In AS microeconomics the examiner may set you a question about the effects of a new supplier entering a market. There are also frequent questions on the costs and benefits of competitive markets compared to industries dominated by a monopolist or a handful of new firms. In A2 economics, contestable markets form an important part of your study of the theory of market structures, economic welfare and efficiency.
Tim Weber, Business editor of the BBC News website has written a superb article on the competitive pressures building inside the mobile phone market – “as the market for high-end mobiles gets ever more crowded, which should you pick?” – this is a classic tale of a market space become evermore congested as the likes of Apple, Microsoft, Research in Motion and Symbian (developers of the software that run most of Nokia’s smart-phones) compete with each other for a share of the lucrative corporate and personal sector market.
It is a market where performance, functionality, speed and reliability of access, look and feel of the hardware and the length of battery life are all important non-price factors influencing consumer preferences. Price is significant – and the article makes reference to the need to attract heat-seekers or ‘early adopters’ – consumers who are willing to pay a premium price for being among the first to be seen using a new piece of kit.
Despite the obvious barriers to entry for new participants, the smart-phone market is increasingly contestable even though it is dominated by a handful of major players. The increasing use of open-source software has helped to make the battle for market dominance a more intense affair.
Far from being geeky, this is an article that gives you a super case study in how the existing operators are competing with each other. How will the market for smart-phones be affected by the recession?
Regular articles on the economics of contestable markets appear on my blog here:
One of John Kay’s phrases in his piece in the Financial Times yesterday will stay with me for the remainder of my teaching career. In a piece which focuses on the malign influences of political lobbying by huge economies of scale businesses that have been in relative decline for many a long year, John writes:
“That is true of the carmakers, whose problems are of much longer standing than the current downturn. In automobiles as in many industries, economies of scale are technological, the diseconomies of scale human. Human factors in business are generally more influential than technological ones in determining the long run fate of a company.”
This is a terrific article to use when discussing the root causes of government failures that can result from subsidies and bail-outs given to companies deemed “too large to fail.”
The remainder of John’s article can be found at his excellent web site
Honda’s decision to pull their team out of Formula One for next season and their desperate bid to find a buyer for operation provides an example of the shut down point in operation. The costs of putting two cars on the grid are simply staggering - in the order of £150 million per season. And with the global economic downturn hitting marketing budgets for many of the main sponsors of international sport, it is hardly surprising that the first of the major teams has decided that there is no business rationale for staying within the sport. So Honda was the first - who will be next? Answer - keep an eye on Williams.
The Guardian/Observer carried a feature on this story at the weekend and included a nifty graphic which showed the location of the F1 team bases in the UK. McLaren are based in Woking but Renault, Honda, Williams and Red Bull are all clustered in the east Midlands. Partly this is an accident of history - namely the availability of disused airfields after the war. But the article is worth reading as an example of the external economies of scale that can be generated when a group of producers develop and expand in a relatively small geographical area. And as the extract below suggests, the negative multiplier effects that might occur if there is a wider retreat from F1 would be huge.
“Most of the teams currently racing are based in the UK, along with their R&D operations. A whole network of industries, such as component suppliers, engineering and design firms, have sprung up in Britain, mostly in central England, to serve the sport both here and abroad.”
“F1 also helps to support a far larger motorsport industry in the UK, for example rally car racing and all its associated industries. Estimates of the total number of jobs dependent on motorsport in the UK vary between 45,000 and 110,000. Geoff Goddard, professor in Motorsport Engineering Design at Oxford Brookes University, estimates that it accounts for 1 per cent of GDP, not insignificant when compared to car manufacturers, which represent about 5 per cent.”
The BBC today has two stories on the economics of fishing. Firstly the government has announced a £5m plan to fund the de-commissioning of some of the UK’s in-shore fishing fleet in a bid t oreduce what the government regards as fundamental excess capacity in the industry.
This BBC video looks at the background
Secondly the rising stocks of cod in the north sea has led in part oa rise in the size of the annual cod quota given to scottish fishermen by the European Union as part of their common fisheries policy. But the thorny issue of discarding excess fish remains unsettled. The quotas refer to landed cod which encourages fishing vessels to dump much of the fish they have caught before they reach home in order to avoid fines for over-fishing. The result is a deadweight loss of scarce resources in an industry already suffering from the long term decline in fish stocks.
See also “Scots anger over discarded fish”
Wagon Automotive is a car parts business that supplies a cluster of the biggest volume car manufacturers in the UK. With sales of new cars slumping by over a third, the fall in demand for vehicles inevitably has a negative impact on the demand for component parts - economists call this the derived demand effect. The slump in demand allied to problems in agreeing a fresh line of finance from the banks is likely to cause Wagon Automotive to go into administration this week with the prospect of hundreds of job losses. Expect many more examples of supply-chain demand and employment effects to hit the headlines in the coming months.
The Times has a focus today on the multiple roles and contributions made by the social entrepreurship sector - plenty of excellent mini case studies for students and teachers here.
This BBC article on the granting of permission for a giant wind farm off the coast of North Wales might be a good example of the importance of economies of scale in making renewable sources of energy more cost efficient. And heading to the web site of the Gwynt y Môr Offshore Wind Farm accesses some resources on the potential costs and benefits of a scheme that might provide electricity for up to 500,000 homes. If construction goes to plan, the wind farm will start to produce power from 2012.
BA has announced a slump in the number of premium passengers.
The airline has taken the strategic decision note to slash prices for these customers because they are the most profitable segment of their operations. But last month the number of passengers fell by over 10 per cent contributing to a decline in the carrier’s load factor, which measures how full each plane is from 76.6% to 74.4%.
Global economic turbulence forces BA and many other airlines into a series of difficult decisions. The income elasticity of demand for airline travel is likely to be strongly positive especially for luxury travel and on routes where there is genuine competition the price elasticity of demand is also likely to be a constraint on how high fares can be.
In line with many other carriers, BA is cutting back services on some routes in a bid to reduce spare capacity and there have been several stories circulating in the media about BA entering into negotiations with the Australian carrier Qantas to form a giant international operator.
A hat tip to a fellow presenter on our revision workshops in London whose acronym to remember some of the effects of monopoly power in markets struck a chord with me
Service - does the lack of competition affect the quality of service to consumers?
Prices - how high are prices compared to competitive / contestable market
Efficiency - productive, allocative and dynamic
Welfare - what are the overall welfare outcomes? Is there a net loss of welfare in markets dominated by businesses with monopoly power?
Are there anymore useful revision acronyms out there that you use? Please share them via the blog!
The Co-Operative movement is a super mini case study to use when discussing different forms of business ownership and the principle-agent problem endemic in many quoted companies. This article from the BBC reports a strong rise in profits for the Co-Operative group, many of whose members have donated their dividends to charitable / social causes. The Co_Operative movement is the UK’s largest mutual retailer with a strong brand awareness and market share in sectors such as retail pharmacy, funeral services and independent travel.
Is this the day that the chill winds of recession really start to hit what is left of the traditional high street?
the wonder of Woolworths. At 6pm tonight the Board of Woolworths met to confirm what had long been on the cards – which the cash-strapped business, laden with over £150m of net debt was bowing to the inevitable and heading into administration.
Deloitte, the appointed administrator must now try to find a buyer for some or all of the Woolworths chain. But the sad fact is that hundreds of stores will close and thousands of staff must face losing their jobs. The Times reports that up to 30,000 jobs are at risk if the 800 plus stores close for good. And the Telegraph suggests that a firesale of unsold stock by the administrators could prompt an aggressive price war on the high street in the run up to Christmas.read more...»
The small cut in VAT is a staggeringly inept piece of policy-making from a government that has completely lost control of public finances and which is groping in the dark for ways to stabilise demand and confidence as the lagged effects of asset price deflation take hold.
Even the UK Treasury does not expect retailers to pass on all of the decrease in VAT from 17.5% to 15%. And why should they? Many have already started offering sizeable price discounts in a bid to shift excess stock - 10% off, 25% one-day sales, 4 for 3 offers. All of these are more significant that the marginal reduction in VAT. Many consumers who do not understand percentages may be perplexed when they find out that a £100 television which used to sell for £117.50 with VAT at 17.5% and which might now retail for £115 - involves a reduction of £.50 which is a fall of 2.13%.
And for thousands of smaller businesses across the UK the menu costs of changing price lists, menus and catalogues will be an additional burden at a time of commercial distress. This article from Management Today considers some of the difficulties.
Jason Gordon from Ernst and Young sums this up well in an article in today’s Telegraph:
“This is a non-trivial thing to implement. It’s not just the cost of printing the tickets, it’s the time and cost of employing a member of staff to change all the prices, when they could be putting stock on shelves. This is right in the middle of peak trading and most retailers have more important things to juggle.”
Don’‘t forget that the VAT cut will be reversed in 13 months time bringing a fresh set of price adjustment costs. For small traders who do not have access to fully-computerised business systems this is not a trivial issue.
We read today that the government considered raising VAT to 18.5% from 2011. The same menu cost arguments apply to small increases in VAT.
Leander McCormick-Goodhart looks at the perilous state of the US car market
Surely nobody would allow Detroit, the backbone of American industry, to go bankrupt?
In a last effort to prevent collapse of the US auto industry, Detroit is seeking a bailout. The CEOs of the big three automakers- GM, Ford and Chrysler- have appealed for a $25 billion package.
Detroit has come under scrutiny, with accusations of mismanagement and the fundamental inability to reform itself.read more...»
Street hawkers normally have an instinctive ability - honed through several generations - to spot well-heeled tourists a mile off and engage in a spot of first degree price discrimination and exploit informaton failure among confused jet-lagged travellers. Here is a neat short story of a Dutch couple who may just have bought the most expensive plate of four samosas in commercial history. Then again, perhaps they were just the first to complain to the local police.
The article is also memorable for alerting us to the availability of camel urine - a bargain at just over £1.34 per litre.
Pirelli is a global name in vehicle tyres - a brand which ought to be able to ride out the storm engulfing the world of vehicle manufacturing. But as this BBC video shows, a downturn in the market demand for new cars is having an immediate effect right the way through the supply chain of the industry and Pirelli is having to take strong action.
Pirelli’s plant in Carlisle in Cumbria is slashing the hours available to their permanent workforce in response to a slump in orders for new tyres. Although most jobs look to be safe, the cutback in hours will hit the pay-packets of hundreds of workers in a region where per capita GDP is persistently below the national average. And this decline in real take home pay will affect retail businesses and the local housing market. The short video clip is a good example of derived demand and also the inter-relationships between markets - it is also a sign of a tyre company keen not to lose its grip.
A big hat tip to my colleague David Fox who alerted me to this superb three-minute BBC video which takes us inside the Goodfella’s pizza site in Naas, Republic of Ireland - a fully-integrated plant that produces over two million frozen pizzas every week! There is so much in this video. I suggest showing it a couple of times and then gathering together the contributions from students and turning it into a mind map or a word cloud - perhaps using wordle
I tried with one group and they came up with
Bulk purchase of ingredients
Economies of linked processes.
High labour productivity (very small workforce)
Standardised products - important for branding
Economies of increased dimensions
Perfectly elastic supply
A great short video resource!
Is anyone heading to a local Marks and Spencer store tomorrow for the 20% off for a day sale?
Opinions are mixed about the motivations behind this marketing ploy. It seems to me that the likeliest explanation is that a struggling M&S is becoming desperate to shift piles of unsold autumn fashions and homeware. John Lewis emailed people tonight with a matching price reduction in stores for the coming weekend. Savvy customers will stay clear of this particular discount window. Indeed if we all stay home and wait, we can expect even bigger reductions in prices as stores try to clear stock ahead of what promises to be a terribly difficult early spring in the shops.
In business there are often important barriers to entry which act to limit the ability of businesses to break into new markets. The Bottom Line on Radio 4 this week considered the existence of these barriers. Leading the discussion was Will King, the founder and CEO of KMI King of Shaves, the innovative UK-based personal grooming business that has successfully broken into the shaving product markets and whose new four bladed razor is now number three in handle sales to Gillette. King mentioned that there were over 20,000 patents in the razor and personal grooming industry including mechanical hinges on the construction of razors which requires new entrants to design their way around the patents.
The panelists on the programme discussed a number of other entry barriers - among them:
1. Intellectual patents and ownership of technology - but patents are needed to provide an incentive to invest
2. Expertise and reputation of the incumbent - intangibles
3. Licences are important such as professional qualifications
4. Inherent suspicion among consumers about new ideas - behavioural economics tells us that many people are quite happy with their default choices - it may take a while for any change in preferences to occur.
5. Regulations and legislation involving employing people - a major barrier for fast-growing smaller businesses many of whom are highly innovative
The Bottom Line is always worth a listen - the podcast is available for free from iTunes. And this weeks programme also considered which kinds of sectors will weather the storm and do well in a recession? The different nature of a recession this time around may well give us a clue to the likely winners from the downturn especially with credit so hard to find.
It was thought that successful businesses during the current downturn would tend to be:
1. Agile and entrepreneurial, customer centric
2. Businesses with low debts and those who are cash rich - cash flow management is becoming critical - cash flow forecasts will come under increasing scrutiny.
3. High energy businesses that swim against the tide
4. Knowledge building companies
The Bottom Line
When was the last time you savoured a ‘stacking weekend’? No, I don’t mean endless hours of family fun playing Connect 4 or Jenga; I refer instead to the practice of ordering a box set of your favourite television programme and setting aside many hours to enjoy a series back-to-back before gorging on the DVD extras!read more...»
Car hire firms, hotels, cruise companies, laptop manufacturers, online retailers - they are all at it. The weakness of UK retail sales confirmed by some of the worst figures in recent years from the British Retail Consortium is prompting a renewed bout of deep discounting by businesses desperate to improve their cash flow and maintain sales volumes during the descent into recession. Pre-Christmas sales have been brought forward (to judge from one pleading email from Play.com this afternoon - forget it I use Amazon by default!) and an ‘unbeatable’ offer from a well known car hire company offering a rate of just £18 per day for a three-day mid week rental. I always thought that Hertz Van Rental was a famous WWI pilot?
How sensitive are we to these price discounts?
I suspect for hard-pressed teachers slogging their way through the November marking mud, the generous discounts on city breaks will be especially attractive.
And the incredibly cheap prices for new laptops from the likes of Dell are enticing although they serve to remind me of just how much I paid for my last notebook just under three years ago!
For most retailers it is a time when cherished profit margins are sacrificed in the search for saavy consumers. And it is a response to the flight towards discount shops at a time when household budgets have been put under an enormous squeeze.
Sales in bricks and mortar shops are declining - but online sales are defying the recession and taking up a bigger slice of total retail sales. This piece by Rory Cellan Jones asks whether the high street will survive the online onslaught?
An email found its way to me today from Pearson Education regarding the launch of their new online diagonistic assessment website (why dont they just call it a VLE) My Econ Space
It provides an interesting slant on pricing for an externally hosted online service for students and their teachers.read more...»
The economy might be skating on thin ice, but the market demand for artificial skating rinks shows no sign of melting away judging from the number of temporary ice rinks that are springing up across the length and breadth of the country.read more...»
One of the annual rituals for A2 Economics teachers is the lesson when we cover the assumptions that lie behind the model of perfect competition and ask the perennial question - are there any real-world industries that come close to this particular market structure?
In the past I have used local fruit markets, clusters of nightclubs or bars in busy tourist venues and auctions for newly caught fish as examples of markets which satisfy some of the criteria needed for perfect competition to exist. It allows one to discuss the importance of low entry and exit costs into and out of the market; the significance of many sellers supplying essentially homogeneous products and the role that price transparency plays in shaping the incentives of buyers and sellers.
A colleague suggested to me a few weeks ago that his local racecourse provided a suitable example to use. He is often to be found at summer and early autumn meetings after school in the evening, enjoying the occasional bet, a stunning location but more importantly the chance to watch competitive markets in action - namely on-course betting!read more...»
Today we heard of another instance of consolidation in the European Union aviation industry. Lufthansa has agreed with Michael Bishop, founder of BMI to up their stake in the UK airline from 30 per cent to 80 per cent by buying out Sir Michael’s own equity stake in the business.
Having acquired Swiss Airlines a while back Lufthansa continues to build a broader base for its operations, and in buying BMI it gains a well established mainly short-haul operator which has a significant number of scarce and hugely valuable landing slots from Heathrow. Lufthansa will emerge as the second-biggest carrier behind British Airways at Heathrow. Virgin has 3 percent of slots at Heathrow, the main airport for London; bmi has 12 percent and British Airways more than 40 percent. These land slots represent an important barrier to entry for airlines wanting the green light to expand their operations at chosen airports.
Just as a few weeks back, when the government nudged Lloyds TSB into mating with embattled bank HBoS, at times of great economic and financial uncertainty, many mergers and takeovers are born of necessity rather than excessive optimism.
And this creates a possible headache for the Competition Policy authorities who must make a judgement about whether to allow the integration to proceed without intervention or insist that the newly enlarged business divests some of their operations to ensure that the markets remain competitive.
When the survival of a business is at stake and with it thousands of jobs, are the competition authorities more inclined to turn a blind eye? The answer is probably YES and there will be many more mergers in the airline industry before the current economic crisis is over.
Here is a good example of how fluctuating demand in one industry has an effect on sales and profits in another.
Akzo Nobel, the world’s largest paint maker, which bought the Dulux paint manufacturer when it took over ICI last year in a deal worth £8 billion, has announced a sharp fall in profits to €367 million. They plan to make 3,500 workers redundant including many workers in the UK. Business is being affected by the international slump in residential and commercial property construction which has led to a fall in market demand for decorative paints. Paint is a product where much of the volume of sales is derived from demand for the uses for paint. So a slump in the building industry - with many housing projects being mothballed - will impact on sales.
And profits are being squeezed by a rise in the costs of raw materials used in manufacturing paint.
The Dutch business has a world-wide reputation for producing high quality protective paints and other coverings used in home and industrial applications. Just recently they won a sizeable contract from McDonalds which involves supplying a range of paint products for the re-imaging of hundreds of its Purely Simple style restaurants.
If eating in is the new going out, life is going to get really tough for hundreds of mid-market restaurants in the months ahead.
Hard-pressed consumers hit by a potent combination of falling property and share prices, declining real incomes, a slump in confidence and fears of huge job losses, are cutting back on non-essential items in their monthly budgets. They are eating out less or perhaps switching to lower-priced chains that – on the plate at least – seem to offer better value for money.
How can restaurants respond to the threat posed by a fall in discretionary spending?read more...»
Here is a really good example of two businesses looking to exploit opportunities from the economic downturn.
Travelodge - which is owned by Dubai International Capital - has announced an fresh expansion plan which fits into its long-term aim to grow to over 70,000 rooms in nearly 1000 hotels by 2020 and to be the biggest hotel operator in London by the time the Olympics arrives in 2012.
And as part of the organic growth strategy, Travelodge is teaming up with the discount food retailer Aldi to develop sites together into supermarkets and hotels. Notably two of the initial projects in this joint venture are in Middlesbrough (on Teesside) and in Newquay in Cornwall - both in regions where per capita incomes are substantially below the national average.
Both businesses are taking advantage of the collapse in demand for commercial and residential property - which is freeing up land for others to invest in.
The Royal Mail produced some pretty decent results last week. Their operating profit for the first six months of their financial year doubled to £177million - a welcome return to profitability for a mail network that has come under huge pressure from increasing competition within the recently deregulated market.read more...»
Under the threat of scrutiny from the Office of Fair Trading and conscious that in a recession, consumers are prepared to travel further in search of value for money - the price war at the pumps between the leading supermarkets shows few signs of ebbing. Asda and WM Morrisons set the latest ball rolling this week and Tesco and Sainsbury have fallen into line in quick order. It is difficult to work out who - if anyone - is assuming the mantle of price leader in this battle for fuel sales.
Crude oil prices are back where they were this time last year and fuel prices are pretty close to the levels seen in the Fall of 2007. For all of the talk of petrol and diesel prices taking weeks to change in response to the fluctuating price of crude, this market seems to be adjusting pretty swiftly. This can not be said for electricity and gas prices - Robert Peston picks up on this in his blog today.
A feature on the roles that capital markets play written by Alec Chrystal and available on the BBC website - the answer according to Chrystal lies with asking another question - why do we need limited companies who can then list on a stock market as a means of broadening their ownership and raising fresh capital:
“The benefit to companies from having their shares publicly traded is that they can issue new shares to raise capital for future investment. The only alternative source of funding would be to increase debt (by borrowing more from banks or issuing bonds).”