What's in store?

"A damp squib" seems to be the verdict of industry commentators on the Competition Commission's report into supermarkets, which was published last month.

The sense of anti-climax is all the more marked as the report was supposed to represent a high point in New Labour's crusade against "Rip Off Britain", coming after two and a half years of scrutiny into the sector by the competition authorities.

"It's a typical British reaction" says Deidre Trapp, partner at Freshfields Bruckhaus Deringer, which advised Tesco on the response to the report. "If the commission gives the industry a clean bill of health, no one is out there rejoicing." In fact, not only was the industry found to be "broadly competitive", the commission also exonerated its major players of excessive pricing.

It has been "a huge drag on time and even greater cost to the business in financial terms," claims Dr Kevin Hawkins, Safeway's director of communications, whose job it was to deal with the commission. The Office of Fair Trading began its initial investigation in July 1998. He recalls: "I said at the time if a full and thorough investigation is the price that we pay to negate some of the stupid things that are being said about supermarkets' profits, then so be it."

But it has been a high price to pay. According to a senior lawyer at one supermarket giant, the bill for external consultants alone came to £2m. The publication of the last month's report was an industry-defining moment and all of its major players made every effort to ensure that their message was heard. The five groups directly in the commission's sights were Tesco, Asda, J Sainsbury, Safeway and William Morrison. The total cost to the industry has been estimated at a staggering £20m.

There has been considerable cynicism as to why supermarkets were dragged through this exercise in the first place. "It was a political decision based on the clamour from the Government about 'Rip Off Britain'," says one supermarket lawyer.

Iceland's company secretary Paul Attwood says: "The actual report itself was the biggest anti-climax ever." He recalls that one of the first commission sessions coincided with the Wal-Mart acquisition of Asda. The British Retail Consortium told the chairman that the industry was competitive enough and that the merger was going to introduce yet more competition. "He recognised the point totally," Attwood recalls. "There are a lot of other industries that need a more thorough investigation than supermarkets."

One lawyer says that the work generated by the commission was "an absolute pain in the neck. We had far more important and practical things to do than satisfy a commission that really didn't have much of a job to do."

But Herbert Smith competition partner Dorothy Livingston, who represented one of the suppliers, believes that the industry was ripe for review. "The consequence of being a high-profile consumer business is that if there are aspects of your business that attract a lot of criticism it is natural that an inquiry should be considered and, at some point, take place," she says. The last inquiry into supermarkets was back at the beginning of the 1980s, whereas motor manufacturers have endured five monopoly inquiries since then.

Jim Wheaton, competition partner at Clifford Chance, which represented the Co-operative Wholesale Society, believes that it is wrong to dismiss the report as ineffectual. He believes that there are long-term implications for UK and European regulators in viewing mergers that produce oligopolistic markets.

He points out that the supermarkets were not found to be innocent on all counts. In fact, practices such as persistently selling below cost and varying prices in different geographical areas were held to be against the public interest. But the remedies were said to be "disproportionate" to the evil caused.

"What this means for mergers in this sector remains to be seen," says Wheaton. "I think [the authorities] are going to be extremely cautious, but not just in this industry." The commission might not have acted, but in his opinion it was "a finely balanced judgement". He adds: "I just sense that it could have gone the other way."

Philip Hardman, head of legal at the Co-operative Wholesale Society, says that the group was three years into a major refocusing and it was essential that the project was not "frustrated" by an "overgenerous treatment" of the bigger superstore players. He does not believe that has happened. But he is disappointed that there were findings of anti-competitive activities, yet the only tangible legacy will be the "modest undertakings" of a legally binding code of practice to govern the relationship between supplier and retailer.

Such a code might seem "modest" to the Co-op, but it is being taken seriously by the big five stores that are to be subject to its terms.

According to the commission, "there appeared to be a climate of apprehension among many suppliers in their relationship with the main parties". Indeed, many suppliers declined to give their names and provided allegations of heavy-handed approaches by the stores, including insisting upon payments for stocking and displaying products.

The retailers believe that the draft code is one-sided. "The problem is that it is based on a model of the supplier/retailer relationship which is atypical of the whole," says Safeway's Hawkins, adding that it treats Unilever in the same manner as a local fruit and veg producer. He argues that the code is based on a "much more black and white adversarial model" which understates "the degree of mutuality and cooperation" between the two sides.

J Sainsbury's group secretary Nigel Matthews also has his doubts about the code. "This is soft law," he says. "It's a regulatory issue and not something that we're negotiating in a voluntary way with our suppliers. It's being imposed by the Competition Commission after its investigation." He adds that he hopes the parties can reach "a workable and practicable code".

Of course, it has not just been the commission that has been examining the practices of the supermarkets. "Rip-off Britain" has made good copy, and the press and consumer groups have had a field day second-guessing what recommendations it might make.

One such rumour was that the stores would be forced to sell off land in an attempt to defeat local monopolies. "It was a fairly major distraction having to deal with the publicity issues as well as dealing with the case," says Trapp at Freshfields. "Those sort of observations start to do immediate damage to the companies concerned." This scare story prompted a fall in share prices.

Another emotive charge was that the stores were capitalising on the misfortunes of the farmers. But according to David Aitman, a competition partner at Denton Wilde Sapte who advised J Sainsbury, the report concluded that the farmers did not have a case.

The farming lobby argued that the price of meat had fallen but that savings were not reflected in the shops. But Aitman points out that such an analysis overlooked the fact that stores had to cope with the effects of the BSE disaster and bear the additional cost of bringing meat to the market. He also added that farmers do not sell directly to the shops but to cooperative selling organisations.

An inevitable effect of an inquiry on this scale is that it has a depressive effect on the industry, as groups play down major strategic moves through fear of antagonising the authorities.

According to Hawkins, some of us may have benefited more than others from an effective block on corporate activity. There has been much speculation that a couple of years of behind-the-scenes merger talks would lead to an outbreak of consolidation. But he detects "a slight bias" against further major activity, adding that the authorities will be judging a merger on its effects on local markets and not on the national market.

According to Wheaton at Clifford Chance, such an investigation "almost freezes" the industry. He says it would have been "very courageous" for any company to have considered a merger at this time. Aitman agrees, saying that the last two and a half years of scrutiny has not been the most encouraging backdrop for corporate activity. "I think the barriers to mergers have to an extent been lifted, and some people will look at their options again," he says.