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Articles for the ‘Economics for Business: Ch 14’ Category

Nudging mainstream economics

The annual Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, normally known as the Nobel Prize in Economics, has been awarded 49 times since it was founded in 1969. Many well-known economists have been recipients of the award. This year it had been awarded to Richard Thaler for his research in behavioural economics. The award recognises his work in integrating economics with psychology.

Richard H. Thaler has incorporated psychologically realistic assumptions into analyses of economic decision-making. By exploring the consequences of limited rationality, social preferences, and lack of self-control, he has shown how these human traits systematically affect individual decisions as well as market outcomes.

In total, Richard Thaler’s contributions have built a bridge between the economic and psychological analyses of individual decision-making. His empirical findings and theoretical insights have been instrumental in creating the new and rapidly expanding field of behavioural economics, which has had a profound impact on many areas of economic research and policy.

Instead of making the assumption that people are rational maximisers, behavioural economists look at how people actually behave and respond to various incentives.

For example, people may be motivated by concepts of fairness and be prepared to make personal sacrifices for the sake of others. Such concepts of fairness tend to depend on the social context in which choices are made and can be influenced by the way choices are framed.

Also people may not weigh up costs and benefits but use simple rules of thumb, or heuristics, when making decisions. This might be an example of rational behaviour when time or information is limited, but the use of such heuristics often becomes engrained in behaviour and the rules become just habit.

People may also suffer from a lack of willpower or ‘present bias’. They may spend more than they can afford because they cannot resist the temptation to have a product. They may overeat because of the short-term pleasure it brings and ignore the long-term effects on their health.

Understanding how people make choices and the temptations to which they succumb can help policymakers devise incentives to change behaviour to achieve various social goals.

One type of incentive is nudging. A well-known example is people’s choice about whether to become an organ donor in the event of their death. If people are required to opt in to such a scheme, they may never get round to doing so. However, if they are required to opt out if they do not want to participate, many more people would thereby be donors and more organs would become available.

Another form of nudge is making desirable things fun. A well-known experiment here was encouraging people to use the stairs rather than the escalator when exiting a subway by making the stairs like a musical keyboard. See here for more examples.

The UK government set up a Behavioural Insights Team – also known as the Nudge Unit (now independent of government) to find ways of encouraging people to behave in their own or society’s best interests.

But it is not just governments which use the insights of behavioural economists such as Thaler. The advertising and marketing industry is always examining the most effective means of influencing behaviour. A classic example is the loss leader, where consumers are tempted into a shop with a special offer and then end up buying more expensive items there rather than elsewhere.

Firms and advertisers know only too well the gains from tempting people to buy items that give them short-term gratification – such as putting chocolate bars by the tills in supermarkets.

Understanding consumer psychology helps firms to manipulate people’s choices. And such manipulation may not be in our best interests. If we are being persuaded to buy this product or that, are we fully aware of what’s going on and how our tastes are being affected? Would we, by standing back and reflecting, make the same choices as we do on impulse or out of habit?

And governments too can seek to manipulate people in ways that some may find undesirable. Governments may try to influence us to follow their particular political agenda – as may newspapers. Certainly, during election or referendum campaigns, we are being nudged to vote a particular way.

It is important then for us to understand when we are being nudged or otherwise persuaded. Do we really want to behave in that way? Just as it is important, then, for governments and firms to understand individuals’ behaviour, so too it is important for individuals to understand their own behaviour.

Articles
Richard Thaler’s work demonstrates why economics is hard The Economist, RA (11/10/17)
Nobel in Economics Is Awarded to Richard Thaler The New York Times, Binyamin Appelbaum (9/10/17)
The Making of Richard Thaler’s Economics Nobel The New Yorker, John Cassidy (10/10/17)
Nobel prize in economics awarded to Richard Thaler The Guardian, Richard Partington (10/10/17)
Richard Thaler is a controversial Nobel prize winner – but a deserving one The Guardian, Robert Shiller (11/10/17)
What the mainstreaming of behavioural nudges reveals about neoliberal government The Conversation, Rupert Alcock (17/10/17)
This year’s economics Nobel winner invented a tool that’s both brilliant and undemocratic Vox, Henry Farrell (16/10/17)
How a critic of economics became the disciplines Nobel-winning best friend The Guardian, Tiago Mata and Jack Wright (25/10/17)

Podcast
How Richard Thaler changed economics BBC, More of Less, Tim Harford (14/10/17)

Questions

  1. For what reasons may individuals not always weigh up the costs and benefits of purchasing an item?
  2. Give some examples of the use of heuristics in making consumption decisions?
  3. Is the use of heuristics irrational?
  4. Explain how people considering that they have behaved fairly is influenced by the social context of their behaviour?
  5. Find out what is meant by the Dictator Game and how it can challenge the assumption that people behave selfishly. How is the ‘dictator’s’ behaviour affected by the possible payoffs?
  6. Thaler suggested that Brexit could be an example of behavioural economics in action. Find out what he meant by this. Do you agree?
  7. Give some examples of ways in which the government can nudge people to persuade them to behave in socially or individually desirable ways.
  8. Find out what is meant by the ‘endowment effect’ and how it influences people’s valuation of items they own.
  9. Why may nudging by governments be undemocratic?
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How behavioural economics can help you stick to New Year’s resolutions

Many or us make New Year’s resolutions: going on a diet, doing exercise, spending more time studying. But few people stick to them, even though they say they would like to. So how can people be motivated to keep to their resolutions? Well, the experiments of behavioural economists provide a number of insights into the problem. They also suggest various incentives that can be used to motivate people to stick to their plans.

Central to the problem is that people have ‘time inconsistency’. They put a higher weight on the benefits of things that are good for them in the future and less weight on these benefits when they have to act now. You might strongly believe that going to the gym is good for you and plan to go next Monday. But when Monday comes, you can’t face it.

Another part of the time inconsistency problem is the relatively high weighting given to short-term gratification – eating chocolates, watching TV, spending time on social media, staying in bed. When thinking about whether you would like to do these things in, say, a couple of days’ time, you put a low weight on the pleasures. But thinking about doing them right now, you put a much higher weight on them. As the well-known saying goes, ‘Hard work often pays off after time, but laziness pays off now’.

So how can people be motivated to stick to their resolutions? Behavioural economists have studied various systems of incentives to see what works. Some of the findings are as follows:

•  People are generally loss averse. To get us to stick to New Year’s resolutions, we could devise a system of penalties for breaking them, such as paying 20p each time you swear!
•  Given people’s time inconsistency, devising a system whereby you get treats after doing something you feel is good for you: e.g. watching TV for 30 minutes after you’ve done an hour’s revision. Rewards should follow effort, not precede them.
•  Having simple clear goals. Thus rather than merely saying ‘I’ll eat less’, you devise a meal plan with menus that meet calorie and other dietary goals. Rather than saying, ‘I’ll exercise more’, you commit to going to the gym at specific times each week and doing a specific amount of each exercise.
•  Ritualising. This is where you devise a regime that is feasible to stick to. For example, you could always write a shopping list to meet your dietary goals and then only buy what’s on that list; or you and your flatmates could have a rota for household chores.
•  Social reinforcement. This is where people have a joint plan and help each other stick to it, such as going to the gym at specific times with a friend or group of friends, or joining a support group (e.g. to lose weight, or give up drinking or smoking).
•  Avoiding temptation. For example, if you want to give up chocolate, don’t have any in the house.
•  Using praise rather than criticism. People generally respond better to positive incentives than negative ones.

Behavioural economists test these different incentive mechanisms to see what works best and then to see how they can be refined. The testing could be done experimentally, with volunteers being given different incentives and seeing how they respond. Alternatively, data could be collected on the effects of different incentive mechanisms that people have actually used, whether at home or at work.

The advertising and marketing industry analyses consumer trends and how people respond to pricing, quality, display, packaging, advertising, etc. They want to understand human behaviour so that they can ‘direct’ it in their favour of their clients. Governments too are keen to find ways of encouraging people to do more of things that are good for them and less of things that are bad.

The UK government’s Behavioural Insights Team looks at ways people can be ‘nudged’ into changing their behaviour, see the blog A nudge in the right direction?

But back to New Year’s resolutions, have you made any? And, if so, have you thought about how you might stick to them? Have you thought about the incentives?

Podcast
Dan Ariely talks “Payoff” WUNC 91.5: North Carolina Public Radio, Dan Ariely talks to Frank Stasio (3/1/17)

Articles and blogs
50 New Year’s Resolution Ideas and how to Achieve Each of Them Lifehack, Ivan Dimitrijevic (31/12/16)
5 New Year’s Resolutions You Can Keep (With The Help Of Behavioral Science Research) Forbes, Carmen Nobel (3/1/17)
The science behind keeping your New Year’s resolutions BT, SNAP PA (30/12/15)
The Guardian view on New Year resolutions: fitter, happier, more productive The Guardian, Editorial (3/1/17)
The Behavioral Economics of Your New Year’s Resolutions The Daily Beast, Uri Gneezy (5/1/14)
The psychology of New Year’s resolution The Conversation, Mark Griffiths (1/1/16)
Apply Behavioral Economics for a Better New Year Wharton Blog Network, William Hartje (16/1/14)
The Kardashians Can Help Your New Year’s Resolutions Huffington Post, John Beeby (29/12/16)
Using economics to score with New Year resolutions The Hindu, Venky Vembu (4/1/17)
Be It Resolved The New York Times, John Tierney (5/1/12)

Goal-setting site
stickK ‘Set your goals and achieve them!’

Questions

  1. Explain what is meant by time inconsistent behaviour. Is this the same as giving future costs and benefits a lower weighting than present ones (and hence having to discount future costs and benefits)?
  2. Give some examples of ways in which your own behaviour exhibits time inconsistency. Would it be accurate to describe this as ‘present bias’?
  3. Would you describe not sticking to New Year’s resolutions as ‘irrational behaviour’?
  4. Have you made any New Year’s resolutions, or do you have any plans to achieve goals? Could you alter your own personal incentives and, if so, how, to make it more likely that you will stick to your resolutions/goals?
  5. Give some examples of ways in which the government could ‘nudge’ us to behave in ways that were more in our own individual interests or those of society or the environment?
  6. Do you think it’s desirable that the advertising industry should employ psychologists and behavioural economists to help it achieve its goals?
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Using incentives to affect throwaway behaviour

Can behavioural economics be applied to the case of Sweden? The Swedish government is trying this out by changing government policy in a way that may encourage its residents to change their behaviour.

People in many countries in the world live in what is often called a ‘throwaway society’. If something breaks, it’s often easier and cheaper simply to get rid of it and buy a new one. But with changes in government policy, including VAT cuts on repairs to white goods, the objective is to encourage consumers to repair their goods, rather than buying new ones. This is also contributing towards the wider objective of sustainable consumption, which is being promoted by the Swedish government.

Per Bolund, who is one of Sweden’s six Green Ministers, spoke about this policy commenting that:

“Consumers are quite active in changing both what they buy and how they buy in Sweden … We believe that getting lower costs for labour is a big part in making it more rational to repair rather than just to buy cheap and throw away …If we don’t change the economic incentives the change will never come.”

Whether or not this policy works will take some time to see, but it’s certainly an interesting test of how changing incentives affect consumer behaviour. You can read about other examples of nudging in the following blog A nudge in the right direction?.

Articles
Waste not want not: Sweden to give tax breaks for repairs The Guardian, Richard Orange (19/9/16)
Can Sweden tackle the throwaway society? BBC News (20/9/16)
Trendy now, trash tomorrow Huffington Post, Kirsten Brodde (29/9/16)
Hong Kong needs a strategy quickly for dealing with waste South China Morning Post (27/9/16)

Questions

  1. If VAT on repairs falls, how will this affect consumer behaviour?
  2. Do you think there would be an income and a substitution effect from this change in government policy? What would they be?
  3. How is the Swedish government using incentives to change consumer behaviour?
  4. If it is cheaper to buy a new white good, then is it rational to buy a new one rather than repair an existing one?
  5. How effective do you think this policy would be in encouraging consumers to change their behaviour?
  6. Find some other examples of how people might be nudged to behave in ways that are in their own interest or that of society.
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A nudge in the right direction?

Behavioural economists study how people’s buying, selling and other behaviour responds to various incentives and social situations. They don’t accept the simplistic notion that people are always rational maximisers. As the Livemint article below states, “According to behavioural economists, the human brain neither has the time nor the ability to process all the information involved in decision making, as assumed by the rational model.” Instead, rationality is bounded: people use simple rules of thumb in making decisions – rules they have developed over time in the light of experience.

So can people’s behaviour be altered by understanding their limited rationality? Advertisers are only too well aware of a number of psychological ‘tricks’ to change people’s purchasing behaviour. For example, wanting to be approved of by your friends is used by advertisers to sell various fashion products and toiletries. Often, people need only a relatively small ‘nudge’ to change the way they behave.

And it is not just advertisers who are using the insights of behavioural economics. Governments are increasingly trying to find ways of nudging people to behave in ways that are better for themselves or for society.

In 2010, David Cameron set up a ‘Nudge Unit’, formally know as ‘The Behavioural Insights Team‘. It has produced a number of academic papers on topics as diverse as tax compliance, incentives for university attendance, charitable giving in the workplace and using SMS reminders to reduce missed hospital appointments. The academic evidence can then be use as the basis for policy.

Another nudge unit has been set up in Australia (see second article below). The USA, Singapore and various other countries are increasingly using the insights of behavioural economics to devise policy to affect human behaviour.

Two recent pieces of work by the UK team concern ways of discouraging doctors from over-prescribing antibiotics and using encouraging text messages to FE students to reduce dropout rates. Another nudge has been used by the tax authorities (HMRC) who have been sending out texts to remind people to pay their taxes on time and to make them aware that they are being monitored. The message read, “Most people pay on time to avoid penalties”.

The articles below look at these recent initiatives and how human behaviour can be changed in a relatively low-cost way. In most cases this involves a simple nudge.

Articles
Nudge-unit trials reveal best ways to prod people Sydney Morning Herald, Nick Miller (29/8/15)
Government ‘nudge unit’ to attempt to change people’s behaviours Sydney Morning Herald, Nick Miller (15/9/16)
New frontiers of human behaviour Livemint, Biju Dominic (15/9/16)
Doctors ‘nudged’ into prescribing far fewer antibiotics New Scientist (15/9/16)
GPs handing out fewer antibiotics after warning of over-prescribing, says study BT (15/9/16)
Study of colleges shows ‘encouraging’ texts dramatically cut dropout rates FE Week, Paul Offord (22/7/15)
The text messages getting teenagers better grades BBC Today Programme, David Halpern and Fiona Morey (15/9/16)
Ping! Pay your tax now or face a penalty. HMRC sends out ‘threatening’ SMS texts to taxpayers The Telegraph, Christopher Hope (15/9/16)

Publications of Behavioural Insights Team
Publications list BIT
The Behavioural Insights Team’s Update Report: 2015–16: overview BIT (15/9/16)
The Behavioural Insights Team’s Update Report: 2015–16 BIT (15/9/16)
Blog BIT

Questions

  1. Explain what is meant by bounded rationality.
  2. Give some examples from your own behaviour of decisions made using rules of thumb.
  3. Should we abandon models based on the assumption of rational maximising behaviour (e.g. attempts to maximise consumer surplus or to maximise profit)?
  4. Find out some other examples of how people might be nudged to behave in ways that are in their own interest or that of society.
  5. How might people be nudged to eat more healthily or to give up smoking?
  6. To what extent can financial incentives, such as taxes, fines, grants or subsidies be regarded nudging? Explain.
  7. Why, do you think, the message by an Australian hospital, “if you attend, the hospital will not lose the $125 we lose when a patient does not turn up” was successful in reducing missed appointments by 20%, while the message, “if you do not attend, the hospital loses $125″ was not as effective?
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Transforming capitalism

Short-termism is a problem which has dogged British firms and is part of the explanation of low investment in the UK. Shareholders, many of which are large pension funds and other financial institutions, are more concerned with short-term returns than long-term growth and productivity. Likewise, senior managers’ rewards are often linked to short-term performance rather than the long-term health of the company.

But the stakeholders in companies extend well beyond owners and senior managers. Workers, consumers, suppliers, local residents and the country as a whole are all stakeholders in companies.

So is the current model of capitalism fit for purpose? According to the new May government, workers and consumers should be represented on the boards of major British companies. The Personnel Today article quotes Theresa May as saying:

‘The people who run big businesses are supposed to be accountable to outsiders, to non-executive directors, who are supposed to ask the difficult questions. In practice, they are drawn from the same, narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough.

We’re going to change that system – and we’re going to have not just consumers represented on company boards, but workers as well.’

This model is not new. Many countries, such as France and Germany, have had worker representatives on boards for many years. There the focus is often less on short-term profit maximisation and more on the long-term performance of the company in terms of a range of indicators.

Extending this model to stakeholder groups more generally could see companies taking broader social objectives into account. And the number of companies which put corporate social responsibility high on their agenda could increase significantly.

And this approach can ultimately bring better returns to shareholders. As the first The Conversation article below states:

This is something that research into a ‘Relational Company’ model has found – by putting the interests of all stakeholders at the heart of their decision making, companies can become more competitive, stable and successful. Ultimately, this will generate greater returns for shareholders.

While CSR has become mainstream in terms of the public face of some large corporations, it has tended to be one of the first things to be cut when economic growth weakens. The findings from Business in the Community’s 2016 Corporate Responsibility Index suggest that many firms are considering how corporate responsibility can positively affect profits. However, it remains the case that there are still many firms and consumers that care relatively little about the social or natural environment. Indeed, each year, fewer companies take part in the CR Index. In 2016 there were 43 firms; in 2015, 68 firms; in 2014, 97 firms; in 2013, 126 firms.

In addition to promising to give greater voice to stakeholder groups, Mrs May has also said that she intends to curb executive pay. Shareholders will be given binding powers to block executive remuneration packages. But whether shareholders are best placed to do this questionable. If shareholders’ interests are the short-term returns on their investment, then they may well approve of linking executive remuneration to short-term returns rather than on the long-term health of the company or its role in society more generally.

When leaders come to power, they often make promises that are never fulfilled. Time will tell whether the new government will make radical changes to capitalism in the UK or whether a move to greater stakeholder power will remain merely an aspiration.

Articles
Will Theresa May break from Thatcherism and transform business? The Conversation, Arad Reisberg (19/7/16)
Democratise companies to rein in excessive banker bonuses The Conversation, Prem Sikka (14/3/16)
Theresa May promises worker representatives on boards Personnel Today, Rob Moss (11/7/16)
If Theresa May is serious about inequality she’ll ditch Osbornomics The Guardian, Mariana Mazzucato and Michael Jacobs (19/7/16)
Theresa May should beware of imitating the German model Financial Times, Ursula Weidenfeld (12/7/16)

Questions

  1. To what extent is the pursuit of maximum short-term profits in the interests of (a) shareholders; (b) consumers; (c) workers; (d) suppliers; (e) society generally; (f) the environment?
  2. How could British industry be restructured so as to encourage a greater proportion of GDP being devoted to investment?
  3. How would greater flexibility in labour markets affect the perspectives on company performance of worker representatives on boards?
  4. How does worker representation in capitalism work in Germany? What are the advantages and disadvantages of this model? (See the panel in the Personnel Today article and the Financial Times article.)
  5. What do you understand by ‘industrial policy’? How can it be used to increase investment, productivity, growth and the pursuit of broader stakeholder interests?
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Sainsbury’s and Argos: Good or bad?

There has been a link between Sainsbury’s and Argos, with Sainsbury’s offering Argos concessions in some stores. But now, we’re looking at a much more significant link, with Sainsbury’s offering £1.3 billion for control of Home Retail Group’s Argos.

Many have questioned the sense of this offer, wondering what Sainsbury’s will gain from purchasing Argos, but Sainsbury’s has indicated it will boost sales, give itself access to a more advanced delivery network and Argos customers. Argos has worked hard to update its image, moving towards a more technology based catalogue and promising same day delivery in a bid to compete with companies, such as Amazon.

Online delivery is a costly business, with suggestions that retailers make losses on each delivery and hence pay customers to shop online. This move by Sainsbury’s may therefore be an investment in expanding its online delivery services and using the infrastructure that Argos already has. This will therefore help Sainsbury’s to invest in this sought after customer service, without having to invest millions into providing the infrastructure in the first place. This move may give Sainsbury’s a first mover advantage in the grocery sector, which may force other competitors to follow suit.

We could write for hours on the ins and outs of this potential deal and undoubtedly commentators will argue both for and against it. The following articles consider the good and bad sides and the future of grocery retailers in the UK.

Why does Sainsbury’s want to buy Argos? BBC News, Katie Hope (01/02/16)
Sainsbury’s agrees terms to buy Home Retail Group in £1.3bn deal The Guardian, Sean Farrell and Sarah Butler (02/02/16)
Sainsbury’s bets on Argos takeover for digital age Reuters, James Davey and Kate Holton (02/02/16)
Sainsbury’s returns with £1.3bn offer for Argos The Telegraph, Jon Yeomans and Ashley Armstrong (02/02/16)
Sainsbury’s could shut up to 200 Argos stores Sky News (12/01/16)
Sainsbury’s strikes deal to buy Home Retail Group Financial Times, Mark Vandevelde, Arash Massoudi and Josh Noble (02/02/16)

Questions

  1. What are the benefits to Sainsbury’s of taking over Argos?
  2. Why have many critics been surprised by this take-over?
  3. What is meant by a first mover advantage?
  4. Do you think that grocery retailers should diversify further or focus on their core business?
  5. Commentators suggest that delivery costs more to retailers than the price charged to consumers. Can you illustrate this using cost and revenue curves?
  6. Online delivery infrastructure is a big fixed cost for a firm. How will this change the shape of a firm’s cost curves and what impact will this have on profits following changes in market output?
  7. Do you think this take over will cause any concerns by competition authorities?
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Jim Slater: the legacy

Jim Slater, who has just died at the age of 86, was a tycoon of the 1970s, probably unknown to most reader of this blog. But his legacy lives on and many will question whether the actions of the banking sector and big business today is a reflection of the lessons that were not learnt 40 years ago.

Slater was a businessman: perhaps the businessman in the 1970s, building up a company that in today’s money and the height of its success, would have been worth billions. Buying and selling companies, asset stripping and investing created Slater Walker, which shot to success and then crumbled to failure, taking with it a bailout from the Bank of England of £110 million. You might look at that figure and compare it with the bail outs of more recent times and think – peanuts. But think about how prices have changed and convert £110 million into today’s money and that’s a hefty bail out. A key question is whether the willingness of the government and Bank of England to bail out key banks and financial sector businesses has encouraged the irresponsible lending that led to the credit crunch. Was there a moral hazard? Had Slater Walker been left to fail, would the world look a slightly different place?

Perhaps a little extreme, but I wonder, if we were to look back over the past 50 to 60 years, whether we would find other cases of key businesses being bailed out, which set a precedent for other companies to grow, without necessarily taking full responsibility for it. Jim Slater will certainly leave a legacy behind him .

Jim Slater and the warning from the 1970s that we ignored BBC News, Jonty Bloom (20/11/15)

Questions

  1. What is meant by asset stripping?
  2. If a company like Slater Walker had not been bailed out, do you think the economy would have suffered?
  3. If Slater Walker had been left to fail, would that have changed the business model of some of our largest banks and reduced the chance of a financial crisis 40 years later?
  4. Do you think the concept of moral hazard is relevant here?
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The profitability of teams in the English Premier League

Deloitte recently published its 24th Annual Review of Football Finance and it contained some surprising results. Historically, most teams in the English Premier League (EPL) have made accounting losses with any increases in revenues being offset by higher wage costs. However, this report found that in 2013–14 most teams in the EPL actually made accounting profits.

The Deloitte’s review reported that the combined operating profits of clubs in the EPL increased from £82 million in 2012–13 to £614 million on 2013–14 – an enormous increase of 649%. Nearly all of the teams (19 out of 20) in the league made an operating profit while 14 also reported pre-tax profits. Dan Jones, head of Deloitte’s Sports Business Group, commented that:

“The change in club profitability in 2013–14 was more profound than anything we could have forecast.”

Why has the profitability of teams in the EPL suddenly improved so dramatically? One important factor was the significant increase in revenue. The combined income of the teams was £3.26 billion in 2013–14 – an increase of £735 million, or 29% on the previous year. Although match-day and commercial revenue both increased, the majority of this growth in income (nearly 80%) came from the sale of broadcast rights. The 2013–14 season was the first year of a new three-year contract that raised over £1.7 billion per year from the sale of these rights in both the UK and overseas.

However, clubs in the EPL have received big increases in revenue from TV deals before and still made substantial accounting losses. For example, the broadcasting contract that ran from 2010–13 generated over £1.1 billion per season – a £243 million per annum increase on the previous deal. Significantly, in the first year of this deal (2010–11), 81% of this increase in revenue went straight into higher player salaries, whereas in 2013–14 this figure was only 16%. The ratio of wages to turnover also fell from 71% in 2012–13 to 58% in 2013–14

So why did a smaller proportion of the increase in revenue go to the players compared with previous years? The explanation appears to be the impact of two new controls and regulations that were implemented by the EPL at the beginning of the 2013–14 season.

One of these has received considerable media attention and is similar to UEFA’s Financial Fair Play regulations. The Profitability and Sustainability Rules allow the clubs to make a maximum cumulative loss of £105 million over three seasons before having to face sanctions from the league. The size of the permissible loss is significantly higher than in the UEFA regulations.

The other control that has received far less attention is called Short-Term Cost Control (STCC). This regulation places limits on the extent to which clubs can increase their total wage bill. It operates from 2013–14 to 2015&ndash16: i.e. it covers the same three years as the current TV deal. For the 2013–14 season it worked in the following way.

If teams had a wage bill of less than £52 million they faced no restrictions on their spending on players’ salaries. Only Crystal Palace (£46 million) and Hull City (£43 million) fell into this category. Unsurprisingly, the five biggest spending clubs, Man Utd, Man City, Chelsea, Arsenal and Liverpool, had much greater wage bills of £215m, £205m, £192m, £166m and £144m respectively.

Any of the 18 teams that exceeded the £52m limit would still not face sanctions if their wage bill increased by £4 million or less. For example, Stoke City’s wage bill only increased from £60m to £61m, while Tottenham Hotspur’s increased from £96m to £100m. Some clubs actually managed to reduce their total wage bill, including the champions, Manchester City, which managed to lower its from £233m to £215m.

However, there were still 12 teams with a total wage bill that was greater than £52 million in 2013–14 and which had increased by more than £4 million on the previous year. For these teams not to face any sanctions, they had to prove to the EPL that any of the increase above £4 million was either due to player contracts entered into before January 2013 or could by financed from the following two sources.

• Club Own Revenue Uplift
• Profit from player transfers

Whereas the profit from player transfers is straightforward, the ‘Club Own Revenue Uplift’ requires some explanation, as it excludes a very important part of teams’ incomes – Central Fund payments.

Some revenues earned by clubs in the EPL are referred to as ‘Central Fund payments’. These are, in effect, income payments from money that is raised centrally by the EPL on behalf of the clubs and then distributed to the teams using an agreed formula. The majority of the revenue generated under this category is from the broadcast deals, although some commercial income, such as the sponsorship of the league, also falls under this category. For some teams the money raised from Central Fund payments makes up the majority of their revenue.

‘Club Own Revenue’ in STCC calculations refers to all revenues other than those from Central Fund payments. This includes a number of income streams that the club has more direct control over. They include:

• Gate money/other match-day revenue
• Commercial deals negotiated by the individual club
• Income from playing in European competitions, including TV revenue.

The uplift refers to increases in revenue from these sources compared to 2012–13.

For example, assume a club has made no profit from its transfer dealing and did not enter into any significant player contracts prior to January 2013. If this club’s wage bill increased from £100m in 2012–13 to £110m in 2013–14 then it would have to provide evidence to show that £6m of this increase could be financed from growth in its Club Own Revenue. In other words, it would have to demonstrate how its income from gate money, commercial deals and playing in Europe was at least £6m higher in 2013–14 than it had been in 2012–13.

It will be interesting to see if (1) the profitability of the clubs continues to improve in future years and (2) the STCC regulations are extended when the new broadcast deal comes into effect in 2016–17.

The EPL Proves Cost Control Works The Judge 13 (4/6/15)
English Premier League clubs made more revenue than Spain and Italy’s clubs combined UK Business Insider, Lianna Brinded (4/6/15)
Premier League football club revenues and profits soar BBC News, Bill Wilson (4/6/15)
Deloitte Premier League list: Clubs’ revenue boom to £3.3billion as Tottenham record highest ever pre-tax profits after Gareth Bale transfer The Independent, Joanna Bourke (4/6/15)
Annual Review of Football Finance 2015 Premier League clubs generate over £3bn revenue in season of records Deloitte (4/6/15)
Premier League top of the rich list with record income of £3.26bn The Guardian, David Conn (4/6/15)

Questions

  1. What is the difference between an operating profit and a pre-tax profit?
  2. If a club reports that it is making an accounting profit, does this mean that it must be making an economic profit? Explain your answer.
  3. Give some examples of the economic costs of running a football club that might not be included in accounting calculations of profit.
  4. How is the profit/loss from player transfers calculated?
  5. Explain why the current rules may give teams that play in European competitions a competitive advantage.
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A new look for New Look?

New Look was founded in 1969 and is an iconic budget retailer found on most British high streets. In its history, it has been a family business; it has been listed on the London stock exchange; returned to a private company and then had the potential to be re-listed. Now, it is moving into South African ownership for £780 million.

90% of New Look will now be owned by Christo Wiese who controls Brait and who has been linked with other take-overs of British retailers in recent years. The remaining 10% will remain in the hands of the founding family. The company has been struggling for some time and in 2010 did have plans to relist the company on the London Stock Exchange. However, volatile market conditions meant that this never occurred and the two private equity firms, Apax and Permira, appeared very eager to sell. New Look’s Chairman, Paul Mason, said:

“This is an ideal outcome for New Look. The Brait team demonstrated to us that they have the long-term vision to help Anders and the team grow this brand.”

It is not yet clear what this move will mean for the retailer, New Look, but with an estimated £1 billion debt, it is expected that changes will have to be made. It is certainly an attractive investment opportunity and New Look does have a history of high rates of growth, despite its current debt. Furthermore, the debt levels are likely to have helped Mr. Wiese obtain a deal for New Look. Fashion retailing is a highly competitive market, but demand always appears to be growing. It is still relatively ‘new’ news, so we will have to wait to see what this means for the number of stores we see on the high streets and the number of jobs lost or created. The following articles consider this new New Look.

South African tycoon buys New Look fashion retailer BBC News (15/5/15)
South African tycoon enters UK retail fray with New Look purchase Financial Times, Andrea Felsted, Clare Barrett and Joseph Cotterill (15/5/15)
New Look snapped up by South African tycoon The Guardian, Sean Farrell (15/5/15)
New Look sold to South African billionaire for £780m The Telegraph, Elizabeth Anderson and Andrew Trotman (15/5/15)

Questions

  1. Why might a company become listed on the London stock exchange?
  2. How would volatile economic circumstances affect a company’s decision to become listed on the stock market?
  3. What do you think this purchase will mean for the number of New Look stores on British high streets? Do you think there will be job losses or jobs created by this purchase?
  4. How do you think the level of New Look’s debt affected Christo Wiese’s decision to purchase New Look?
  5. Which factors are likely to affect a firm’s decision to take-over or purchase another firm?
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Nudging people onto the stairs: fun theory in action

Economics is about choices. But how can people be persuaded to make healthy choices, or socially responsible or environmentally friendly choices? Behavioural economists have studied how people can be ‘nudged’ into changing their behaviour. One version of nudge theory is ‘fun theory’. This studies how people can be persuaded into doing desirable things by making it fun to do so.

I came across the first video below a couple of days ago. It looks at a highly successful experiment at the Odenplan underground station in Stockholm to persuade people to make the healthy choice of using the stairs rather than the escalator. It made doing so fun. The stairs were turned into a musical keyboard, complete with sound. Each stair plays a piano note corresponding to its piano key each time someone treads on it. As you go up the stairs you play an ascending scale.

After installing the musical staircase, 66% more people than normal chose the stairs over the escalator.

The fun theory initiative is sponsored by Volkswagen. The Fun Theory website is ‘dedicated to the thought that something as simple as fun is the easiest way to change people’s behaviour for the better. Be it for yourself, for the environment, or for something entirely different, the only thing that matters is that it’s change for the better.’

VW held a competition in 2009 to encourage people to invent fun products designed to change people’s behaviour. There were over 700 entries and you can see them listed on the site. The 13 finalists included the musical staircase, traffic lights with quiz questions on the red, a Connect Four beer crate, fun tram tickets (giving entry to an instant-win lottery), a pinball exercise machine, a speed camera lottery where a winner is chosen from those abiding by the speed limit, a jukebox rubbish bin (which plays when people add rubbish), a one-armed vending machine, a fun doormat, car safety belts linked to a car’s entertainment system, car safety belt with a gaming screen which turns on when buckled, a bottle bank arcade system and the world’s deepest bin (or at least one which sounds as if it is). The winner was the speed camera lottery.

The fun theory site
Thefuntheory.com

Fun theory videos
Piano Staircase – Odenplan, Stockholm (on Vimeo)
The Speed Camera Lottery (on VIMP.com, Kevin Richardson)
Garbage Jukebox (on YouTube)
The World’s Deepest Bin (on Vimeo)
Bottle Bank Arcade (on YouTube)

Questions

  1. Does fun theory rely on rational choices?
  2. Other than through having fun, how else may people be nudged into changing their behaviour?
  3. Go through some of the entries to the Fun Theory Award and choose three that you particularly like. Explain why.
  4. Invent your own fun theory product. You might do this by discussing it groups and perhaps having a group competition.
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