Understanding Regulation

Facts, Analysis and Comment

Alcohol Pricing

British Governments have for many years been concerned about supermarkets' price promotions on alcohol which may encourage antisocial behaviour and binge drinking. One problem is that the supermarket are not allowed to agree amongst themselves that they will stop competing on alcohol pricing as this would constitute a cartel. UEA's Bruce Lyons summarised the issues nicely as follows in a posting in 2010:

'The new UK government is proposing to ban below-cost selling of alcohol as a way to address the binge drinking culture amongst some groups of people. Tesco has responded with a counter-proposal for a minimum price per unit of alcohol, which is also proposed for Scotland by the devolved government. The UK budget deficit is huge so major spending cuts and tax rises are inevitable, possibly including on alcohol. Which of these three measures is the best way to use the price system to achieve the government's aims without substantial anticompetitive side-effects?

Binge drinking is a serious problem in the UK. A late-night stroll down many a High Street or a glance in at a hospital casualty ward provides all-too-frequent evidence of the harm this does to (mainly) young people and the distress and disturbance it causes to others. The externalities associated with excessive drunkenness mean that it may be appropriate to intervene in the market. The question is: how?

Needless to say, there is much to be done through education, socialisation and provision of less harmful diversions. Other countries have much cheaper alcohol available yet do not face the same level of problem. Nevertheless, we have probably reached the stage where we need to think about economic incentives as a supplementary kick with a view to shifting behaviour patterns. This thought is given impetus by the fact that supermarkets use alcohol as a loss-leader to bring footfall into their stores. The most sure-fire bet of the forthcoming World Cup is that we will have to scramble our trolleys over piles of cheap lager before we can reach the salad and strawberries during the coming weeks. So, what would each of the proposals mean?

Ban on Below-Cost Selling: Supermarket pricing is not straightforward; in particular, it is not typically a fixed mark-up on marginal (or even average) cost. One reason is that supermarkets are more concerned with the revenue per 'basket' of groceries sold than they are with profit on individual products. Also, for example, Asda does not want to be seen to be undercut by Tesco (or vice versa) on a high-profile product line, yet one may get a better supply price than the other. Another reason is that supply price (i.e. cost to the supermarket) is typically highly non-linear: various discounts are often attached to the level and growth of sales, special offers and numerous other features of the supply arrangement. This makes it difficult to determine the 'cost' below which the price cannot be set. The French have experienced such problems with similar legislation, but a sensible method of calculation should still be feasible. Supermarkets might also worry that if the ban was binding, it would reveal their commercially sensitive supply prices. It is not clear what this would do to their negotiations with manufacturers.

Minimum Price: Sir Terry Leahy, head of Tesco, has recently gone on record to support a minimum price for alcohol. This would have two effects. First, it would set the same minimum price for all sellers, so there would be no revelation about negotiated prices or problem about measuring 'cost'. Second, minimum prices could be regulated above 'cost'. This would provide a greater demand effect, but it would also give supermarkets higher profits. It is doubtful whether they are sufficiently competitive for this to induce fully equivalent lower prices on other products. Promotional activities, including product placement on the shelves, advertising and sponsorship, consequently have a bigger payoff as each extra unit sold becomes so much more profitable. The result is a switch of competitive strategy to these demand enhancing activities and possibly even higher alcohol consumption despite higher prices. An effective alcohol-suppression programme should squeeze margins at the same time as raising retail prices. The obvious way to do this is to raise the tax on alcohol.

Tax Rises: The UK government has also stated that it will 'review alcohol taxation and pricing to ensure it tackles binge drinking without unfairly penalising responsible drinkers, pubs and important local industries'. The latter may include farmers who have recently planted new orchards to provide cider apples (cider is still relatively lightly taxed and is the source of some of the lowest priced alcohol). Nevertheless, as I wrote in connection with minimum tobacco prices, higher taxes have the great benefit that the money goes to taxpayers, not to supermarkets or their suppliers.

Overall, a combination of tax increase with a ban on below-cost selling (to stop cross-subsidisation) is probably the least anti-competitive price mechanism to induce less binge drinking. However, more analysis needs to be done to see if a minimum price set close to cost would be more practical without harming supermarket and manufacturer competition or stimulating other forms of promotion. Incidentally, either combination could have the side-effect of helping specialist off-licences and corner shops which do not have the supermarkets' option of cross-subsidy.'


Martin Stanley