Category: Essential Economics for Business: Ch 04

Price fixing agreements between firms are one of the most serious breaches of competition law. Therefore, if detected, the firms involved face substantial fines (see here for an example), plus there is also the potential for jail sentences and director disqualification for participants. However, due to their secretive nature and the need for hard evidence of communication between firms, it is difficult for competition authorities to detect cartel activity.

In order to assist detection, competition authorities offer leniency programmes that guarantee full immunity from fines to the first participant to come forward and blow the whistle on the cartel. This has become a key way in which competition authorities detect cartels. Recently, competition authorities have introduced a number of new tools to try to enhance cartel detection.

First, the European Commission launched an online tool to make it easier for cartels to be reported to them. This tool allows anonymous two-way communication in the form of text messages between a whistle blower and the Commission. The Commissioner in charge of competition policy, Margrethe Vestager, stated that:

If people are concerned by business practices that they think are wrong, they can help put things right. Inside knowledge can be a powerful tool to help the Commission uncover cartels and other anti-competitive practices. With our new tool it is possible to provide information, while maintaining anonymity. Information can contribute to the success of our investigations quickly and more efficiently to the benefit of consumers and the EU’s economy as a whole.

Second, the UK Competition and Markets Authority (CMA) has launched an online and social media campaign to raise awareness of what is illegal under competition law and to encourage illegal activity to be reported to them. The CMA stated that:

Cartels are both harmful and illegal, and the consequences of breaking the law are extremely serious. That is why we are launching this campaign – to help people understand what cartel activity looks like and how to report it so we can take action.

This campaign is on the back of the CMA’s own research which found that less that 25% of the businesses they surveyed believed that they knew competition law well. Furthermore, the CMA is now offering a reward of up to £100,000 and guaranteed anonymity to individuals who provide them with information.

It will be fascinating to see the extent to which these new tools are used and whether they aid the competition authorities in detecting and prosecuting cartel behaviour.

Articles

CMA launches crackdown on cartels as illegal activity rises The Telegraph, Bradley Gerrard (20/03/17)
European Commission launches new anonymous whistleblower tool, but who would use it? Competition Policy Blog, Andreas Stephan (21/03/17)
CMA launches campaign to crackdown on cartels Insider Media Limited, Karishma Patel (21/03/17)

Questions

  1. Why do you think leniency programmes are a key way in which competition authorities detect cartels?
  2. Who do you think is most likely to blow the whistle on a cartel (see the article above by A.Stephan)?
  3. Why is it worrying that so few businesses appear to know competition law well?
  4. Which of the two tools do you think is most likely to enhance cartel detection? Explain why.

Earlier this week FIFA, the world governing body of football, announced plans to expand the World Cup from 32 to 48 teams starting in 2026. It is fair to say that this has been met with mixed reactions, in part due to the politics and money involved. However, for an economist one particularly interesting question is how the change will affect the incentives of the teams taking part in the competition.

As a result of the change in the first stage of the competition, teams will be play the two other teams in their group. The best two teams in the group will then progress to the next round with the worst team going home. This is in contrast to the current format where the best two teams from a group of four go through to the next round.

Currently, in the final round of group matches all four of the teams in the group play simultaneously. However, an immediate implication of the new format is that this will no longer be the case. Instead, one of the teams will have finished their group matches before the other two teams play each other. This could have important implications for the incentives of the teams involved. To see this we can recall a very famous match played under similar circumstances between West Germany and Austria at the 1982 World Cup.

The results of the earlier group games meant that if West Germany beat Austria by one or two goals to nil both teams would progress to the next round. Any other result would mean that Algeria progressed at the expense of one of these two teams. The way in which the match played out was that West Germany scored early on and much of the rest of the game descended into farce. Both teams refused to attack or tackle their opponents, as they had no incentive to so (see here for some clips of the action, or lack of!).

There is no evidence to suggest that West Germany and Austria had come to a formal agreement to do this. Instead, the two teams appear to have simply had a mutual understanding that refraining from competing would be beneficial for both of them.

This is exactly what economists refer to as tacit collusion – a mutual understanding that refraining from competition and keeping prices high benefits all firms in the market. Much like the fans who had to sit through the farce of a game (you can hear the frustration of the crowd in the video clip linked to above), the end result is harm to consumers who have to pay the higher prices or go without the product.

For this reason governments use competition policy to try to stop situations arising in markets that make the possibility of tacit collusion more likely. One way in which this is done is by preventing mergers in markets where tacit collusion appears possible and would be facilitated by the reduction in the number of firms as a result of the merger. The equivalent for the World Cup would be preventing a change in the format of the competition.

An alternative approach is to tinker with the rules of the game in order to make collusion harder. FIFA seems to have some awareness of the possibility of doing this as it is suggesting that it may require all tied games to extra-time and then a penalty shoot-out in order to determine a winner. Clearly, this would go at least some way to alleviating concerns about tacit collusion in the final group matches because coordinating on a draw would no longer be possible. In a similar fashion, competition authorities can also intervene in markets to change the rules of the game (see for example the recent intervention in the UK cement industry).

Therefore, more generally, the World Cup example highlights the fact that variations in the structure of markets and the rules of the game can have significant effects on firms’ incentives and this can have important consequences for market outcomes. It will certainly be fascinating to see what rules are imposed for the 2026 World Cup and how the teams taking part respond.

Articles

World Cup: Fifa to expand competition to 48 teams after vote BBC News (10/1/17)
How will a 48-team World Cup work? Fifa’s plan for 2026 explained The Guardian, Paul MacInnes (10/1/17)
The Disgrace of Gijón and the 48-team FIFA World Cup Mike or the Don (12/1/17)

Questions

  1. What is the difference between tacit collusion and a cartel?
  2. Why does a reduction in the number of firms in a market make collusion easier?
  3. What other factors make collusion more likely?
  4. How does competition policy try to prevent the different forms of collusion?

We all know that our spending changes during the Christmas period: namely we spend a lot more than during the rest of the year. This applies across the board – we buy more clothes, food and drink, even though each day, we can generally only wear, eat and drink the same amount as usual! This has some interesting points from a behavioural economics stance, but here I’m going to think about the impact of this on some key retailers.

Marks & Spencer have previously made headlines for the wrong reasons: poor sales on clothes and the need for serious restructuring of its stores, target audience and marketing in order for this long-standing retailer to remain current and competitive. Although sales were expected to rise in the Christmas period, they did significantly better than expected, with sales growth of 2.3%, above the expected 0.5%. More encouragingly, this growth was not just in food, but in clothing and homeware as well.

One of the key reasons given for this above-expected improvement in sales was the conveniently timed Christmas, falling on a Sunday and hence giving extra shopping days. M&S have said that this certainly helped with their Christmas trading. Although this was good for Q4 trading, the timing will not play ball for Easter and they are expecting a negative effective during that trading period. Some analysts have said that despite the growth being boosted by the timing of Christmas, there were still signs of a change in fortunes. Bryan Roberts from TCC Global said:

“It might be the sign of some green shoots in that part of the business.”

This is consistent with the Chief Executive, Steve Rowe’s comments that despite the timing of Christmas adding around 1.5% to clothing and home sales growth, the recovery was also due to “better ranges, better availability and better prices”.

It appears as though many other retailers have experienced positive growth in Christmas sales, with the John Lewis Partnership seeing like-for-like sales growth of 2.7%, with Waitrose at a 2.8% rise.

The other interesting area is supermarkets. Waitrose and M&S are certainly competitors in the food industry, but at the higher end. If we consider the mid-range supermarkets (Asda, Morrisons, Sainsbury’s and Tesco), they have also performed, as a whole, fairly well. The low-cost Aldi and Lidl have been causing havoc for these supermarket chains, but the Christmas period seemed to prove fruitful for them.

Tesco saw UK like-for-like sales up by 1.8%, which showed significant progress in light of previously difficult trading periods with the emergence of the low-cost chains. Q$ was its better quarter of sales growth for over five years. One of the key drivers of this growth is fresh food sales and its Chief Executive, Dave Lewis said “we are very encouraged by the sustained strong progress that we are making across the group.” However, despite these positive numbers, Tesco only really met market expectation, rather than surpassing them as Morrison, Sainsbury’s and Marks & Spencer did.

Perhaps the stand-out performance came from Morrisons, with its best Christmas performance for seven years. Another casualty of the low-cost competitors, it has been making a recovery and Q4 of 2016 demonstrated this beyond doubt. Like-for-like sales for the nine weeks to the start of 2017 were up by 2.9%, with growth in both food and drink and clothing.

Morrisons has been on a long and painful journey, with significant reorganisation of its stores and management. While this has created problems, it does appear to be working.

We also saw a general move up to the more premium own-brands and this again benefited all supermarkets. Morrisons Chief Executive, David Potts said:

“We are delighted to have found our mojo … Every year does bring its challenges, but so far we haven’t seen any change in consumer sentiment. Customers splashed out over Christmas and wanted to trade up … We are becoming more relevant to more people as we turn the company around.”

So it seems to be success all round for traders over the Christmas period and that, in many cases, this has been a reversal of fortunes. The question now is whether or not this will continue with the uncertainty over Brexit and the economy.

Articles

M&S beats Christmas sales forecast in clothing and homeware BBC News (12/1/17)
Marks & Spencer reports long-awaited rise in clothing sales The Telegraph, Ashley Armstrong (12/1/17)
Marks and Spencer reveals signs of growth in clothing business Financial Times, Mark Vandevelde (12/1/17)
Tesco’s festive sales lifted by fresh food The Telegraph, Ashley Armstrong (12/01/17)
Tesco caps year of recovery with solid Christmas Reuters, James Davey and Kate Holton (12/1/17)
Tesco, Marks & Spencer, Debenhams, John Lewis and co cheer strong Christmas trading Independent, Josie Cox and Zlata Rodionova (12/1/17)
Morrisons sees best Christmas performance for seven years BBC News (10/12/17)
Morrisons enjoys some ‘remarkable’ Christmas cheer’ The Guardian, Sarah butler and Angela Monaghan (10/1/17)
Record Christmas as Sainsbury’s ‘shows logic of Argos takeover’ The Guardian, Sarah Butler and Angela Monaghan (11/1/17)

Questions

  1. Why have the big four in the supermarket industry been under pressure over the past 2 years in terms of their sales, profits and market share?
  2. How have the changes that have been made by M&S’ Chief Executive helped to boost sales once more?
  3. Share prices for supermarkets have risen. Illustrate why this is on a demand and supply diagram. Why has Tesco, despite its performance, seen a fall in its share price?
  4. What are the key factors behind Morrison’s success?
  5. What type of market structure is the supermarket industry? Does this help to explain why the big four have faced so many challenges in recent times?
  6. If there has been a general increase in sales across all stores over the Christmas trading period, that goes beyond expectations, can we infer anything about customer tastes and their expectations about the future?

The economic climate remains uncertain and, as we enter 2017, we look towards a new President in the USA, challenging negotiations in the EU and continuing troubles for High Street stores. One such example is Next, a High Street retailer that has recently seen a significant fall in share price.

Prices of clothing and footwear increased in December for the first time in two years, according to the British Retail Consortium, and Next is just one company that will suffer from these pressures. This retail chain is well established, with over 500 stores in the UK and Eire. It has embraced the internet, launching its online shopping in 1999 and it trades with customers in over 70 countries. However, despite all of the positive actions, Next has seen its share price fall by nearly 12% and is forecasting profits in 2017 to be hit, with a lack of growth in earnings reducing consumer spending and thus hitting sales.

The sales trends for Next are reminiscent of many other stores, with in-store sales falling and online sales rising. In the days leading up to Christmas, in-store sales fell by 3.5%, while online sales increased by over 5%. However, this is not the only trend that this latest data suggests. It also indicates that consumer spending on clothing and footwear is falling, with consumers instead spending more money on technology and other forms of entertainment. Kirsty McGregor from Drapers magazine said:

“I think what we’re seeing there is an underlying move away from spending so much money on clothing and footwear. People seem to be spending more money on going out and on technology, things like that.”

Furthermore, with price inflation expected to rise in 2017, and possibly above wage inflation, spending power is likely to be hit and it is spending on those more luxury items that will be cut. With Next’s share price falling, the retail sector overall was also hit, with other companies seeing their share prices fall as well, although some, such as B&M, bucked the trend. However, the problems facing Next are similar to those facing other stores.

But for Next there is more bad news. It appears that the retail chain has simply been underperforming for some time. We have seen other stores facing similar issues, such as BHS and Marks & Spencer. Neil Wilson from ETX Capital said:

“The simple problem is that Next is underperforming the market … UK retail sales have held up in the months following the Brexit vote but Next has suffered. It’s been suffering for a while and needs a turnaround plan … The brand is struggling for relevancy, and risks going the way of Marks & Spencer on the clothing front, appealing to an ever-narrower customer base.”

Brand identity and targeting customers are becoming ever more important in a highly competitive High Street that is facing growing competition from online traders. Next is not the first company to suffer from this and will certainly not be the last as we enter what many see as one of the most economically uncertain years since the financial crisis.

Next’s gloomy 2017 forecast drags down fashion retail shares The Guardian, Sarah Butler and Julia Kollewe (4/1/17)
Next shares plummet after ‘difficult’ Christmas trading The Telegraph, Sam Dean (4/1/17)
Next warns 2017 profits could fall up to 14% as costs grow Sky News, James Sillars (4/1/17)
Next warns on outlook as sales fall BBC News (4/1/17)
Next chills clothing sector with cut to profit forecast Reuters, James Davey (4/1/17)
Next shares drop after warning of difficult winter Financial Times, Mark Vandevelde (22/10/15)

Questions

  1. With Next’s warning of a difficult winter, its share price fell. Using a diagram, explain why this happened.
  2. Why have shares in other retail companies also been affected following Next’s report on its profit forecast for 2017?
  3. Which factors have adversely affected Next’s performance over the past year? Are they the same as the factors that have affected Marks & Spencer?
  4. Next has seen a fall in profits. What is likely to have caused this?
  5. How competitive is the UK High Street? What type of market structure would you say that it fits into?
  6. With rising inflation expected, what will this mean for consumer spending? How might this affect economic growth?
  7. One of the factors affecting Next is higher import prices. Why have import prices increased and what will this mean for consumer spending and sales?

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?