Imagine you run a business where your product is so hot it doesn’t even touch the store shelves. It flies out the door faster than you can ship it to the retailer. What a great problem to have. This is the problem facing Bellamy’s Organic, Tasmanian based maker of Bellamy’s Organic Infant Formula. Their infant formula is in such great demand in Australia and overseas that they cannot keep up. How does a business respond to these circumstances?
Bellamy’s is watching its product fly out the door. Lots of this product is finding its way overseas to China. Chances are it’s being onsold at a large markup, with profit going to middlepersons, rather than Bellamy’s and its shareholders. This is a classic example of excess demand for the product. There are clearly people who are willing to pay more than the current supermarket price for the product. In introductory economics courses taught around the world, the concepts of demand and supply are used to illustrate who benefits from a transaction. There is consumer surplus and producer surplus. Somewhere in the recent past, Bellamy’s Organic Infant Formula became so hot that the demand for the product increased dramatically. Bellamy’s thinks there’s a lot of consumer surplus in this product at current prices. Their response is to increase the market price. They are punting that even at a new higher price, everything they’ve got to sell is going to continue to fly off the shelves. In raising price they are hoping to turn some consumer surplus into producer surplus, increasing their own profits.
It’s a fine line they have to tread. Infant formula would be a sensitive product to try to increase prices and profits on, it’s easy to criticise. But it’s a far cry from profiteering, where for example, suppliers raise the price of petrol or bottled water after a natural disaster like a hurricane or flood. Under Australia’s Competition and Consumer Act 2010, businesses are free to set prices for their products as they choose, as long as they do not collude and fix prices. They cannot impose minimum prices on resellers, nor can they sell at below cost in order to harm competitors, known as predatory pricing. This is where Coles comes in. Once the baby formula is delivered to them, they are free to choose the price they sell it at, just like Bellamy’s determines the price they sell it to Coles for. It is not public what the profit margins on this product are and I am not aware of how the supermarket price has evolved over the past year. But just like Bellamy’s, Coles would have an incentive to raise prices too. We can think of at least two reasons they might not have raised price. First, competition between supermarkets might be so strong that if they do raise price, they might lose a lot of business. Given the shortages, I suspect this is not the case. The second is that they were afraid of a public relations disaster. Raising the price of baby formula is not a good look, it’s trying to turn a bigger profit off consumers who cannot fend for themselves, babies.
According to a story in The Age (“Coles strategy to shame suppliers”, 19 December 2015), Coles has turned the tables on Bellamy’s, making it very clear that they are simply passing on price rises from the manufacturer. In doing so, they are putting pressure back on the producer and have turned consumer advocate. A clever public relations move given they were penalised $10 million by the ACCC for their dealings with suppliers in the past.
What about the babies? In a market based economy stuff is allocated by price, to those that can pay. Infant formula is no different. Higher prices mean people will look for a substitute. Whether it’s the local or international consumers who need to substitute, only time will tell. The massive demand for the trusted Australian product will entice more producers into the market. On 30 November 2015, Bellamy’s announced a strategic manufacturing arrangement with Fonterra Australia to ramp up production, showing that in this case market forces do work, though production is not a tap that can simply be turned on when demand increases. These things will take time. In the meantime, desperate parents will struggle to get their hands on their favoured organic infant formula and people will call for restrictions on per customer sales and on overseas trade of the product. The good news is babies grow up and won’t be drinking formula for ever, their parents’ woes will be a distant memory, eventually.