case that prices and incomes will rise due to economy-wide inflation. Even at modest levels of annual inflation (i.e. in line with the Bank of England’s 2% inflation target), over time it would be the case that a fixed price cap would gradually move further away from the otherwise market-determined price of the food item. The cost burden associated with this will increase, regardless of who ultimately bears that cost. For this reason, the level of the cap, or the rate at which it can increase, would need to be reviewed periodically.

Regardless of whether the caps were linked to an inflation measure or another index, it is likely that the price caps become less aligned with prevailing market conditions for the supply of particular food items over time. This would be due to the cap being anchored to historical prices, while the costs of producing and supplying different foods can change at different rates and may not be fully reflected.

This could lead to the price cap becoming either too restrictive or too generous, potentially undermining the objective of the policy. This suggests that periodic review would be required to align prices with prevailing market conditions.

The rate chosen for any specific food product and the effect of that choice would depend on how the initial price of that food product is set, but some outline ways in which prices could be uprated include:

• Consumer Price Index: The Consumer Price Index (CPI) tracks the price of a selection of goods over time to give an indication of how overall prices change over time. While it may seem ineffectual to uprate a food price with CPI, it includes the cost of other goods and services such as transport, clothing and recreation. Given food prices have risen more sharply than other goods in recent years this would limit the impact of food inflation specifically. However, this may not always be the case.
• Wages: Linking the growth in food prices to overall wage growth, or perhaps growth in wages of those on low-incomes, specifically links any uprating of prices with the issue of affordability. Once a price is set the affordability remains constant relative to people’s incomes. As outlined in Chapter 1 the growth in wages in recent years is lower than food price rises.
• Hybrid indexation: A bespoke combination of ratings could be selected that are responsive to a variety of changes over time, for example both wage growth and food production input cost increases.

The methods outlined above for initial price setting and uprating are by no means exhaustive. Whatever approach is taken to setting and increasing prices in future there would be a need to consider the particular circumstances faced by individual products, and different approaches may need to be taken for products as a result.

For any price cap scheme the choices of goods, the initial price set and uprating combine in very different ways for the consumer and industry. We would like to hear from you about the opportunities and risks associated with these approaches, including any preferred options.

Alternative Models

The provisions outlined in Annex A illustrate a model that would involve setting price caps for each specific food product described in the Regulations, with the potential for those prices to be uprated. Those maximum prices would be kept under review and updated over time.

Nevertheless, we are aware this is not the only model for price cap setting and we would welcome views on any alternatives you might wish the Scottish Government to consider. Some of these are outlined here for your consideration.

• Profit Limitation: Recognising that input costs for food producers and suppliers change over time it could be an approach for the market to continue to set the price arising from costs but to limit the total profit allowable for a retailer on specified essential items. It is unclear how much benefit this would derive for the consumer however given the scale of competition in the Scottish retail market. This also does not limit profits prior to the retailer in other parts of the food supply chain. It would also require a full understanding of the input costs for the retailer including but not limited to taxes and business rates, labour and energy.
• Trigger Based: Instead of setting a price we could examine whether it is possible to implement a scheme that would see Ministers able to put in place caps on price rises in response to predefined triggers. This would mean that if price rises exceeded a benchmark, then a price cap for the good concerned could be put in place. There are a variety of measures that could be used as a benchmark – for example specifying a percentage above CPI and if price rises for a given product were to increase past that point the Scottish Government would have the ability to intervene. This would require significant price monitoring to implement.
• Retailer based: While the details above relate to the grocery market as a whole, an approach could be taken to fix the price of the lowest priced item (say the lowest priced variety of bread) sold by a retailer from a point in time and only allow that price to rise at a particular rate (which is less than the rate of food inflation for a set period of time). The effect of this is that different retailers would sell their “essential items” at different prices as the price cap is made by reference to the individual retailer’s market price. Issues with this approach include anti-avoidance behaviour or selecting a date which coincides with promotions. However, this approach may be administratively less complicated.
• Basket based: By setting the total price of a basket of certain goods this allows a retailer to have flexibility in setting individual item prices. While this approach allows for competition and flexibility, it becomes more difficult to monitor and ensure compliance, and it becomes complicated for retailers who may not stock specific items. This approach may only be possible in the context of an obligation to stock specific items that make up the basket, which is not included in the draft proposals.
• Standardised calculation and periodic review: Alternatively, the capped price could be calculated by some standardised method for a fixed period of time, which would then be subject to recalculation at specific intervals. This is similar to the approach of Ofgem’s UK-wide electricity price cap. While this prevents extreme price fluctuations in the short term, the price paid by the consumer over a much longer period of time may not differ significantly from the price that would be paid if a cap was not in place.

Cost of implementation

There would be costs associated with the implementation of the duty. These include ensuring adherence of pricing to that set out in regulation, compliance and other associated costs. It is further recognised that a price cap would have differing impacts on different retailers depending on the price at which the retailer had sold specific products before a cap is put in place. It is proposed that the price of each product set in Regulations would be the same across Scotland and not vary by retailer. We would welcome views on the potential consequences of this approach.

While it could be the case that the cost difference between the normal market price for an item and the capped price could result in a direct cost to the retailer this may instead result in the cost burden being distributed elsewhere, for example through the increased cost of non-capped items sold by the retailer or passed along to one or many of the actors within the supply chain for that product.

Consultation questions

24. What factors do you think the Scottish Government should take into account when deciding the level at which a price cap is set for any essential food item?

25. Should Ministers set initial price caps below observed market prices in order to deliver an immediate affordability benefit? [Yes. No. Unsure]

• Please explain your answer, considering any benefits or risks to this approach.

26. What approach do you think Ministers should take when setting the initial capped price of a food product? Please consider the benefits and risks to any approaches detailed.

27. How should the price of a price capped item change over time? Please consider the benefits and risks to any approaches detailed.

28. Do you agree or disagree that the level of price caps should be the same for all businesses in scope and across all parts of Scotland? [Agree. Disagree. Unsure]

• Please explain your answer.