Tag: natural monopoly

The term ‘Google it’ is now part of everyday language. If there is ever something you don’t know, the quickest, easiest, most cost-effective and often the best way to find the answer is to go to Google. While there are many other search engines that provide similar functions and similar results, Google was revolutionary as a search engine and as a business model.

This article by Tim Harford, writing for BBC News, looks at the development of Google as a business and as a search engine. One of the reasons why Google is so effective for individuals and businesses is the speed with which information can be obtained. It is therefore used extensively to search key terms and this is one of the ways Google was able to raise advertising revenue. The business model developed to raise finance has therefore been a contributing factor to the decline in newspaper advertising revenue.

Google began the revolution in terms of search of engines and, while others do exist, Google is a classic example of a dominant firm and that raises certain problems. The article looks at many aspects of Google.

Just google it: The student project that changed the world BBC News, Tim Harford (27/03/17)

Questions

  1. Is Google a natural monopoly? What are the characteristics of a natural monopoly and how does this differ from a monopoly?
  2. Are there barriers to entry in the market in which Google operates?
  3. What are the key determinants of demand for Google from businesses and individuals?
  4. Why do companies want to advertise via Google? How might the reasons differ from advertising in newspapers?
  5. Why has there been a decline in advertising in newspapers? How do you think this has affected newspapers’ revenue and profits?

Concerns have been expressed about the UK’s relatively poor record of upgrading broadband services so that households can receive ultrafast connectivity. Some commenters have argued that future economic growth prospects will be harmed if the UK continues to lag behind its leading rivals.

Much of the fixed line system that allows people to connect to broadband was originally installed many years ago for the land-line telephone network. The so called ‘final mile’ consists of copper-based wiring that is carried from street cabinets to the premises of the end-user. This wiring is transported via a huge network of telegraph poles and cable ducts (small underground tunnels).

In order for people to gain connectivity to ultrafast broadband this copper based wiring needs to be replaced by fibre optic cables. This is commonly referred to as Fibre to the Premises (FTTP). Unfortunately, the UK has a relatively poor record of installing FTTP. Japan and Korea were forecast to have 70% and 63% coverage by the end of 2015 as opposed to just 2% in the UK.

Why is the UK’s record so poor? Many observers blame it on the structure of the industry. In other network industries, such as those for gas pipeline and electricity grids, the business responsible for managing the infrastructure, National Grid, is a regulated monopoly. This company does not directly supply services to consumers using the network it is responsible for maintaining. Instead, customers are supplied by the retail sector of the industry, where firms compete for their business. This sector includes the so-called ‘big six’ (British Gas; npower; SSE; Scottish Power; EDF; E.On) and a number of smaller suppliers such as Ovo Energy and Ebico.

The structure of the fixed line telecommunications sector is very different. The company that manages the ‘final mile’, Openreach, is a subsidiary of BT. BT also competes with other Internet Service Providers (ISPs), such as TalkTalk and Sky, to supply broadband to customers using this network. Its market share of 32 per cent makes it the largest player in the broadband market. Sky and TalkTalk have market shares of 22 per cent and 14 per cent respectively. Virgin Media also supplies 20 per cent of this market using its own network of ducts and cables.

Given that in most cases ISPs such as Sky and TalkTalk are stuck with the network Openreach provides, BT may have limited incentives to invest. It can still earn a good return from its infrastructure of copper-based wiring and avoid installing expensive FTTP. Dido Harding, the chief executive of TalkTalk, argued that:

“We need to separate Openreach from the rest of BT to create a more competitive, pro-investment market”

Ofcom, in its recent review of the market, has taken a different approach. Rather than creating an entirely separate monopoly business to manage the network (i.e. splitting Openreach from BT), the regulator instead opted for a policy of encouraging competition between different suppliers that deploy fibre optic cables. It states in the report that:

“We believe competition between different networks is the best way to drive investment in high-quality, innovative services for customers.”

This competition could come from ISPs such as TalkTalk and Sky or other smaller network providers such as CityFibre and Gigaclear.

One major problem with this approach is that potential new entrants might be deterred from entering the market because of the very high initial costs involved in building a new network in order to deploy FTTP. In particular, the costs of digging up the roads and laying the ducts are considerable. Matt Yardley, author of a study on the industry, said:

“It is widely accepted that civil works such as digging trenches account for up to 80% of broadband deployment costs.”

One way of reducing these costs and encouraging more competition is to allow rival firms access to the existing ducts and poles that are currently managed by Openreach. Once access has been obtained, these firms could effectively rent space inside the ducts and lay fibre optic cables alongside the existing copper-based wiring. Vodafone reported that a similar policy in Spain had reduced its capital expenditure of building FTTP by 40 per cent compared with constructing its own network of ducts and poles.

Ofcom first introduced this type of policy in 2010 when it launched its Physical Infrastructure Access (PIA) initiative. Unfortunately it has proved to be relatively unsuccessful with very little demand for PIA from rival firms. The success of this type of policy will depend on a number of factors including (1) the prices charged by Openreach to access and rent space inside the ducts; (2) the simplicity of any relevant administration; and (3) the availability and reliability of information about the ducts. With this last point, key issues include:

Where they are located .
How much space is available: i.e. is there enough space for firms to lay fibre optic cables alongside the existing wiring?
What condition they are in: i.e. are they flooded or clogged up with sand and mud, which will involve expensive work to make them usable again?

Firms did complain about the pricing structures and bureaucratic nature of the administration process under the PIA scheme. However, their most significant concerns were about the uncertainty that was created by the lack of information about the ducts and poles. For example, analysts from the consultancy firm, Reburn, argued that if a firm contacted Openreach to try to obtain access to the network it was informed that:

“We don’t know what condition the ducts and poles are in. Please pay £10 000 for a survey. Also unfortunately we are rather busy and we can only start in six weeks.”

Matthew Hare, the chief executive of Gigaclear, argued that it was like going to a shop where the assistant says:

“Give me some money, and I’ll tell you whether you can have it or not.”

In response to these criticisms Ofcom has introduced a number of changes to PIA, which has been re-named Duct and Pole Access (DPA). In particular, it has imposed a new requirement on Openreach to create a database that provides information on the location, condition and capacity of its ducts and poles. The database must be made available to rival ISPs and network providers. DPA must also be provided on the same timescales, terms and conditions to all businesses including other parts of BT – this is referred to as ‘equivalence of inputs’.

The first big test of this policy is in Southend where City Fibre is hoping to deploy 50km of fibre optic cables using DPA. However, reports in the media have suggested that the initial surveys have found very limited capacity in some of the ducts, which would make DPA impossible.

It will be interesting to see how the trial in Southend progresses. If it is successful, then DPA may be viable for about 40 per cent of premises in the UK. If it fails, then Ofcom might ultimately have to force Openreach to be completely separated from BT.

Articles

How the gothic city of York became a broadband battleground The Telegraph, Kate Palmer (22/5/16)
City Fibre first to mount BT challenge after Openreach is told to share network The Telegraph, Kate Palmer (1/3/16)
Challenges as CityFibre Moot Using BT Cable Ducts in Southend-on-Sea ISPreview, Mark Jackson (2/5/16)
CityFibre to build pure fibre infrastructure for Southend Networking (5/4/16)
Ofcom tells BT to open up infrastructure to rivals The Guardian, Rob Davies (26/2/16)

Questions

  1. Draw an average total cost curve to illustrate the economics of building a network of ducts and poles. Label the minimum efficient scale.
  2. To what extent does DPA create a contestable market?
  3. For DPA to deliver productive efficiency, what must be true about the economies of scale of laying fibre optic cables?
  4. In the run-up to Ofcom’s review of the telecoms industry, many commentators described Openreach as being a natural monopoly. To what extent do you agree with this argument?
  5. What are the advantages of marginal cost pricing? What issues might a regulator face if it tried to impose marginal cost pricing on a natural monopoly?
  6. Using a diagram, explain how the network of ducts and poles might be a natural monopoly in rural areas but not in densely populated urban areas.
  7. Discuss how Ofcom has tried to increase the level of separation between Openreach and BT.

Some eyebrows were raised when the English Premier League (EPL) recently published the final payments to each of the clubs from the revenue generated by the latest TV deal. The headlines were that Liverpool received the highest individual pay-out of £97,544,336! Cardiff City received the lowest pay-out of £62,082,302. What caught the eye of the headline writers was that the revenue from the lowest pay-out this season (the payment to Cardiff) was greater than the highest pay-out from the previous season (a payment of £60,813,999 to Manchester United).

The 2013-14 season was the first year of the latest 3 year deal for the rights to broadcast EPL games on the television, internet and radio. As part of this deal BSkyB are paying £760 million each year for the rights to broadcast 116 EPL games per season in the UK. BTSport are paying £246 million per year for the rights to broadcast 38 EPL games per season. In addition to selling the rights to broadcast games in the UK, the EPL also separately sells the rights to broadcast games in other countries. For example Cable Thai Holdings paid £205 million for a 3 year deal to show EPL matches in Thailand while NowTV paid £128 million for a similar deal in Hong Kong. In total the EPL earns approximately £1.8 billion per season from the sale of their domestic and international media rights.

The approach taken by the EPL to manage the sale of the broadcasting rights has raised considerable debate amongst economists and policy makers. There are two very different methods that can be used by teams in a league to sell the rights. They are the Individual Sales Model (ISM) and the Collective Sales Model (CSM). In the ISM each club is responsible for marketing and selling the rights to broadcast its home games. The ISM is currently employed by both La Liga in Spain and Primeira Liga in Portugal. In the CSM the rights are sold jointly by the league, federation or national association on behalf of the teams involved. This CSM is currently used by the majority of the football leagues in Europe. The EPL sold the rights for 2013-16 on behalf of the 20 clubs using a sealed bid auction.

Some economists and policy makers have criticised the CSM, claiming that it is an example of a cartel that simply restricts output and leads to higher prices. Each club is considered to be the equivalent of a firm in a traditional industry. The argument is based on a number of observations about the teams. They:

• are each separately owned and submit their own individual set of accounts
• compete with each other to buy inputs (i.e. the players) to produce an output (i.e. a match)
• individually market and set the price for the outputs they produce i.e. the ticket for the games and the prices of the merchandise such as football shirts

If this view of the industry is taken, the league or federation looks rather like a restrictive agreement between independent competitors that creates monopoly market power. As evidence to support this interpretation of the CSM, reference is often made to the details of the contract between the EPL and BSkyB and BTSport. As part of this agreement the number of live matches that can be broadcast is restricted to 154.This represents just over 40% of the maximum total of 380 that could be shown. Teams are effectively prohibited from individually selling the rights to matches that are not selected for broadcast in the collective deal as they must seek permission from the EPL. Over ten years ago the Director General of the Office of Fair Trading commented that:

Within the market the Premier League has a major if not unique position. By selling rights collectively…it is acting as a cartel. The net effect of cartels is to inflate costs and prices. Any other business acting in this way would be subject to competition law and I see no reason why the selling of sport should be treated differently.

The EPL has always defended it actions by claiming that any increase in the number of televised games would have a negative impact on the attendance at matches.

An alternative view focuses on the peculiar or unique characteristics of sports leagues. In particular it is argued that sport is unusual because the level of co-operation required between the teams and a league to produce matches is far greater than that required by firms in other industries to produce output. Agreements have to be made about issues such as the timing and venue of the games as well as the rules under which they will be played. However unlike a traditional cartel arrangement these agreements do not simply control and restrict output. They also improve the entertainment value of the game and hence the quality of the product. Some authors have argued that because of these unique characteristics, the league rather than the individual team should be considered as the equivalent to a firm in a more traditional industry. In this ‘single entity theory’ teams are viewed as divisions of a single organization i.e. the league. The league is treated as a natural monopoly that legally owns the broadcast rights of the clubs rather than a cartel of separate firms. Others have argued that it is more sensible to think of the league as a joint venture between the teams.

Not only are the levels of co-operation required much greater than in traditional industries but it is also argued that competitive balance is important for a successful league. If the same teams always win most of the games then there are concerns that fans will find this boring and it will reduce their willingness to pay to watch matches in either the stadium or on television. It is argued that the CSM makes it easier to distribute the TV money more equally and so helps to maintain competitive balance in a league. The White Paper on Sport published by the European Union in 2007 stated that:

Collective selling can be important for the redistribution of income and can thus be a tool for achieving greater solidarity within sports.

The debate continues about whether the CSM used by the EPL is an example of a restrictive cartel which acts against the public interest or a business practice that helps to improve the quality of the product for the customer.

Premier League clubs earn record-breaking sums thanks to TV bonanza The Telegraph (14/5/14)
Liverpool top earners over season with £99m – and bottom side Cardiff got £64m (so see what your team received in 2013-14 Mail Online (11/5/14)
Cardiff earn more TV cash than champions Man Utd did in 2013 BBC Sport (14/5/14)
Relegated Cardiff Earn More TV Revenue than Man Utd Tribal Football (14/5/14)
TV Bonanza for Premier League Clubs Pars Herald (18/5/14)
Season of woe hits home in money league Express & Star (15/5/14) .

Questions

  1. What is a natural monopoly? Draw a diagram to illustrate your answer.
  2. What is a cartel? Find three real-world examples of cartel agreements.
  3. It was explained in the article how the EPL sells the rights to broadcast just over 40% of the total number of matches played per season. Draw a diagram to illustrate and explain how this might be an example of a cartel agreement that restricts output and results in higher prices.
  4. The EPL defends its decision to restrict the number of games that can be televised in its domestic deal by claiming that any increase would have a negative impact on attendance at the matches. To what extent do you think that watching a live game on the television is a substitute for watching it in the stadium? Draw a demand and supply diagram to illustrate a situation where they are strong substitutes. Explain how the concept of cross price elasticity could be applied to this example.
  5. Outline how a sealed bid auction works. What are the advantages of using a sealed bid auction as opposed to other types of auction.
  6. Can you think of any other economics arguments that could be used to defend the use of the CSM for the sale of the broadcast rights?

In many parts of the UK, bus services are run by a single operator. In other parts, it is little different, with the main operator facing competition on only a very limited number of routes. Over the whole of England, Scotland and Wales there are 1245 bus operators, but the ‘big five’ (Arriva, FirstGroup, Go-Ahead, National Express and Stagecoach) carry some 70% of passengers. Generally these five companies do not compete with each other, but, instead, operate as monopolies, or near monopolies, in their own specific areas. On average, the largest operator in an urban area runs 69% of local bus services.

Given this lack of competition and potential abuse of monopoly power, the Office of Fair Trading referred local bus services in Great Briatin (excluding London) to the Competition Commission (CC) in January 2010. The CC has just published its final report. Paragraph 5 of the summary to the report states:

We concluded that there were four features of local bus markets which mean that effective head-to-head competition is uncommon and which limit the effectiveness of potential competition and new entry. These features are the existence of: high levels of concentration; barriers to entry and expansion; customer conduct in deciding which bus to catch; and operator conduct by which operators avoid competing with other operators in ‘Core Territories’ (certain parts of an operator’s network which it regards as its ‘own’ territory) leading to geographic market segregation.

And paragraph 8 states:

We decided on a package of remedies with three main elements to address the AECs [adverse effects on competition] that we found. First, the remedies include market-opening measures to reduce barriers to entry and expansion, thereby reducing market concentration and providing an environment in which competition is likely to be sustained. By reducing barriers to entry and expansion, we also expect it to become harder for operators to sustain a coordinated outcome. Second, the remedies include measures to promote competition in relation to the tendering of contracts for supported services. Third, we made recommendations about the wider policy and regulatory environment, including emphasizing compliance with and effective enforcement of competition law.

The following articles look at the findings of the report and at the potential for improving the service to passengers, in terms of quality, frequency and price.

Articles
Competition regulator outlines bus market shake-up The Telegraph (20/12/11)
Bus market not competitive, Competition Commission says BBC News (20/12/11)
Passengers ‘need more bus rivalry’ Press Association (20/12/11)

Competition Commission publications
CC sets out Future Destination for Bus Market Competition Commission News Release (20/12/11)
Bus Market Inquiry: Final Report, Case Studies and Appendices Competition Commission (20/12/11)
Local Bus Services: Accompanying Documents Competition Commission (20/12/11)

Questions

  1. What are the barriers to entry in the market for local bus services?
  2. In what circumstances are local bus services a natural monopoly? Is this generally the case?
  3. In a non-regulated bus market, how could established operators use predatory pricing to drive out new entrants?
  4. How may offering reductions for return tickets reduce competition on routes where there is a large operator and one or more smaller ones?
  5. What practices can established large operators use to drive out smaller competitors?
  6. Go through the four reasons given by the CC why head-to-head competition in local bus markets is uncommon and in each case consider what remedies could be adopted by the regulator or by local authorities.
  7. Which of the remedies proposed by the CC involve encouraging more competition and which involve tighter regulation?

Anyone who lives in the South West can argue that they get a raw deal. Not only are the average salaries in this region lower than in the rest of the United Kingdom, but their water bills are 40% higher than those elsewhere in England and Wales. South West Water is the only provider of water in the South West and hence there are no other competitors that households or businesses can switch to, despite the extortionate prices.

Many households and businesses in the region are struggling to cope with the unfair bills, as people are forced to sacrifice other things in order to find the money. Furthermore, it can be argued that these higher bills are actually used for the benefit of everyone else in the United Kingdom. Since privatisation, South West Water are responsible for cleaning and maintaining over one third of the UK’s beaches and the prices they are charged by SW Water reflect this £2 billion cost. Moreover, with a relatively low population, this large cost cannot be spread across many people. Instead, the small population has to pay larger bills. A hairdresser, who does use a lot of water, is finding herself crippled by water bills of some £2,500. And this bill will pay to clean the beaches in the South West so that people living elsewhere can benefit from the beautiful surroundings.

There is now wide recognition of how unfair this scenario is and proposals have been suggested, ranging from a government grant (hardly likely given the state of public finances) to a levy on other regions’ bills to compensate SW Water for their clean-up costs. However, no decision has been made about how to progress and so for now, residents of the region must just simply grin and bear it, while sacrificing expenditure on other areas and seeing residents from across the UK benefit from their sacrifice.

P.S. If you hadn’t guessed it, yes I do live in the South West!

Why is water so expensive in the South West? BBC News (13/7/10)
North Devon MP Nick Harvey tackles unfair South West Water charges Barnstaple People (14/7/10)

Questions

  1. What is privatisation? Assess the advantages and disadvantages of the privatisation of water some 20 years ago.
  2. Does South West Water have a monopoly?
  3. Which of the 3 proposals is the most beneficial to those a) living in the South West, b) businesses in the South West c) the government and d) the rest of the country?
  4. Which proposal would you recommend and why?
  5. Is it fair that those in the South West should pay disproportionately more to clean and maintain beaches, which are used by everyone?
  6. Is the concept of market failure relevant in this case? Explain your answer.