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Posts Tagged ‘bargaining power’

Ramifications from the recent dispute between Tesco and Unilever

An earlier post on this site described a recent row between Tesco and Unilever that erupted when Unilever attempted to raise the prices it charges Tesco for its products. Unilever justified this because its costs have increased as a result of the UK currency depreciation following the Brexit decision.

It also appears that more general concerns that the fall in the value of sterling would lead to higher retail prices were prevalent around the time that the Tesco Unilever dispute came to light. Former Sainsbury’s boss, Justin King, made clear that British shoppers should be prepared for higher prices. He also said that:

Retailers’ margins are already squeezed. So there is no room to absorb input price pressures and costs will need to be passed on. But no one wants to be the first to break cover. No business wants to be the first to blame Brexit for a rise in prices. But once someone does, there will be a flood of companies because they will all be suffering.

It is interesting to consider further why the Tesco and Unilever case was the first to make the headlines and why their dispute was resolved so quickly. In addition, what are the more general implications for the retail prices consumers will have to pay?

Arguably, Unilever saw itself as having a strong hand in negotiations with Tesco because its product portfolio includes a wide variety of must-stock brands, including Pot Noodles, Marmite and Persil, that are found in 98% of UK households..

Unilever has been criticised for using the currency devaluation as an excuse to justify charging Tesco more, since most of its products are made in the UK. However, Unilever was quick to point outthat commodities it uses in the manufacture of products are priced in US dollars, so the currency devaluation can still affect the cost of products that it manufactures in the UK. In addition, Unilever’s chief financial officer, Graeme Pitkethly, insisted that price increases due to rising costs were a normal part of doing business:

We are taking price increases in the UK. That is a normal devaluation-led cycle.

On the other hand, even if the cost increases faced by Unilever are genuine, it is interesting to speculate whether it would have been so quick to adjust its prices downwards in response to a currency appreciation. After all, a commonly observed phenomenon across a range of markets is ‘rockets and feathers’ pricing behaviour i.e. prices going up from a cost increase more quickly than they go down following an equivalent cost decrease.

Compared to Unilever, some other suppliers are likely to have less bargaining power – in particular, those competing in highly fragmented markets and those producing less branded products. In such markets the suppliers may be forced to accept cost increases. For example, almost 50% of butter and cheese consumed in the UK comes from milk sourced from EU markets. Protecting such suppliers is one of the key roles of the Grocery code of conduct that the UK competition agency has put in place.

From Tesco’s point of view it will have benefited from good publicity by doing its best to protect consumers from price hikes. Helen Dickinson, chief executive of the British Retail Consortium, said:

Retailers are firmly on the side of consumers in negotiating with suppliers and improving efficiencies in the supply chain to control the inflationary pressure that is building through the devaluation of the pound.

However, it is also clear that Tesco had its own motives for resisting increased costs for Unilever’s products. In such situations both supplier and retailer should be keen to avoid a situation where they both impose their own substantial mark-ups at each stage of the supply chain. It is well established that this creates a double mark-up and not only harms consumers, but also the supplier and retailer themselves. Instead, the firms have an incentive to use more complex contractual arrangements to solve the problem. For example, suppliers may pay slotting allowances to get a place on the retailers’ shelves in exchange for lower retail mark-ups.

It has also been claimed that cutthroat competition in the supermarket industry, especially from discounter retailers Aldi and Lidl, made Tesco particularly keen to prevent price rises. Some arguments suggest that these discounters will be best placed to benefit from the currency devaluation as they sell more own brands, have a limited range, the leanest supply chains and benefit from substantial economies of scale. On the other hand, they source more of their products from abroad and it has been suggested that:

A fall in sterling will push prices up for everyone who sources products from Europe, but Aldi and Lidl will be affected more than most.

One prediction suggests that the overall impact of the currency depreciation on food prices will be an increase of around 3%. This may be particularly worrisome given concerns that the impact will fall most heavily on benefit claimants and other low-income households.

Outside of the food industry, Mike Rake, the chairman of BT, has highlighted the fact that:

Imported mobile phones and broadband home hubs were already 10% more expensive and the cost would have to be passed on to consumers in the near future.

It is therefore clear that the currency devaluation has the potential to create substantial tensions in the supply-chain agreements across a range of markets. The impact on the firms involved and on consumers will depend upon a wide range of factors, including the competitiveness of the markets, the nature of the firms involved and their bargaining power. Furthermore, evidence from an earlier currency depreciation in Latin America makes clear that the price elasticity of demand will be another factor that determines the impact price rises have.

Finally, it is also worth noting that a potential flip side of the currency depreciation is a boost for UK exports. However, it has been suggested that the manufacturing potential to take advantage of this in the UK is limited. In addition, even the manufacturing that does take place, for example in the car industry, often relies on components imported from abroad.

Articles
The Brexiteers’ Marmite conspiracy theories exposed their utter ignorance of how markets really work Independent, Ben Chu (16/10/16)
Tesco price dispute sends Unilever brand perceptions tumbling Marketing Week, Leonie Roderick (17/10/16)
Unilever and Tesco both benefit from their price row, but Brexit will bring more pain Marketing Week, Mark Ritson (19/10/16)
Why the Tesco v Unilever feud was good for British business campaign, Helen Edwards (20/10/16)

Questions

  1. What are some of the factors that affect a supplier’s bargaining power?
  2. How might the discount retailers respond to the currency devaluation?
  3. Use the figures from Latin America in the article cited above to calculate the price elasticity of demand.
  4. Explain why the price elasticity of demand is an important determinant of the effect of a price rise.
  5. Can you think of other examples of markets that may be particularly prone to price rises following a currency depreciation?
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Apple found guilty of coordinating the fixing of e-book prices

Apple was last week found guilty in the US for its role in the fixing of e-book prices. A subsequent hearing will now be held to determine the damages that Apple will be forced to pay. However, Apple vehemently denies the allegations and looks set to appeal the decision.

To understand what the US Department of Justice (the European Commission has also brought a case) is objecting to, we need to look back to how pricing in this rapidly growing market has evolved over time.

Until the end of 2009 e-books were sold under a wholesale pricing model. Here, publishers charge retailers a wholesale price per book and retailers are then free to charge final consumers whatever price they choose. This all changed in the US (there were also similar developments in Europe) during an eventful period of a few days in January 2010 when Apple unveiled its iPad for April release.

The publisher Macmillian proposed that Amazon switch to an agency pricing model under which the publisher sets the retail price. This is typically referred to by economists as Resale Price Maintenance (RPM). Interestingly, RPM has a long history in the book industry. In the UK for example, throughout most of the last century publishers set prices under the Net Book Agreement, until this broke down in the mid 1990s. In addition, in some countries, for example Germany, books continue to be sold under RPM.

Macmillan also threatened Amazon that if it preferred to keep wholesale pricing it would delay the supply of e-book releases to them. Amazon initially responded by refusing to stock Macmillan titles. However, soon after Amazon ceded to Macmillan’s proposal. Despite this, Amazon made clear its dissatisfaction to its customers:

We have expressed our strong disagreement and the seriousness of our disagreement by temporarily ceasing the sale of all Macmillan titles. We want you to know that ultimately, however, we will have to capitulate and accept Macmillan’s terms because Macmillan has a monopoly over their own titles, and we will want to offer them to you even at prices we believe are needlessly high for e-books.

It turned out that 5 of the 6 major publishers (including Macmillan) had already agreed the same agency terms to sell e-books for Apple devices. Like Macmillan, the other publishers all then also imposed agency pricing on Amazon. Furthermore, crucial to the contracts agreed with Apple was a so called ‘most-favoured customer’ clause which guaranteed that e-books would not be sold elsewhere at prices below those charged to Apple customers. Effectively, therefore, this clause made it necessary for the publishers to impose agency terms on Amazon. The Department of Justice objected to this and believed consumers would be harmed due to higher prices. All of the publishers involved eventually decided to settle the case, leaving Apple alone to fight the case in court.

In the decision Judge Cote concluded that:

the publisher defendants conspired with each other to eliminate retail price competition in order to raise e-book prices, and that Apple played a central role in facilitating and executing that conspiracy. Without Apple’s orchestration of this conspiracy, it would not have succeeded as it did in the Spring of 2010.

It is interesting to consider the reasons why the publishers would be keen to take control of the prices Amazon charges for e-books. Evidence suggests that Amazon was frequently retailing e-books at substantial discounts and even below wholesale costs. One explanation for this is that Amazon was keen to increase demand for Kindle devices. The publishers, on the other hand, might well be concerned about the implications of Amazon dominating the e-book market. Potentially, this would give Amazon significant bargaining power over them.

Of course, such dominance might also have knock-on effects on consumer prices in the long-run. Whether the publishers will be permitted to use agency pricing to mitigate such concerns in the future remains unclear and depends on whether the competition authorities object to agency pricing per se or just the coordinated way in which it was achieved.

As the articles below demonstrate, opinion is strongly divided for and against the judgement against Apple.

EU raids ebook publishers in price fixing investigation The Guardian, Benedicte Page and Leigh Phillips (4/3/11)
Apple Faces Damages Trial Over E-Book Antitrust Violation Bloomberg Businessweek, Bob Van Voris, Adam Satariano and David McLaughlin (10/7/13)
Apple played ‘central role’ in ebook price-fixing conspiracy, says federal judge The Guardian, Amanda Holpuch (11/7/13)
US: Apple found guilty, but what happens next? Competition Policy International (11/7/13)
Why It’s Insane That No One Cares About Apple’s Price-Fixing Conspiracy (AAPL) Seattle pi, Jim Edwards (13/7/13)
Apple Learns The Hazards Of Innovation With E-Book Antitrust Ruling Forbes, Daniel Fisher (10/7/13)

Questions

  1. What are the important features of the e-book market?
  2. What are the key differences between the traditional and e-book markets?
  3. To what extent do Amazon and Apple have different incentives in the e-book market?
  4. Do you think Resale Price Maintenance is more likely to harm competition in the market for traditional or e-books?
  5. What do you think might be the short and long-run implications of this decision?
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