KDI FOCUS Transaction Types of Large Retailers and Policy Directions 2021.03.03
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In their transaction with retailers, suppliers tend to earn less as the share of purchases under special contract grows. This is due not only to the high sales fees (commission) and frequent unfair practices but also, more fundamentally, to the blatant imbalance in bargaining power. Please check out the video!
- LEE. Jinkook, Fellow at KDI
● Go to a related report
- Transaction Types of Large Retailers and Policy Directions
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The yearly national shopping festival, ‘Korea Sale FESTA,’ has always been mired in controversy.
To find out why, KDI conducted an analysis based on the assumption that the issues surrounding the festival stems from the type of transaction that occurs between the retailers and suppliers.
In general, convenience stores and large retail chains deal primarily in direct purchases, and essential items such as food and daily necessities.
In this type of transaction, the retailer first purchases the goods, and then sells them at a profit.
And, because the goods were initially bought, the sale and inventory management of these goods lie solely with the retailer.
In online and home shopping, transactions are mainly done through consignment sales, which involves the supplier granting the retailer the rights to sell its goods.
Once the goods are sold, the retailer remits the proceeds from the sale to the supplier after taking the sales fee.
As for department stores and outlet malls, because the majority of items sold are seasonal and trend sensitive, for example, clothing and cosmetics, there is a high share of store leases and purchases under special contract.
Under a store lease, tenants rent store space from the retailer who, in turn, receives a percentage of the proceeds as rent.
Meanwhile, special contract purchases combine all three of the aforementioned transactions -- direct purchasing, consignment sales, and store leases.
Specifically, the goods are bought on credit by the retailers but sold by the suppliers. The retailers then remit the proceeds as payment, minus a commission, and return any unsold good to the supplier.
So, what determines the type of transaction?
A survey of 1000 suppliers found that the share of direct purchasing declined when the suppliers could not trust the retailer, or when extra investments like professional salespeople and interior decoration were needed in the store.
Also, the more retail partners a supplier had, and the more power a supplier had in determining the type of transaction, the more direct purchases were selected.
On the other hand, if the margin and commission rates are set by the retailer, in other words, if there is a significant gap in bargaining power,
the share of direct purchases becomes notably low.
Then, how does the type of transaction affect suppliers’ sales?
It was found that, suppliers’ sales dropped 260 million won, or 1.8% of the average, on a 1%p increase in special contract purchases.
Other transaction types had no meaningful impact.
To discover why, an examination was conducted into the profit distribution between retailer and supplier.
It was found that for every one million won increase in sales, retailers made 19 thousand won more under direct purchase contracts and over 25 thousand won more under special contract purchases.
Generally, we would assume that the sales fee under direct purchases would be higher as the retailer is responsible for both sales and inventory management.
So, why is it higher under special contract purchases when the supplier shoulders this burden?
When determining the type of transaction, the probability of a direct purchase contract becomes higher if the supplier has more bargaining power.
On the other hand, if this power leans towards the supplier, it is highly possible that transactions will proceed under a special contract.
Essentially, it is the gap in bargaining power that decides the sales fee and margin rate.
Given the fact that the loss retailers suffer in their sales under a special contract is caused by an imbalance of bargaining power, weren’t there any unfair trade practices?
The results of an analysis reveals that, unfair trade practices are at least two to three times more common in special contract purchases compared to other types of transaction.
Special contract purchases are tied to diminished sales as the imposition of disadvantages under this type of transaction is especially widespread,
for example, lowering the prices of supplied goods or increasing the sales fee in the middle of the contract period.
□ In their transaction with retailers, suppliers tend to earn less as the share of purchases under special contract grows. This is due not only to the high sales fees (commission) and frequent unfair practices but also, more fundamentally, to the blatant imbalance in bargaining power. When investigating into unfair trade practices in the retail sector, the government should pay closer attention to how such violations are tied to the type of transaction. It should also work to enhance the negotiation power of suppliers by, for example, diversifying retail channels and strengthening suppliers’ rights to adjust payments. Indeed, ensuring equal bargaining power can contribute to expanding direct purchases and fairness in retail transactions.
- Although the ‘2020 Korea Sale FESTA’ fared better than previous events, both consumers and businesses expressed dissatisfaction.
- The type of transaction contract between supplier and retailer is the causal factor in the disputes over the shopping event.
- This analysis looks into the current status of transaction types, determinants of the transaction type, and the economic impact on suppliers. It then presents the policy suggestions.
- Of the transactions between large retailers and suppliers, 47% is via direct purchases, followed by purchase under special contract (21%), consignment sales (18%), and store leases (14%).
- The share of direct purchases is 68% at large retail chains, 90% at SSMs, and almost 99% at convenient stores.
- Over 95% of the sales at department stores and outlets are achieved via special contract transactions.
- In online and TV shopping categories, the share of consignment sales is overwhelmingly high. Over 95% of the sales at department stores and outlets are achieved via special contract transactions.
- The imbalance in bargaining positions and power between retailer and supplier may be smaller in direct purchasing due to the significant average transaction amount.
- Direct purchasing is preferred for essential items e.g. raw/fresh /processed food, office stationery and toys, and kitchen and bathroom hygiene products.
- Purchase under special contract is preferred for baby products, cosmetics, sports/leisure goods, clothing and accessories, and furniture/interior items.
- The type of transaction chosen is affected by the characteristics of the type of retail and goods and the interplay between the two.
- Suppliers are less likely to choose direct purchasing if they have a low level of trust in the retailer.
- The more advanced retailers’ purchase systems are, the higher the share of direct purchases.
- Meanwhile, the more salespeople or interior decoration is needed, the lower the share of direct purchases.
- The share of direct purchases tends to increase when the supplier expands its retail partners and is the party that proposes transaction type.
- The share of direct purchases tends to decrease when the margin rate, sales fee, and rental rate os determined by the retailer.
- The sale of flagship products shed 260 million won for every 1%p increase in the share of direct purchases.
- Retailers’ margin rate and sales fee are lowest in direct purchases and the highest in purchases under special contract.
- In purchases under special contract, the supplier will likely have less bargaining power.
- The gap in bargaining power is relatively large in purchases under special contract which increases sales fees and reduces sales.
- This study analyzed the relationship between transaction type and unfair trade practices based on the FTC’s resolutions in the retail business industry (‘98-‘20).
- Unfair trade practices occur 2-3.5 times more often in purchases under special contract.
- One of the most frequently reported violations in terms of special purchase contracts is the imposition of disadvantages. This is not isolated from the finding about the relationship between special contract purchases and reduced sales.
- The most frequent violation in direct purchases is the ban on returning goods.
- Most disputes between retailer and supplier are due to the flaws in the initial transaction agreement.
- Questions and contents in the written survey on the retail sector need to be revised to better capture the transaction patterns and alleged violations from the view of transaction type.
- The unfairness of changing contract details should be included as an important criterion for the ‘Guidelines for Examination of Injustice on Purchase under a Special Contract.’
- Careful consideration is needed when seeking policy intervention in the selection of a specific type of transaction contract.
- Transactions via direct purchases should be pursued by improving suppliers’ bargaining power which is a significant underlying factor.
- Korea Sale FESTA needs an overhaul and a new concept by, for example, making changes to the sales environment and purchasing propensity.
II. Current Status of Transaction Types in Korea’s Large-scale Retail Industry
III. Factors that Affect Transaction Type
IV. How Transaction Type Affects Suppliers’ Sales
V. Relationship between Transaction Type and Unfair Trade Practices
VI. Policy Suggestions
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