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Posts Tagged ‘competition commission’

Is Google abusing its dominant market position?

In April 2015 the European Commission (EC) opened a formal investigation into the behaviour of Google in the market for smartphones and tablets. On the 20th April Google was sent a preliminary judgment (referred to formally as a Statement of Objections) in which it was accused of abusing its dominant market position. The European Commissioner argued that the case was similar to the famous and protracted investigation into the conduct of Microsoft.

In the early 2000s Microsoft had a dominant position in the market for desktop operating systems. It has been estimated that 97% of all computing devices at the time used Microsoft Windows. This market power attracted the attention of the EC who accused the company of using its dominance in the operating systems market to restrict competition in complementary markets for software such internet browsers and media players. This led to a complex legal battle between the two parties.

Windows is proprietory software and computer manufacturers have to pay Microsoft a licence fee to install it on their machines. Before the rulings by the EC, Microsoft could make a licence for Windows conditional on other Microsoft software such as Internet Explorer and Media Player being pre-installed. This is known as bundling and in this case the EC came to the conclusion that it restricted competition. The European Commissioner, Margrethe Vestager recently stated that

“If Microsoft’s media player was already there when you bought a PC, it would be hard to persuade people to even try an alternative, so innovators would be at a big disadvantage”

Microsoft lost most of its competition battles with the EC and had to pay a total of €2.2 billion in various fines. It was also forced to change its conduct. For example, the EC instructed Microsoft to provide its users with a choice of internet browsers.

The marketplace for operating systems has gone through some significant changes since the early 2000s. By 2016 Microsoft’s market share had fallen to 26 per cent. One of the major reasons for this decline has been the increasing popularity of smartphones and tablets.

Google’s Android operating system dominates the mobile market with a market share of over 80 per cent. However, the economics of the Android operating system are very different from those of Windows. Unlike Windows, Android is an example of ‘open-source software’. This means that, rather than having to obtain a licence fee, mobile handset or tablet manufacturers can freely install Android on their devices and are not obliged to pre-install other Google software – both Amazon and Nokia have done this. ,

Another major difference is that it is relatively straightforward for rival firms to develop software that can run on Android. Microsoft was accused of making it very difficult for rival software companies to develop products that would run smoothly on the Windows operating system.

It would appear far easier for rival firms to compete with Google than it ever was with Microsoft when it had a dominant market position. It might therefore seem surprising that the EC has accused Google of abusing its dominant market position.

Rather than any restrictions surrounding the licencing conditions for the operating system the EC’s objections to Google’s behaviour focus on its licencing conditions for other proprietary software products it provides. In particular, the EC has focused on the Google Play Store.

The pre-installation of the Google Play Store is seen as vital to the commercial success of any Android phone. Google Play Store was launched in 2012 and brought three previously separate services together – Android Market, Google Music and Google eBookstore. It is the official app store for all users of a device with an Android operating system. It has been argued that a mobile phone store would not stock an Android phone unless it had Google Play Store pre-installed because it is so highly valued by customers.

Therefore it is vital for Android smartphone and tablet manufacturers to obtain a licence for the Play Store. The conditions for obtaining a licence are outlined in the Mobile Application Distribution Agreement. This specifies that a number of other Google apps must also be pre-installed on the device in order for a licence to be granted for the Play Store. These apps include Gmail, Google Chrome, Google Drive, Google Hangouts, Google Maps, Google Search and YouTube. The manufacturer is free to install any other non-google apps.

The EC has specifically objected to the condition that Google Search has to be installed and set as the default search engine. It is concerned that this that will make it very difficult for other search services to compete with Google because (1) manufacturers will have limited incentives to pre-install any competing search engines and (2) consumers will have less incentive to download competing search engines.

The EC has also expressed concerns that the pre-installation of Google Chrome as the mobile browser will also have a negative impact on competition and innovation in this market.

Companies are given 12 weeks to respond after they have received a preliminary judgment. If they do not accept the objections, then the EC will take several months to come to a final ruling and suggest some appropriate remedies. In this case, the most likely remedy is the removal of the licence conditions for the Google Play Store. If Google appeals the ECs decision to the General Court of the EU, it could take years until a final judgment is made.

Murad Ahmed, the European Technology Correspondent at the Financial Times commented that

“One lesson Google might want to learn from Microsoft’s example is while it fights the EU watchdog it is not overtaken by a less distracted competitor.”

Articles
Europe v Google: how Android became a battleground The Guardian (20/4/16)
EU accuses Google of using Android to skew market against rivals The Guardian (20/4/16)
Google faces EU charge over Android ‘abuse of dominance’ BBC News (20/4/16)
Google hit with EU competition charges for ‘abusing’ dominant position with Android Independent (20/4/16)
Everything you need to know about Google and its EU battle The Telegraph (20/4/16)

Questions

  1. Draw a diagram to compare and contrast the price and quantity in a competitive market with a situation where a firm has market dominance. Clearly state any assumptions you have made in the analysis.
  2. What factors does the EC consider when judging if a firm has a dominant position in the market?
  3. This blog has focused on one aspect of Google’s behaviour/conduct that has raised concerns with the EC. What other elements of Google’s conduct has the European Commission objected to?
  4. Explain the difference between pure and mixed bundling.
  5. What impact does bundling have on consumer welfare?
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Competition Commission action in the cement market: remedies announced

A few months ago, in a post on this site I reported that the Competition Commission (CC) had completed their provisional investigation into the concrete and cement market in Great Britain. As I discussed, they concluded that coordination between the main cement producers was resulting in high prices. They are particularly concerned about the impact of high prices in this market because:

Cement is an essential product for the construction and building sectors and the amount of such work that is funded by the public purse only underlines the importance of ensuring that customers get better value for money. We believe our measures can bring about a substantial, swift and lasting increase in competition in this economically vital market.

The next step was for the CC to consider how they could remedy the situation and hopefully improve competition in the market.

Earlier this month, the CC announced the remedies they intend to impose. Having previously suggested that they intended to impose hard-hitting measures, they have been true to their word. The market leader, Lafarge Tarmac, will be required to sell one of its cement plants to facilitate a new entrant into the market. According to Professor Martin Cave, the CC’s Deputy Chairman who led the inquiry:

We believe that the entry of a new, independent cement producer is the only way to disturb the established structure and behaviour in this market which has persisted for a number of years and led to higher prices for customers.

In addition, the CC is also putting in place measures to limit the publication of production data and price announcements. It is hoped that these measures will reduce transparency in the market.

However, Lafarge Tarmac disagrees with the sale they are being forced to make. This is in part because, as I discussed in the earlier post, they had previously been allowed by the CC to form a joint venture (JV) with one its main rivals:

We are disappointed that the Competition Commission has asked Lafarge Tarmac to divest another cement plant only a year after it allowed the creation of the JV. This is not reasonable or proportionate and we have not been given a fair opportunity to defend our position.

In addition, Lafarge Tarmac is quoted in the above article as suggesting that the end result of the CC’s intervention will be harm to consumers. It will be extremely interesting to monitor how this market develops.

Articles
Competition Commission confirms plan for new cement producer The Construction Index, (14/01/14)
Competition Commission improves competition in the UK. Again. Global Cement, (22/01/14)

Report
Aggregates, cement and ready-mix concrete market investigation, Final report, Competition Commission, (14/01/14)

Questions

  1. Why might the publication of production data and price announcements help to facilitate coordination between firms?
  2. Would you expect the new entrant or the measures to limit the publication of production data and price announcements to have more impact on competition in the market?
  3. Using a supply and demand model, describe the impact the CC’s intervention could have on the construction market.
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Capping interest rates on payday loans: a government U-turn?

In an apparent U-turn, the Chancellor, George Osborne, has decided to cap the interest rates and other charges on payday loans and other short-term credit. As we have seen in previous news items, the sky-high interest rates which some of the poorest people in the UK are being forced to pay on these loans have caused outrage in many quarters: see A payday enquiry and Kostas Economides and the Archbishop of Canterbury. Indeed, the payday loan industry has been referred by the OFT to the Competition Commission (CC). The CC is required to report by 26 June 2015, although it will aim to complete the investigation in a shorter period.

It was becoming increasingly clear, however, that the government would not wait until the CC reports. It has been under intense pressure to take action. But the announcement on 25 November 2013 that the government would cap the costs of payday loans took many people by surprise. In fact, the new body, the Financial Conduct Authority, which is due to start regulating the industry in April 2014, only a month ago said that capping was very intrusive, arguing that it could make it harder for many people to borrow and push them into the hands of loan sharks. According to paragraph 6.71 of its consultation paper, Detailed proposals for the FCA regime for consumer credit:

The benefits of a total cost of credit cap has been looked at by the Personal Finance Research Centre at the University of Bristol. This report highlighted that 17 EU member states have some form of price restriction. Their research was ambiguous, on the one hand suggesting possible improved lending criteria and risk assessments. On the other, prices may drift towards a cap, which could lead to prices increasing or lead to a significant reduction in lenders exercising forbearance. Neither of these latter outcomes would be beneficial for consumers. Clearly this is a very intrusive proposition and to ensure we fully understand the implications we have committed to undertake further research once we begin regulating credit firms and therefore have access to regulatory data.

The government announcement has raised questions of how imperfections in markets should be dealt with. Many on the centre right argue that price controls should not be used as they can further distort the market. Indeed, the Chancellor has criticised the Labour Party’s proposal to freeze gas and electricity prices for 20 months if it wins the next election, arguing that the energy companies will simply get around the freeze by substantially raising their prices before and after the 20 months.

Instead, those on the centre right argue that intervention should aim to make markets more competitive. In other words, you should attempt not to replace markets, but to make them work better.

So what is the reasoning of the government in capping payday loan charges? Does it feel that, in this case, there is no other way? Or is the reasoning political? Does it feel that this is the most electorally advantageous way of answering the critics of the payday loan industry?

Webcasts and podcasts
Payday Loans To Be Capped By Government Sky News (25/11/13)
New law to cap cost of payday loans BBC News, Robert Hall (25/11/13)
Osborne: ‘Overall cost’ of payday loans to be capped BBC Today Programme (25/11/13)
George Osborne announces cap on payday loan charges amid concerns ITV News (25/11/13)

Articles
UK to cap payday lenders’ interest charges Reuters, Steve Slater, Paul Sandle, Kate Holton and William James (25/11/13)
Capping payday loans: from light touch to strong arm Channel 4 News, Faisal Islam (25/11/13)
Payday loans: New law to cap costs BBC News (25/11/13)
Payday loan ‘risk to mortgage applications’ BBC News (26/11/13)
Q&A: Payday loans BBC News (25/11/13)
George Osborne is playing social democratic catch-up on payday loans The Guardian, Larry Elliott (25/11/13_
Payday loans cap: George Osborne caves in following intervention led by Archbishop of Canterbury Independent, Oliver Wright (25/11/13)
The principle, the practice and the politics of fixing payday loan prices: why? And why now? Conservative Home, Mark Wallace (25/11/13)
George Osborne and the risky politics of chutzpah New Statesman, Rafael Behr (26/11/13)
Chancellor too quick off the mark on payday lending cap The Telegraph, James Quinn (25/11/13)
Crap and courage of convictions: the political problem with Osborne’s payday loan plan Spectator, Isabel Hardman (26/11/13)

Payday loan calculator
Payday loan calculator: how monthly interest can spiral BBC Consumer (7/11/13)

Questions

  1. What types of market failing exist in the payday loan industry?
  2. What types of controls of the industry are being proposed by George Osborne?
  3. What is the experience of Australia in introducing such controls?
  4. What alternative forms of intervention could be used to tackle the market imperfections in the industry?
  5. What were the proposals of the FCA? (See paragraph 6.6 in its document, Detailed proposals for the FCA regime for consumer credit.)
  6. According to a representative example on Wonga’s website, a loan of £150 for 18 days would result in charges of £33.49 (interest of £27.99 and a fee of £5.50). This would equate to an annual APR of 5853%. Explain how this APR is calculated.
  7. The proposal is to allow a relatively large upfront fee and to cap interest rates at a relatively low level, such as 4% per month, as is the case in Australia. Explain the following comment about this in the Faisal Islam article above: “The upfront fee, in theory, should change the behavioural finance of consumers around taking the loan in the first place (there are ways around this though). So this is an intervention based not on lack of competition, but asymmetries of information in consumer finance.”
  8. Comment on the following statement by Mark Wallace in the Conservative Home article above: “If overpriced payday loans should be capped, why not overpriced DVDs, sandwiches or, er, energy bills?”
  9. Compare the relative advantages and disadvantages of George Osborne’s proposal with that of Justin Welby, the Archbishop of Canterbury (see the news item, Kostas Economides and the Archbishop of Canterbury).
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An energy cartel?

As Elizabeth noted in Fuelling the Political Playing Field, there has been much debate recently about energy prices in the UK. Four of the ‘Big Six’ energy companies have now announced price rises. They average 9.1% – way above the rate of consumer price inflation and even further above the average rate of wage increases. What is more, they are considerably above the rate of increase in wholesale energy prices, which, according to Ofgem, have risen by just 1.7% in the past year.

The bosses of the energy companies have appeared before the House of Commons Energy and Climate Change Select Committee to answer for their large price increases. The energy companies claim that the increases are necessary to cover not only rising wholesale prices, but also green levies by the government and ‘network charges’ for investments in infrastructure. However, it is hard to see how, even taking into account all three of these possible sources of cost increases, the scale of price increases can be justified.

Another possible explanation for the price hikes is that they are partly the result of a system of transfer pricing (see). The energy industry is vertically integrated. Energy companies are not only retailers to customers, but also generators of electricity and wholesale shippers of gas. It is possible that, by the producing/shipping arms of these companies charging higher prices to their retailing arms, the retailers’ costs do indeed go up more than the wholesale market cost. The result, however, is higher profits for the producing arms of these businesses. In other words, a higher transfer price allows profits to be diverted from each company’s retailing arm to its producing arm.

This is an argument for making the wholesale market more competitive and for stopping the by-passing of this market by producing arms of companies selling directly to their retailing arms. What the companies are being accused of is an abuse of market power and possibly of colluding with each other, at least tacitly, to support the continuation of such a practice.

So is the answer a price freeze, as proposed by the Labour Party? Is it an investigation of the energy market by the Competition Commission? Or is it, at least as a first step, much more openness by the energy companies and transparency about their pricing practices? Or is it to encourage consumers to switch between energy companies, including the smaller ones, which at present account for less than 5% of energy supply? The videos, podcasts and articles consider these issues.

Webcasts and Podcasts
Energy bosses blame high bills on wholesale prices Channel 4 News, Gary Gibbon (29/10/13)
Why are energy bosses being questioned? BBC News, Stephanie McGovern (29/10/13)
Key questions Big Six energy companies must answer The Telegraph, Ann Robinson (29/10/13)
Energy bosses offer excuses for prices rises The Telegraph (29/10/13)
Energy bosses face MPs over price rises BBC News, John Moylan (29/10/13)
Energy boss ‘can’t explain’ competitors’ price hikes The Telegraph (29/10/13)
Ovo boss: Competition Commission would take too long BBC News (30/10/13)
Dale Vince: Energy market is ‘dysfunctional’ BBC Today Programme (30/10/13)
Tony Cocker: Public mistrust energy industry BBC Today Programme (30/10/13)
Ed Davey: Energy deals not just for ‘internet savvy’ BBC Today Programme (31/10/13)

Articles
Energy giants ‘charge as much as they can get away with’ The Telegraph, Peter Dominiczak (29/10/13)
UK energy markets need perestroika Financial Times (27/10/13)
Britain’s energy utilities must embrace glasnost Reuters, John Kemp (29/10/13)
Small energy firms ‘escape levies’ BBC News (30/10/13)
Is the energy market structurally flawed? BBC news, Robert Peston (30/10/13)
The energy market needs a Competition Commission investigation Fingleton Associates, John Fingleton (12/10/13)
Energy firms raised prices despite drop in wholesale costs The Guardian, Rowena Mason (29/10/13)
Only full-scale reform of our energy market will prevent endless price rises The Observer, Phillip Lee (26/10/13)
Energy Giants Blame Rising Bills On Green ‘Stealth Taxes’ Huffington Post, Asa Bennett (29/10/13)
Big Six energy firms ‘like cartel’ Belfast Telegraph (30/10/13)
Energy boss says he hasn’t done sums on green levies The Telegraph, Georgia Graham (30/10/13)
Graphic: How your energy bills have soared in ten years The Telegraph, Matthew Holehouse (30/10/13)
British energy suppliers’ explanations for price hikes just don’t add up The Guardian, Larry Elliott (31/10/13)
The 18th energy market investigation since 2001: Will this one be different? The Carbon Brief, Ros Donald (31/10/13)
Energy: Is there enough competition in the market? BBC News, Hugh Pym (26/11/13)

Information and Reports
Wholesale [electricity] market Ofgem
Wholesale [gas] market Ofgem
Response on wholesale energy costs Ofgem Press Release (29/10/13)
Response to Government’s Annual Energy Statement Ofgem Press Release (31/10/13)
Real Energy Market Reform The Labour Party

Questions

  1. Why may the costs of energy paid by the energy retailers to energy producers/shippers have risen more than the wholesale price?
  2. Explain what is meant by transfer pricing. How could transfer pricing be used to divert profits between the different divisions of a business?
  3. How can transfer pricing be designed by multinational companies to help them minimise their tax bills?
  4. Why is policing transfer pricing arrangements notoriously difficult?
  5. What evidence is there to show that switching between retailers by customers can help to drive retail energy prices down?
  6. How did the old electricity pool system differ from the current wholesale system?
  7. Should electricity companies be forced to pool the electricity they generate and not sell it to themselves through bilateral deals?
  8. Comment on the following: “The current electricity trading arrangements ‘create the very special incentive for the oligopolists. …The best of all possible worlds is where nobody invests. As supply and demand close up, the price spikes upwards, and supernormal profits result.’”
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A payday inquiry

When people take out loans they typically do so to spend and with the UK economy in its current state, many would argue that this is a good thing. The ‘payday loan’ industry took advantage of the weak economy and the squeezed households in the UK and for the past few years, we have seen constant adverts that will appeal to many households. But, is the industry as competitive as the adverts would have us believe?

An inquiry into this industry has been on-going for some time, and it has now been referred to the Competition Commission, due to ‘deep-rooted problems with the way competition works’. For some, a payday loan is a short term form of finance, but for others it has become a way of living that has led to a debt spiral. Frank McKillop, policy manager at Abcul said:

There is a clear demand for instant credit and across the country we are increasingly seeing members who have debts with multiple payday lenders and a record of rolling over debts, or going to one payday lender to clear the debt to another.

One problem identified by the OFT is that customers have found it difficult to compare costs and this has led, in some cases, to customers paying back significantly more than they originally thought. Customers being unable to repay loans will ring warning bells for many people, with no-one wanting a return to the height of the credit crunch.

The OFT has criticized payday loan companies for competing not on costs, but on the speed of approval and using certain unapproved tactics as part of their advertising. The selling point of such companies is that you can have the money in a very short time period. However, the criticism is that this leads to loans being given to those who are unable to afford them. Key credit checks are not being done and with late night texts being sent to often financially vulnerable people, it is no wonder that complaints have been received. In a statement, the OFT said:

The competitive pressure to approve loans quickly may give firms an incentive to skimp on the affordability assessment which is designed to prevent irresponsible lending and protect consumers.

[the business models of companies were] predicated on making loans which are unaffordable, leading to borrowers paying far more than expected through rollovers, additional interest and other charges.

While payday loans are legal and there are many companies offering them, it is what they are competing over, which seems to be in question. The industry itself has begun to change its practices, providing more information to customers, only allowing loans to be rolled over three times and the potential to freeze repayments if the customer gets into financial difficulty. If more stringent checks are completed and hence timing does not become the only grounds for competition, then the problems above may become less significant. With the ongoing OFT inquiry into the practices of the payday loan industry and the continuing demand for such financing, it is likely that we will see much more of both the good and the bad that it has to offer. The following articles consider the investigation.

Webcasts
Balls warns against payday loans ‘blank cheque’ BBC News (27/6/13)
Payday lender investigation could be delayed by bureaucracy Telegraph, Steve Hawkes (27/6/13)
Payday lenders to face ‘tougher restrictions’ on advertising BBC News, Simon Gompertz (1/7/13)
Payday lending rates BBC News, Julio Martino and Stella Creasy (2/7/13)

Articles
Regulator to investigate payday loan industry Financial Times, Elaine Moore and Robert Cookson (27/6/13)
Q&A: Payday loans BBC News (31/5/13)
Payday loans: reining in an industry that is a law unto itself Guardian (27/6/13)
Payday loans industry to face competition inquiry BBC News (27/6/13)
Payday loans firms face competition inquiry Sky News (27/6/13)
Payday loans market faces competition inquiry Guardian, Hilary Osborne (27/6/13)
OFT refers payday loans to Competition Commission Scotsman, Jane Bradley (27/6/13)
Five reasons why we all need to worry about payday lenders Telegraph, Emma Simon (27/6/13)

OFT documents
Payday lending compliance review Office of Fair Trading (27/6/13)

Questions

  1. Into which market structure would you place the payday loans industry? Make sure you justify your answer.
  2. What is the role of the (a) the OFT and (b) the Competition Commission? Do these authorities overlap?
  3. What part does advertising play in this industry?
  4. To what extent is the payday loan industry a possible cause of another credit crunch?
  5. Why has the OFT referred this industry to the Competition Commission?
  6. To what extent are payday loans an essential part of an economy?
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Competition Commission promises hard-hitting action in the cement market

The Competition Commission (CC) recently completed their provisional investigation into the cement and concrete market in Great Britain (press release). They concluded that coordination between the main cement producers is resulting in high prices.

In contrast, to illegal cartels (see for example the recent post on this site), the firms in this market are not accused of doing anything illegal. Instead, the CC’s concern is with tacit collusion. Here, no illegal communication between firms takes place, firms simply do not compete intensely due to a mutual understanding that high prices are collectively beneficial.

Economic theory suggests that one key factor that facilitates tacit coordination is a low number of firms in the market. The UK cement market certainly meets this criteria as it is an oligopoly with just three main players plus a new entrant. The CC concluded that:

In a highly concentrated market where the product doesn’t vary, the established producers know too much about each other’s businesses and have concentrated on retaining their respective market shares rather than competing to the full.

They estimate that this cost consumers over £180m in a 3 year period.

Whilst tacit collusion is not illegal, competition authorities can try to prevent it from arising by intervening in mergers that they believe will make it more likely. In fact, the new entrant to the cement market came about due to sales required by the CC before they would allow a joint-venture between two of the main players to go ahead. Clearly the CC’s recent findings suggest that this intervention was not sufficient to ensure intense competition in the market. However, an additional tool available to the authorities in the UK is to be able to remedy harm to competition undercovered as a result of an investigation into the market. In some cases this may even involve breaking-up firms in the market (see for example the decision to force BAA to sell several airports).

When deciding on how to remedy the problem in the cement market, the CC will be keen to avoid the past mistakes of their Danish counterparts. In a famous case, in 1993 the Danish authorities attempted to increase competition in the concrete market by publishing individual sellers’ prices. The idea was that this would stimulate competition by encouraging buyers to shop around. However, evidence published here suggests that this in fact increased prices by around 15%! Why? The paper examines possible explanations and concludes that the information published by the competition authorities helped firms to monitor each others behaviour and therefore facilitated tacit coordination in the market. This is entirely consistent with economic theory which shows that another key factor which facilitates tacit coordination is market transparency.

The CC suggest that such monitoring is also possible in the GB market:

Established information channels such as price announcement letters can signal their plans, and tit-for-tat behaviour and cross-sales can be used to prevent or retaliate against any moves to disturb the overall balance between the different players in this market.

According to the above press release, the remedies the CC are considering include: the sale of capacity or plants by the leading players in the market, creation of buying groups, prohibition on price announcements and restrictions on the publication of industry level data. This suggests that the CC are well aware that reducing market transparency can play a key role in preventing coordination. It will be fascinating to, first, see what the CC opt for, then, what impact this has on competition in the industry.

Articles
Same product, same price? Competition in the UK Global Cement (22/05/13)
Competition Commission uncovers `serious problems’ in cement market Graham Huband, The Courier (22/05/13)
Competition Commission call for cement sell-off Mark Leftley, London Evening Standard (21/05/13)

Competition Commission documents
CC looks to break open cement market Competition Commission Press Release (21/5/13)
Aggregates, cement and ready-mix concrete market investigation Competition Commission core documents (various dates)

Questions

  1. Explain tacit collusion using a Prisoner’s dilemma game.
  2. Is cement the type of product where we might expect coordination to be most likely?
  3. Why is cement an important market in the UK economy?
  4. The first article above suggests that most of the management team at the new entrant came from the other main players in the market. Do you think this may significantly affect the likelihood of tacit collusion?
  5. Evaluate the pros and cons of the alternative remedies the CC are considering.
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An auditing of competition

The Big Four are well known: Deloitte, Ernst and Young, KPMG and PWC. They act as auditors for 90% of the UK’s stock-market listed companies. They have a very close relationship with the companies that they audit and because of this have faced criticism of not warning of the financial crisis. A further accusation is that the relationship between auditors and managers has become blurred.

In some sense, there is a problem of divorce of ownership from control. The companies that are audited by the Big Four have shareholders who are interested in profits and their dividends. But they employ managers who are responsible for the day-to-day running of the business. However, there are concerns that the auditors have become more concerned with meeting the interests of the managers and not of the shareholders. It has been suggested that the company’s management tend to ‘present their accounts in the most favourable light, whereas shareholder interests can be quite different.’ Laura Carstensen, the chair of the Audit Investigation Group said:

It is clear that there is significant dissatisfaction amongst some institutional investors with the relevance and extent of reporting in audited financial reports … management may have incentives to present their accounts in the most favourable light, whereas shareholder interests can be quite different.

The Big Four have been criticised for limiting competition in the industry. The Competition Commission has said that companies typically stay with the same auditing firm and this acts to limit competition. One suggestion to encourage competition is to enforce rotation of Auditors. However, the Big Four have said that the market remains competitive, ‘healthy and robust’ and that any enforcement as noted above would not be in the public interest. Other, smaller auditing companies have praised the preliminary report of the Competition Commission. One firm said:

No one solution will achieve market correction, but rather a combination of tendering requirements, encouragement of transparency and dialogue between auditors, companies and investors, and reform of outdated exclusionary practices should provide a backdrop for a healthier FTSE 350 audit market.

The report is not yet final, but the future of the Big Four is somewhat uncertain, especially with the European Commission’s desire to break them up. The following articles look at this industry.

Big Four accountants reject claims over high prices and poor competition The Guardian, Josephine Moulds and David Feeney (22/2/13)
Competition Commission raps Big Four accountants BBC News (22/2/13)
Big Four’s rivals welcome audit shake-up Financial Times, Adam Jones (22/2/13)
UK’s “Big Four” accountants under fire from watchdog Reuters, Huw Jones (22/2/13)
Big Four chastised by Competition Commission The Telegraph, Helia Ebrahimi (22/2/13)
The uncompetitive culture of auditing’s big four remains undented The Guardian, Prem Sikka (23/2/13)
Big Four accountants ‘in closed club on audits’ Independent, Mark Leftly (23/2/13)

Questions

  1. What is the role of the Competition Commission?
  2. Explain with other examples the problem of the divorce of ownership from control. How might the interest of shareholders and managers differ? Can they ever be aligned?
  3. Is market share a good measure of the competitiveness of an industry?
  4. What are the benefits of competition?
  5. Why has the regulator suggested that the Big Four are limiting competition?
  6. What solutions have been proposed by the Competition Commission? Explain how they are likely to stimulate competition in this market.
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A lack of competition in banking

Over the past five years the Office of Fair Trading (OFT) has been closely studying the market for personal bank accounts in the UK. Last week, it announced its latest findings and the evidence seems to suggest that there remains a lack of competition in the market.

On the positive side, it reports that there has been a large fall in unarranged overdraft fees. However, despite this, according to the OFT banks still make on average £139 per year from every active current account. Furthermore, concentration has increased with the four largest banks (Barclays, Lloyds, HSBC and RBS) now accounting for 85% of the market and there has been little new entry. It appears that one of the key factors in enabling these main players to dominate the market and reap high profits is a lack of consumer switching behaviour. According to the OFT chief executive, Clive Maxwell:

Customers still find it difficult to assess which account offers the best deal and lack confidence that they can switch accounts easily. This prevents them from driving effective competition between providers.

Despite all these concerns, the OFT declined to refer the market to the Competition Commission for a more in-depth investigation and potential remedial action. Instead, the OFT will look at the market again in 2015. Richard Lloyd, the executive director at the consumer organisation Which?, was disappointed with this decision and was quoted in the The Guardian as saying:

Everyone – consumers, the government, leading bankers and now the OFT – seems to agree that big change is needed in banking, and that much greater competition on the high street is urgently needed to make the banks work for customers, not bankers.

Whilst at least for the moment, the Competition Commission will not get the chance to take action, there are still several reforms underway that may affect competition in the market. First, the OFT is increasing pressure on banks to allow consumers to have portable account numbers that they can take with them if they switch provider. Second, as a result of the Independent Commission’s review, banks will be required to switch a customer’s account in one week, rather than the average of 18 days it currently takes, and this process will become much more seamless. Finally, Lloyds has agreed to sell over 600 branches to the Co-op in order to meet the European Commission’s requirements following the government bail-out of the bank in 2008. This will increase the Co-op’s share of the current account market to 7%. It will be interesting to see how these reforms affect the market. If there is not substantial evidence of increased competition then the market is likely to face more scrutiny from the competition authorities.

Bank accounts: OFT says significant change needed BBC (25/01/13)
OFT: banks failing consumers The Economic Voice (25/01/13)
Let’s make bank accounts as easy to switch as mobiles The Telegraph, Andrew Oxlade (28/01/13)
OFT chief calls for more competitive banking sector The Telegraph, Denise Roland (30/01/13)

Questions

  1. What type of market structure best fits the banking industry?
  2. What are the barriers to entry in this market?
  3. What are the key features of the market that reduce consumer switching behaviour?
  4. Do you think most people are more likely to switch their mobile phone or current account provider? Explain.
  5. Why does limited consumer switching reduce the intensity of competition?
  6. Do you think the current reforms will result in a substantial increase in competition?
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What’s driving the premiums up?

Everyone who drives in the UK is required to take out car insurance. Whilst fully comprehensive is voluntary, it is compulsory to have at least third party insurance, which covers damage to other vehicles. Insurance premiums are calculated based on a number of different variables, such that two people driving the same car may face wildly different costs.

Although there are many insurance companies to choose from, this industry has been referred to the Competition Commission by the OFT as it was ‘worried the structure of the market was making costs and premiums unnecessarily high.’

According to Moneysupermarket, the average cost of car insurance reached a high of £554 in April 2011, but have fallen by £76 since. With tight incomes across the UK for many families, high car insurance premiums is another strain and thus this investigation will come at an apt time, even though the findings of the CC may not be reported for 2 years. The Association of British Insurers (ABI) said that the investigation would:

‘bring much-needed reforms to the market that will, in turn, result in lower car insurance premiums for consumers’.

The problem seems to be that when an individual is involved in an accident and sends their car off for repairs, their insurance company doesn’t have much control over the bills they end up paying, which can be inflated by £155 each time. This therefore leads into higher costs for the insurance company, which are then passed on the driver in the form of an increased premium. Other concerns were that courtesy cars were being offered, at an estimated cost of £560 per vehicle (according to the OFT) and that drivers were using these cars for longer than necessary, once again causing costs to rise.

Altogether, it has been suggested that the actions of the insurance company of ‘not-at-fault’ drivers, car hire companies, repairers and brokers push up the prices for ‘at-fault’ drivers’ insurance companies. Given that any insurance company is just as likely to be the ‘at-fault’ insurance company, they all face rising costs.

Back in May, the OFT had already decided that the car insurance market required a more detailed investigation, because of the ‘dysfunctionality’ of the market. Following a public consultation, the industry will now face an investigation by the CC. One additional area that may be of interest to the CC came to light last year, where it was found that insurance companies were claiming against themselves in a bid to drive up premiums. Although the investigation will take some time, it is still a timely review for many drivers, who have seen the cost of motoring reach record highs. The following articles consider the market for car insurance.

Car insurance market referred to Competition Commission BBC News (28/9/12)
No quick fix for motor insurance abuses, says watchdog Independent, Simon Read (29/9/12)
Car insurance industry faces probe The Press Association (28/9/12)
Competition Commission referral will take time to lower motor insurance premiums The Telegraph, Rosie Murray-West (28/9/12)
UK car insurance probe over-shadows Direct Line IPO Reuters, Matt Scuffham and Myles Neligan (28/9/12)
Car insurance scrutinized over high premiums Sky News (28/9/12)
Rip-off motor insurance firms face competition watchdogs probe over £225million racket Mail Online, Ray Massey (28/9/12)

Questions

  1. Why are car insurance firms willing to take on other people’s risks?
  2. What conditions must exist in a market for private companies to provide acr insurance (or insurance of any kind)?
  3. Why is third-party insurance compulsory, whereas people can opt for fully comprehensive insurance?
  4. What powers does (a) the OFT and (b) the Competition Commission have? Is it likely that this report will have any impact on car insurance premiums?
  5. What allegations have been made that help to explain why insurance premiums I this industry have increased?
  6. Is there an argument for allowing the industry itself to provide its own regulation?
  7. In which market structure would you place the car insurance industry?
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Rogue fuel prices

When crude oil prices go up, the prices of petrol and diesel go up pretty well straight away and by the full amount, or more, of the crude price rise. When crude prices go down, however, road fuel prices are often slow to fall; and when they do, the fall is less than the full fall in crude prices.

Click on charts below for a larger version. Click here for a PowerPoint of the left-hand chart.

In response to complaints of motorists and haulage companies, the Office of Fair Trading has announced that it will investigate the link between crude prices and prices at the pump. It will report in January 2013.

The review will consider questions of competition and market power. In particular, it will look at the power of the oil companies in determining the wholesale price of road fuel.

It will also examine the retail fuel sector and whether supermarkets are driving out independent retailers. The claim of many independent petrol stations is that supermarkets are selling below cost as a lost leader to encourage people to shop in their stores. They also claim that supermarkets use their buying power to obtain fuel more cheaply.

What is more, most of the petrol stations that are not part of supermarkets are owned by the oil companies. Again, independents claim that oil companies supply fuel more cheaply to their own stations than to independents.

As a result of what many independents see as unfair competition, many are driven out of business. Today there some 9000 petrol stations in the UK; 20 years ago there were twice as many.

The following articles look at the remit of the OFT investigation and at the competition issues in the road fuel market.

Articles
Formal inquiry tries to ease motorist pain at the pumps ITV News, Laura Kuenssberg (5/9/12)
OFT to scrutinise retail petrol market Financial Times, Caroline Binham (5/9/12)
OFT launches probe into pump prices Channel 4 News (5/9/12)
Petrol and diesel prices: Office of Fair Trading launches competition inquiry Guardian, Terry Macalister (5/9/12)
Petrol and diesel price review is launched by OFT BBC News (5/9/12)
Are supermarkets to blame for the devastation of independent petrol retailers by deliberately selling at a loss? This is Money, Tom Mcghie and Neil Craven (8/9/12)
OFT petrol pricing probe welcomed The Grocer, Beth Phillips (7/9/12)
Private businesses welcome OFT’s fuel price investigation Talking Retail (6/9/12)
10 charges that make consumers scratch their heads BBC News Magazine, Lucy Townsend (6/9/12)

Data
Crude Oil Price Index Index Mundi
Daily Brent Crude Spot Price, 1987 to present day US Energy Information Administration
Current UK Petrol Pump Prices What Pric£?
Fuel Prices WhatGas.com

Questions

  1. Describe the structure of the road fuel market, from oil production through to the retailing of petrol and diesel.
  2. What is meant by the terms ‘monosony’ and ‘oligopsony’? Which companies in the road fuel market have significant monopsony/oligopsony power?
  3. What determines the price elasticity of demand for road fuel in (a) the short run; (b) the long run? What implications does this have for the value of the short-run and long-run price elasticities?
  4. Where is the abuse of market power likely to occour in the road fuel market?
  5. To what extent is it in the consumers’ interests for supermarkets to sell road fuel below average cost?
  6. Examine the data for pump prices and crude oil prices and establish whether there is any truth in the claim that pump prices adjust rapidly to a rise in crude prices and slowly to a fall in crude prices.
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