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Posts Tagged ‘pricing strategy’

The sexist surcharge!!

Recent reports in the media have included headlines such as “Sexist surcharge” and “Pink premium?” Various claims have been made that women pay significantly higher prices for similar products than men.

The Times newspaper recently published the results from an investigation it carried out on the prices of hundreds of similar products that were marketed at both men and women. The study found that those products marketed at women cost 37% more on average than similar versions that were marketed at men. Examples included:

Disposable razors: Tesco priced a packet of five of its own-brand disposable razors for women at £1. The key characteristic that targeted the razors at female customers was the colour – they were pink. For the same price, a packet targeted at male customers (i.e. they were blue) contained 10 disposable razors.
Ballpoint pens: Staples priced a packet of five pastel-coloured Bic pens marketed ‘for her’ at £2.99. A packet of five Bic pens that were not in the ‘for her’ range (i.e. they had transparent barrels) were priced at £1.98.
Scooters: Argos increased the price of a child’s scooter by £5 if it was pink instead of blue.

Maria Miller, the chair of the Women and Equalities Select Committee, stated that:

“It is unacceptable that women face higher costs for the same product just because they are targeted at women. Retailers have got to explain why they do this.”

A more detailed study carried out by New York City’s Department of Consumer Affairs was published in December 2015. Average prices were collected for 794 individual items across 5 different industries. The key findings were that products marketed at women were

7 per cent more for toys and accessories
4 per cent more for children’s clothing
8 per cent more for adult clothing
13 per cent more for personal care products
8 per cent more for health products

Interestingly whereas the investigation in the UK only found examples of women paying higher prices than men, the New York study found some goods where the price was higher for men.

Reports in the media have claimed that this is clear evidence of price discrimination. Although this is likely to be true, it is impossible to say for certain without more detailed information on costs.

For example, when referring to the higher price for the razors marketed at women in the UK study, Richard Hyman, an analyst at RAH Advisory, stated that:

“the packaging will be different and they will sell fewer so it could be to do with the volume”

If economies of scale and the different costs of packaging can fully account for the difference in prices between the razors then it is not an example of price discrimination.

Articles
The sexist surcharge – how women get ripped off on the high street The Guardian 19/01/16
Women paying more than men for everyday products The Independent 19/01/16
Price differences for men and women ‘astonishing’ BBC 19/01/16
Pink premium? There are greater problems The Guardian 24/01/16
Being a women costs more than being a man CNBC 23/12/15

Questions

  1. Define price discrimination.
  2. Outline and explain the three different categories of price discrimination.
  3. Could a situation where a firms charges all of its customers the same price for a good or service ever be classed as an example of price discrimination?
  4. A firm with market power may still not be able to successfully implement a policy of price discrimination. Explain why.
  5. Under what circumstances could price discrimination improve allocative efficiency?
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Not so special ‘special offers’

In a blog post on 1 May this year, What’s really on offer?, we looked at the ‘super-complaint‘ by Which? to the Competition and Markets Authority (CMA) about supermarket special offers. The complaint referred to bogus price reductions, ‘cheaper’ multi-buys which weren’t cheaper, smaller pack sizes and confusing special offers. Under the rules of super-complaints, the CMA had 90 days from the receipt of the complaint on 21 April 2015 to publish a response. It has now done so.

Here is an extract from its press release:

In its investigation the CMA found examples of pricing and promotional practices that have the potential to confuse or mislead consumers and which could be in breach of consumer law. Where there is evidence of breaches of consumer law this could lead to enforcement action.

However, it has concluded that these problems are not occurring in large numbers across the whole sector and that generally retailers are taking compliance seriously to avoid such problems occurring. The CMA also found that more could be done to reduce the complexity in unit pricing to make it a more useful comparison tool for consumers. …Nisha Arora, CMA Senior Director, Consumer, said:

‘We have found that, whilst supermarkets want to comply with the law and shoppers enjoy a wide range of choices, with an estimated 40% of grocery spending being on items on promotion, there are still areas of poor practice that could confuse or mislead shoppers. So we are recommending further action to improve compliance and ensure that shoppers have clear, accurate information.

Although the CMA believes that misleading pricing is not as widespread as consumer groups have claimed, in some cases the supermarkets could be fined. The CMA also says that it will work with the supermarkets to eliminate misleading information in promotions.

In addition it recommends that the Department for Business, Innovation and Skills (BIS) publishes guidelines for supermarkets on displaying unit prices in a consistent way. It also recommends that legislation should be simplified on how items should be unit-priced.

The following articles look at the implications of the CMS’ findings.

Articles
Some UK supermarket promotions are misleading, watchdog says Financial Times, Andrea Felsted (16/7/15)
Shoppers beware: Grocers ‘confusing’ consumers with special offers, unit pricing, says government investigation International Business Times, Graham Lanktree (16/7/15)
Supermarket pricing: CMA finds ‘misleading tactics BBC News, Brian Milligan (16/7/15)
How special are special offers? BBC News, Kamal Ahmed (16/7/15)

CMA publications
Response to super-complaint: link to elements of report CMA (16/7/15)

Questions

  1. Give some examples of the types of promotion used by supermarkets?
  2. In what ways might such promotions be misleading?
  3. How is competition from Aldi and Lidl affecting pricing and promotions in the ‘big four’ supermarkets (Tesco, Sainsbury’s, Asda and Morrisons)?
  4. What cost and other advantages do Aldi and Lidl have over the big four? How might the big four reduce costs?
  5. Are misleading promotions systemic across the industry?
  6. How can behavioural economics help to explain consumers’ response to promotions in supermarkets?
  7. What is meant by ‘heuristics’? How might supermarkets exploit consumers’ use of heuristics in their promotions?
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Supermarket wars: a pricing race to the bottom

In an earlier post, Elizabeth looked at oligopolistic competition between supermarkets. Although supermarkets have been accused of tacit price collusion on many occasions in the past, price competition has been growing. And recent developments show that it is likely to get a lot fiercer as the ‘big four’ try to take on the ‘deep discounters’, Aldi and Lidl.

Part of the reason for the growth in price competition has been a change in shopping behaviour. Rather than doing one big shop per week in Tesco, Sainsbury’s, Asda or Morrisons, many consumers are doing smaller shops as they seek to get more for their money. A pattern is emerging for many consumers who are getting their essentials in Aldi or Lidl, their ‘special’ items in more upmarket shops, such as Waitrose, Marks & Spencer or small high street shops (such as bakers and ethnic food shops) and getting much fewer products from the big four. Other consumers, on limited incomes, who have seen their real incomes fall as prices have risen faster than wages, are doing virtually all their shopping in the deep discounters. As the Guardian article below states:

A steely focus on price and simplicity, against a backdrop of falling living standards that has sharpened customers’ eye for a bargain, has seen the discounter grab market share from competitors and transform what we expect from our weekly shop.

The result is that the big four are seeing their market share falling, as the chart shows. (Click here for a PowerPoint of the chart.) In the past year, Tesco’s market share has fallen from 29.9% to 28.1%, Asda’s from 17.8% to 16.3%, Sainsbury’s from 16.9% to 16.2% and Morrisons’ from 11.7% to 11.0%. By contrast, Aldi’s has risen from 3.9% to 5.4% and Lidl’s from 3.1% to 4.0%, while Waitrose’s has also risen, from 4.7% to 4.9%. And it’s not just market share that has been falling for the big four. Profits have also fallen, as have share prices. Sales revenues in the four weeks to 13 September are down 1.6% on the same period a year ago; sales volumes are down 1.9%.

But can the big four take on the discounters at their own game? Morrison’s has just announced a form of price match scheme called ‘Match & More’. If a shopper finds that a comparable grocery shop is cheaper in not only Tesco, Sainsbury’s or Asda, but also in Aldi or Lidl, then ‘Match & More users will automatically get the difference back in points on their card. Shoppers also will be able to collect extra points on hundreds of featured products and fuel’. When the difference has risen to a total £5 (5000 points), the shopper will get a £5 voucher at the till. The idea is to encourage customers to stay loyal to Morrisons.

But what if Tesco, Asda and Sainsbury’s do the same? What will be the impact on their prices and profits. Will there be a race to the bottom in prices, or will they be able to keep prices higher than the deep discounters, hoping that many customers will not cash in their vouchers?

But if effectively the big four felt forced to cut their prices to match Aldi and Lidl, could they afford to do so? This depends on their comparative average costs. At first sight, it might be thought that the big four could succeed in profitably matching the discounters, thereby clawing back market share. After all, they are much bigger and it might be thought that they would benefit from greater economies of scale and hence lower costs.

But it is not as simple as this. The discounters have lower costs than the big four. Their shops are typically in areas where rents or land prices are lower; their shops are smaller; they carry many fewer lines and thus gain economies of scale on each line; they have a much higher proportion of own-brand products; products are displayed in the boxes they come in, thus saving on the staff costs of unpacking them and placing them on shelves; they buy what is cheapest and thus do not always display the same brands.

So is Morrison’s a wise strategy? Will other supermarkets be forced to follow? Is there a prisoners’ dilemma here and, if so, is there any form of collusion in which the big four can engage which is not illegal? Can the big four differentiate themselves from the discounters and the up-market supermarkets in ways that will attract back customers?

It is worrying times for the big four.

Heavy Discounters Up Pressure On The UK’s Big Four Supermarkets Alliance News, Rowena Harris-Doughty (3/6/14)
Tesco loses more market share as supermarket sector slows to record low CITY A.M., Catherine Neilan (23/9/14)
Record low for grocery market growth as inflation disappears Kantar World Panel, Fraser McKevitt (23/9/14)
How Aldi’s price plan shook up Tesco, Morrison’s, Asda and Sainsbury’s The Guardian, Sarah Butler (29/9/14)
Sainsbury’s shares drop 7% on falling sales report BBC News (1/10/14)
Sainsbury results: the reaction Food Manufacture, Mike Stones (3/10/14)
Morrisons Becomes First Of Big Four Grocers To Price Match Aldi, Lidl Alliance News, Rowena Harris-Doughty (2/10/14)
UK: Morrisons Takes On Discounters With Price Match Card KamCity (3/10/14)
Morrisons to match the prices of Aldi and Lidl The Telegraph, Graham Ruddick (2/10/14)
Three reasons why Morrisons price-matching Aldi and Lidl is not a ‘gamechanger’ The Telegraph, Graham Ruddick (2/10/14)

Questions

  1. Would it be possible for the big four to price match the deep discounters?
  2. What is meant by the prisoners’ dilemma? In what ways are the big four in a prisoners’ dilemma situation?
  3. Assume that you had to advise Tesco on it strategy? What advise would you give it and why?
  4. Assume that two firms, M and A, are playing the following ‘game’: firm M pledges to match firm A’s prices; and firm A pledges to sell at 2% below M’s price. What will be the outcome of this game?
  5. Is Morrisons wise to adopt its ‘Match & More’ strategy?
  6. Why is it difficult for Morrisons to make a like-for-like comparison with Aldi and Lidl in its ‘Match & More’ strategy?
  7. Why may Aldi and Lidl benefit from Morrisons’ strategy?
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Easy or not so easyPricing?

The pricing model for low-cost airline seats seems simple. As the seats get booked, so the price rises. Thus the later you leave it to book, the more expensive it will be. But, in fact, it’s not as simple as this. Seat prices sometimes come down as the take-off date approaches. So what is the pricing model?

The general principle of raising prices as the plane fills up still applies. This enables the airline to discriminate between passengers. Holidaymakers and those with flexibility about when, and possibly where, to travel tend to have a relatively high price elasticity of demand. People who wish to travel at the last minute, such as businesspeople and those facing a family emergency, tend to have a much lower price elasticity of demand and would be prepared to pay a higher, possibly much higher, price.

With relatively high fixed costs for each flight, low-cost airlines need to fill, or virtually fill, their planes if they are to make a profit. And it’s not just about the direct revenue from ticket sales. Low-cost carriers also rely on the revenue from selling extras, such as on-board refreshments, hold luggage, hotels, car hire and travel insurance. With variable costs being tiny, the pricing model is about maximising revenue for each flight. So the fuller the plane, the better it is for the airline.

The airlines are very experienced in estimating demand over the period from a flight coming on sale and the departure date. If they get it right, then prices will indeed rise as take-off approaches. But sometimes they get it wrong. If, as time passes, a given flight is filling up too slowly, then it makes sense to be more flexible on prices, cutting them if necessary. Pricing may be easy in principle; but not always easy in practice!

Article
Low-cost air fares: How ticket prices fall and rise BBC News, Erica Gornall (21/6/13)

Papers
Pricing strategies of low cost airlines Air Transport Group, Cranfield University, Keith J Mason (2002)
Pricing strategies of low-cost airlines: The Ryanair case study Journal of Air Transport Management, 15, Paolo Malighetti, Stefano Paleari and Renato Redondi (2009)

Questions

  1. Does a low-cost airline always charge lower prices than a traditional scheduled airline? If not, why not?
  2. Identify the various reasons why holidaymakers may have a relatively elastic demand for a particular flight?
  3. Explain the system of ‘buckets’ of seats?
  4. Are low-cost airlines engaging in price discrimination and, if so, which type?
  5. Are there any variable costs of operating a particular flight (assuming that the flight does actually take place)?
  6. If demand for a flight becomes less elastic as the date of departure gets nearer, why might a budget airline choose to lower the price, at least for a few days?
  7. Why can Ryanair operate with lower costs than easyJet?
  8. Would it be in low-cost airlines’ interests to charge more (a) to overweight people; (b) for using the toilet?
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Information wants to be shared

Most real-world markets are a long way from the perfect information setting assumed in perfectly competitive markets. Many industries therefore rely heavily on word of mouth to increase demand. This is especially true in the digital age where information can spread extremely rapidly and many websites encourage consumer ratings and reviews. Here, information becomes more and more valuable as it is shared with other people.

However, the economist Joshua Gans has suggested that traditional business models are not well suited to fully exploiting the benefits of the sharing of information. This is because, whilst enthusiastic consumers spread the word, the seller has traditionally acted as a gate-keeper, maintaining complete control over who obtains the product. The problem is that this creates a friction which can dampen momentum for the product from building.

In contrast, Gans describes a novel alternative strategy that was used by the band the XX when they released their second album earlier this year. As is becoming more and more common, the band premiered the album as an online stream. However, what was unique about the XX’s approach was that they gave the stream to a single superfan. They hoped that this chosen fan would initiate the spreading of the stream amongst other fans. After a worrying delay in which he enjoyed his monopoly ownership, this is what he eventually did. Just 24 hours later the stream had been player millions of times and the site crashed under the burden.

Of course, one reason why suppliers may need close control is to be able to charge for the product. If the sharing information must involve giving something away for free, it typically makes no commercial sense. However, Gans also points out that recommendations are more credible if the information has been costly to obtain. Otherwise, it may simply be cheap talk and therefore carry little value.

The balancing act for suppliers is therefore to introduce a hurdle cost in obtaining the information whilst trying to ensure that, once it has been passed on, the recipient encounters as little friction as possible in making use of it. Gans suggests that alternative business models can be developed which achieve this balance. If these can profitably encourage the sharing of information a win-win situation for sellers and buyers is created.

Furthermore, Gans is experimenting with selling his new book about sharing information under an example of one such model. Having bought the e-book for $4.99 you will find a coupon at the back which you can pass on to a friend or family member which allows them to buy their own copy of the book for a mere $0.99. However, as he points out, there is a potential danger to this strategy:

“All my readers could form a collective and potentially buy one copy for $4.99 and then a million for $0.99.”

He has said that he plans to be report back on how the book has sold on his blog at a later date, so it will be interesting to see whether or not the experiment was successful.

The folly of replicating the physical world HBR Blog Network, Joshua Gans (17/11/10)
A shared pricing experiment for my book Digitopoly, Joshua Gans (05/10/12)
Information wants to be…..shared O’Reilly Tools of Change for Publishing, Joe Wikert (16/10/12)

Questions

  1. Why will the problems described above not arise in the model of perfect competition?
  2. What type of industries are most likely to rely on word of mouth?
  3. In what type of industries is the friction described above most likely to happen?
  4. Describe the dangers with the strategy Gans is adopting for selling his book?
  5. Explain whether you think these dangers are likely to arise in practice.
  6. How might the business model be modified to avoid these dangers?
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Rise of the planet of the apps

Is Google’s Android catching up with Apple’s iOS in the market for apps? With Android tablets and smartphones taking an ever larger proportion of the market, you would expect so. In the third quarter of 2011, 53% of smartphone shipments used Google’s Android system, compared with only 15% with iOS.

However, Apple is still ahead of Google in the share of apps downloads. To date, there have been 18 billion downloads from the iOS App Store for iPhone, iPad and iPod Touchs compared with 10 billion downloads of Android apps. But Android downloads are growing faster and are set to overtake those of iOS apps in the coming months. This should be boosted with the new Ice Cream Sandwich Android operating system.

But what about revenues earned from downloads? Here the picture is very different. Android Marketplace has earned around $330 million gross revenue for paid apps. Apple’s App Store, by contrast, has earned over 15 times as much: nearly $5000 million. The reason is that 99% of Android apps are free; the figure for App Store apps is 86%. But why is this so and how can Android earn revenues from its apps? And how can app developers earn revenues from the Android market? The following articles look at the economics of apps.

Android Vs. iPhone: The Economics Of Apps Financial Edge, Manish Sahajwani (6/1/12)
Google has an Amazon problem MSN Money, Jim J. Jubak (25/1/12)
Android and the economics of apps BBC News, Rory Cellan-Jones (7/12/11)
Apple Getting Best Of The Android Vs. iPhone Economics Forbes, Manish Sahajwani (6/1/12)
Fragmentation Is Not The End of Android cek.log, Charlie Kindel (14/1/12)

Questions

  1. Why are most Android apps free to download?
  2. What is the business model for (a) developing and (b) offering Android apps?
  3. How can money be made from free apps?
  4. What are the long-term strengths and weaknesses in Apple’s apps business model?
  5. Assess Amazon’s business model for apps for Kindle users.
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Dreaming of a white Christmas

This autumn has been one of the mildest on record. Whilst this may be very nice for most of us, certain industries have been suffering. For example, gas and electricity consumption is down as people delay turning on their heating. One sector particularly badly hit has been clothing. Sales of winter clothes are substantially down and many retailers are longing for colder weather to boost their sales.

Of course, this is not helped by consumer incomes. With inflation at around 5% and average (pre-tax) weekly earnings currently rising by less than 2%, real incomes are falling. In fact over the year, even nominal disposable incomes are down 2.1%, given the rise in national insurance and income tax. And the problem of falling incomes is compounded by worries over the future state of the economy – whether it will go back into recession, with further falls in real income and rises in unemployment.

It’s no wonder that retailers are longing for some cold weather and for their customers to return from the seaside or their garden barbecues to the shopping malls. Look out for the ‘sales’ signs: they’re beginning to spring up as desperate retailers seek to attract wary customers.

Webcast
Retailers slash prices in Christmas build-up BBC News, Tim Muffett (25/11/11)

Articles
Winter woes: warm weather means shoppers aren’t buying as much Guardian, Zoe Wood (21/11/11)
Shoppers urged to be savvy as Christmas sales last for weeks The Telegraph, Victoria Ward (21/11/11)

Data
Earnings tables: Labour Market Statistics ONS (November 2011)
Personal Income and Wealth ONS
Price Indices and Inflation ONS
Personal Inflation Calculator (PIC) ONS

Questions

  1. Identify the determinants of demand for winter clothing.
  2. How responsive is demand likely to be to these determinants (a) over a period of a few weeks; (b) over a period of a few months?
  3. What factors should a retailer take into account when deciding whether to make pre-Christmas discounts?
  4. Assume that you are employed but are afraid of losing your job in a few months’ time. How would this affect your consumption of (a) seasonal goods; (b) durable goods; (c) day-to-day goods?
  5. What longer-term strategies could retailers adopt if they predict tough trading conditions over the next two or three years?
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The importance of price

The law of demand tells us that when the price of a good falls, quantity demanded will rise. But, firms want to know much more than this. They need to know by how much quantity demanded will rise – we refer to this as the price elasticity of demand (PED) and we can categorise it as relatively inelastic or elastic, depending on by how much demand changes relative to the change in price. The price elasticity of demand is crucial for a firm to know, as it gives them vital information about the best price to charge and getting the price right is probably the most important element in a successful business. As Warren Buffett said in a meeting with the staff from the Federal Crisis Inquiry Commission:

‘Basically, the single most important decision in evaluating a business is pricing power. You’ve the power to raise prices without losing business to a competitor, and you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you got a terrible business.’

The grammar may not be entirely correct, but hopefully you get the gist! Should a firm increase price or reduce it? Whatever action it takes, there will be an effect on demand, total revenue and profit. The key question is: what will be the effect? The answer depends on the PED.

If a firm is selling a product for which there are no close substitutes, we would expect demand to be relatively inelastic. This means that the firm can increase the price it charges without seeing any large fall in quantity. On the other hand, if a firm faces a lot of competition and hence there are many substitutes for a product, then demand becomes much more elastic – any increase in a firm’s price will lead to a proportionately larger decrease in the quantity demanded, as customers will simply switch to a cheaper alternative. The article below looks at the concept of price elasticity of demand and how it is used in practice by competing firms.

The importance of pricing power: PEP, CPB Guru Focus (16/10/11)
Pricing strong for Philip Morris in Q3, but volumes also encouraging; dividend yield attractive MorningStar (7/11/11)

Questions

  1. How do we define price elasticity of demand and what formula can we use to calculate it?
  2. If a firm faces an PED of –5, is its demand relatively inelastic or elastic and what does it mean about the responsiveness of customer demand to a change in price?
  3. If a firm faces demand that is (a) relatively inelastic (b) relatively elastic, (c) perfectly elastic (d) perfectly inelastic, what should it do to its price? Explain your answers.
  4. In the article, ‘The importance of pricing power’, is demand for the ‘Daily Racing Forum’ relatively inelastic or elastic? Explain your answer and what it means in terms of the company’s ability to change price.
  5. Is demand for cigarettes likely to be inelastic or elastic? Explain your answer. What does this suggest about a firm’s ability to pass on taxation and excise duties to its customers in the form of higher prices?
  6. Based on the data given in ‘The importance of pricing power’ about the change in demand for Campbell’s Soup and PepsiCo, what conclusions can we reach about PED? How could these firms use this information to set prices and maximise revenue and profit?
  7. Following a change in supply (due to a factor other than price), when will the impact on equilibrium price be larger than the impact on equilibrium quantity?
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Confusing the consumer

You will probably have come across the concept of consumer sovereignty. In the mythical world of perfect markets, producers are at the beck and call of consumers. Firms that are not responsive to consumer demand go out of business. In other words, in order to survive they have to respond to any shifts in consumer demand. These in turn can be the result of changes in tastes, changes in income, changes in the prices of other goods, and so on.

Of course, the real world is not perfect, but it is still often assumed that consumers are powerful in influencing what firms sell and at what prices. Well, firms would much rather be in a position of manipulating consumer tastes and hence the huge amounts spent on advertising and marketing.

And it doesn’t end there. Firms use many pricing practices which, to put it mildly, try to confuse consumers or lure them into buying things by making them think they are getting something much cheaper than they really are. Take the case of airline tickets. Some budget airlines offer tickets at extremely low prices, such as 99p. But if you select such a flight, by the time you get to the final screen where taxes, charges, supplements, luggage, etc. are added, the price could exceed £100! And ask yourself this, when you buy something with 20% off, or when you buy ‘three for the price of two’ how rational was your decision? Did you really want the product? Was the offer really ‘genuine’?

The Office of Fair Trading has recently completed two investigations into pricing. As it stated 14 months ago when the investigations were launched:

The first, into online targeting of advertising and prices will cover behavioural advertising and customised pricing, where prices are individually tailored using information collected about a consumer’s internet use. It is expected that this study will be completed by spring 2010.

The second, into advertising of prices, will consider various pricing practices which may potentially mislead consumers. The study will look in particular, but not exclusively, at how these practices are used online.

The following articles look at some of the practices that firms use to drive sales – practices that deliberately attempt to manipulate the consumer. The assumption of ‘perfect knowledge’ by consumers may be a long way from the truth.

Articles
Shoppers lose out on ‘billions’ because of ‘deceitful’ marketing The Telegraph, Harry Wallop (2/12/10)
OFT warns retailers about ‘misleading’ price offers BBC News (2/12/10)
OFT cracks down on price gimmicks Guardian, Rebecca Smithers (2/12/10)
We’re all gulled by special offers BBC News blogs: Peston’s Picks, Robert Peston (2/12/10)

OFT publications
OFT warning on misleading pricing practices, OFT Press Release 124/10 (2/12/10)
OFT launches market studies into advertising and pricing practices, OFT Press Release 126/09 (15/10/09)
Advertising of Prices, Office of Fair Trading, OFT1291 (December 2010)
Advertising of Prices, Office of Fair Trading, project page
Advertising of Prices Study Overview, Office of Fair Trading, video

Questions

  1. Explain each of the different types of pricing practice investigated by the OFT.
  2. Which of the pricing practices are the most misleading for customers?
  3. What is meant by ‘invisible price increases’? How can they be used to mislead the consumer?
  4. Why do certain pricing practices make it hard for the Office for National Statistics to work out the rate of inflation?
  5. Explain the new framework the OFT is adopting for ‘prioritising enforcement action’.
  6. If we end up buying something that we didn’t really intend to buy, does this mean that we were being irrational?
  7. Is advertising generally in or against the interest of consumers? Explain your answer
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Monopoly power?

Is the power supply industry a cartel? Are the energy companies exploiting a position of market dominance to increase profits at the expense of consumers? At first sight, it would certainly seem so. Despite falling wholesale prices for gas and electricity, the six main power suppliers have not reduced prices to their customers. The result has been a substantial rise in profits. Over the past three years, the average annual gross profit for supplying each dual-fuel customer has been £110. The figure has now risen to £170, a rise of 55%. This is likely to rise further in the short term with further reductions in wholesale energy prices over the next few weeks.

But despite this large increase in profits, the power companies are considering increasing prices this coming winter if wholesale energy prices start to rise again, even though the expected wholesale price rise would still leave them with a gross profit of £140 per dual-fuel customer.

Ofgem, the gas and electricity industry regulator, wrote to the six main companies asking them to explain their pricing position. You can read Ofgem’s report from the link below. In it, Ofgem argues that there is scope for the companies to cut their prices. But Ofgem no longer has the power to cap prices: in 2002 the RPI-X system of price cap regulation was abandoned, since it was felt that there was enough competition between suppliers not to warrant price regulation.The articles below consider the question of whether the companies are justified in their pricing policy or whether they are exploiting their market power to make excessive profits.

No energy cuts despite huge profits (video) Channel 4 News (18/9/09)
Energy bills may rise despite wholesale price drop Times Online (19/9/09)
Where is the will to power? Times Online (19/9/09)
Energy bills set to rise further, companies warn Guardian (18/9/09)
Energy bills ‘unlikely to fall’ BBC News (18/9/09)
Bills face a power surge (Douglas Fraser’s Ledger) BBC News (18/9/09)
An Electricity and Gas Price Cartel? Why Ofgem Can’t Tell iStockAnalyst (17/9/09)

Evidence from Ofgem:
Ofgem’s letter to the six main suppliers and their responses to Ofgem can be read here
Ofgem’s findings can be read in Quarterly Wholesale / Retail Price Report – August 2009
Ofgem Factsheet: Household energy bills explained

Questions

  1. Assess the justification by the power companies for not reducing the price of gas and electricity to their customers.
  2. Explain what is meant by ‘hedging’ in the context of the purchase of gas and electricity.
  3. The power suppliers are an oligopoly. If there is collusion between them, what form does it take? Why is it very hard to find evidence of collusion?
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