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Is Woolworths Limited about to downgrade its profit?

Media reports suggest that supermarket giant Woolworths Limited (ASX: WOW) is trying to squeeze its suppliers for an additional $70 million to help the company meet profit guidance.

Fairfax media says it has obtained documents that reveal Woolworths requesting extra payments from suppliers to fund the gap between sales and profit growth on products it had discounted as part of its “Cheap, cheap” marketing campaign.

Analysts had begun warning that the retailer could report its first fall in underlying net profit in around 16 years – and Fairfax says email requests for payment went on December 4 and 5, just after analysts warnings.

Now the Australian Consumer and Competition Commission (ACCC) is understood to be investigating. Fairfax says a senior Woolworths’ staff member detailed a meeting of category managers in November, in which they were told an estimated $70 million was needed by the end of December.

Extracting additional payments from suppliers is called “margin backfill”, according to the source, and refers to the practice of asking suppliers to pay the difference between the discounted price and the retail price. According to reports, suppliers have been given a deadline by the end of this month.

If the allegations are true, this is a serious issue and something Woolworths didn’t need at this time.

Earlier this week, Coles – owned by Wesfarmers Ltd (ASX: WES) – admitted to 15 instances of unconscionable conduct against 8 suppliers and agreed to pay $10 million in fines. Coles has also agreed to review contracts with hundreds of small suppliers – which is expected to lead to more refunds.

The two retailers dominate the supermarket sector, holding around 70%-80% of the market, with Aldi, Metcash Limited (ASX: MTS) backed IGA stores, Costco and independent retailers making up the difference. Their dominance has clearly given the two large retailers significant power to dictate terms with their suppliers – lose a contract with one or the other and there’s 30% to 40% of a supplier’s revenues gone.

Treating suppliers unfairly doesn’t seem like a good way to do business, whether the retailer is heading for a profit downgrade or not.

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Motley Fool writer/analyst Mike King owns shares in Woolworths. You can follow Mike on Twitter @TMFKinga

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