Category: Economics for Business: Ch 09

5 October 20136 October 2013

Who controls the airports?

No matter the product or service, price is always a key factor and never more so than in tough economic times. In most cases, prices are allowed to be determined by the forces of demand and supply, which gives the equilibrium price. However, in some cases, the government may choose to intervene with a price control, for example rent controls and the national minimum wage. Another market where there is also regulation is the airline industry and the Civil Aviation Authority have recently been criticized by Heathrow Airport for its price control plan.

Whenever we go on holiday, the price we pay for an airline ticket will depend in part on the airport we are taking off from and landing at, as they will charge the airline for landing fees, security, terminals etc. Heathrow airport had proposed that annual rises to its tariffs charged to airlines would increase by 4.6% above RPI inflation. However, this plan has been rejected by the CAA, which has said that the annual tariff rise between 2014 and 2018 should not be above the RPI. Though Heathrow are criticizing the CAA about this restriction, it is an improvement from the initial proposal which would have capped price rises at the RPI minus 1.3%.

Controversy has naturally been created, with the CAA arguing that such price controls are needed to keep prices down and thus benefit consumers and retain the competitiveness of Heathrow airport. But, in contrast, Heathrow has argued that such a cap will put its competitive position under pressure and will risk future investment in the UK. But this isn’t the only criticism of the CAA. Airlines aren’t happy with the ruling either, arguing that the CAA has bowed to the pressure of Heathrow. The contrasting positions of the CAA, Heathrow and airlines are evident in the following quotes, firstly from the Chairwoman of the CAA:

The proposals will put an end to over a decade of prices rising faster than inflation at Heathrow. Tackling the upward drift in Heathrow’s prices is essential to safeguard its globally competitive position. The challenge for Heathrow is to maintain high levels of customer service while reducing costs. We are confident this is possible and that our proposals create a positive climate for further capital investment, in the passenger interest.

Secondly, from Heathrow’s Chief Executive:

This proposal is the toughest Heathrow has ever faced. The CAA’s settlement could have serious and far-reaching consequences for passengers and airlines at Heathrow … We want to continue to improve Heathrow for passengers. Instead, the CAA’s proposals risk not only Heathrow’s competitive position but the attractiveness of the UK as a centre for international investment. We will now carefully consider our investment plans before responding fully to the CAA.

And finally from the IAG Chief Executive, who said:

[The CAA] neglected its new primary statutory duty to further the interests of passengers by endorsing a settlement that allows the UK’s monopoly hub to ignore its inefficiencies and over-reward investors by imposing excessive charges … It is a bad day for customers who have been let down by the CAA.

Any price rise from the airports will be passed on to airlines and these in turn will translate into higher prices for customers. However, is there any truth to Heathrow’s claims that investment will be adversely impacted? As costs rise, profit margins and profit will fall, unless the revenue generated can increase. Price controls restrict the amount that prices can rise and thus unless demand increases by a significant margin, profits will decline. With lower profits, there will be less money for investment and arguably the service that customers face will also decline. However, the CAA suggests that Heathrow will be able to cut its costs and thus protect investment into the future, while retaining its competitive position globally by charging lower prices to airlines. This is unlikely to be the end of the journey, but for the moment, the CAA appears to have put its foot down. The following articles consider the battleground between the CAA and Heathrow.

Regulation in the passenger’s interest, support investment and driving competition The Civil Aviation Authority (3/10/13)
Passengers at Heathrow ‘face £1bn fares hike’ Independent, Matthew Beard (4/10/13)
Heathrow airport attacks regulator’s price control plan BBC News (3/10/13)
CAA proposed Heathrow charges rise in line with inflation The Telegraph, Rebecca Clancy (13/10/13)
Passengers face fare increases as Heathrow and Gatwick are allowed to up landing fees Mail Online (3/10/13)
Heathrow and airlines enraged by CAA price proposals The Telegraph, Alistair Osborne (3/10/13)
Heathrow attacks Civil Aviation Authority over airport charges Financial Times, Andrew Parker (3/10/13)
BAA considers life outside Heathrow as CAA backtracks on charges The Guardian, Gwyn Topham (3/10/13)
Heathrow charge plan disappoints all round Wall Street Journal, Peter Evans (3/10/13)

Questions

What is the role of a regulator?
Explain how the price control outlined by the CAA will affect Heathrow.
If Heathrow is unable to cut costs, what is the likely effect? Using a diagram illustrate the impact on profitability if costs (a) can be reduced and (b) cannot be reduced.
Why are the CAA being criticised by airlines and airports?
How will customers be affected by Heathrow’s planned price rises and the CAA’s proposal?
‘Regulation in the airlines industry is essential to retain competitiveness.’ Evaluate the validity of this statement.

20 July 201320 July 2013

The London Olympics legacy: a cost–benefit analysis

Did the benefits of the London Olympics outweigh the costs? The government’s UK Trade and Industry (part of the Department of Business, Innovation & Skills) has just published a report, London 2012, Delivering the economic legacy, which itemises the economic benefits of the games one year on. It claims that benefits to date are some £9.9 billion.

This compares with costs, estimated to be somewhere between £8.9 billion and £9.3 billion, although this figure does not include certain other costs, such as maintenance of the stadium. Nevertheless, according to the figures, even after just a year, it would seem that the Games had ‘made a profit’ – just.

The £9.9 billion of benefits consist of £5.9 billion of additional sales, £2.5 billion of additional inward investment and £1.5 billion of Olympic-related high value opportunities won overseas. Most of these can be seen as monetary external benefits: in other words, monetary benefits arising from spin-offs from the Games. The ‘internal’ monetary benefits would be largely the revenues from the ticket sales.

In a separate report for the Department of Culture, Media & Sport, Report 5: Post-Games Evaluation, it has been estimated that the total net benefits (net gross value added (GVA)) from 2004 to 2020 will be between £28 billion and £41 billion.

But benefits are not confined just to internal and external monetary benefits: there are also other externalities that are non-monetary. The Culture, Media & Sport report identified a number of these non-monetary externalities. The Summary Report itemises them. They include:

• The health and social benefits of more people participating in sport
• Inspiring a generation of children and young people
• A catalyst for improved elite sporting performance in the UK
• Setting new standards for sustainability
• Improved attitudes to disability and new opportunities for disabled people to participate in society
• Greater social cohesion as communities across the UK engaged with the Games
• Increased enthusiasm for volunteering
• Accelerated physical transformation of East London
• Beneficial socio-economic change in East London
• Important lessons learned for the co-ordination and delivery of other large-scale public and public/private projects

But with any cost–benefit analysis there are important caveats in interpreting the figures. First there may be monetary and non-monetary external costs. For example, will all the effects on social attitudes be positive? Might greater competitiveness in sport generate less tolerance towards non sporty people? Might people expect disabled people to do more than they are able (see)? Second, the costs generally precede the benefits. This then raises the question of what is the appropriate discount rate to reduce future benefits to a present value.

Perhaps the most serious question is that of the quantification of benefits. It is important that only benefits that can be attributed to the Games are counted and not benefits that would have occurred anyway, even if connected to the Games. For example, it is claimed in the UK Trade & Industry report that much of the Olympic park and stadium for the Winter Olympics in Russia was “designed and built by British businesses”. But was this the direct result of the London Olympics, or would this have happened anyway?

Another example is that any inward investment by any company that attended the London Olympics is counted in the £2.5 billion of additional inward investment (part of the £9.9 billion). As the London Evening Standard article below states:

In London, it credited the Games with helping seal the deal for the £1.2 billion investment in the Royal Albert Docks by Chinese developer ABP, the £1 billion investment in Croydon by Australian shopping centre developer Westfield with UK firm Hammerson and the £700 million investment in Battersea Nine Elms by Dalian Wander Group.

It is highly likely that some or all of these would have gone ahead anyway.

Then there are the £5.9 billion of additional sales. These are by companies which engaged with the Olympics. But again, many of these sales could have taken place anyway, or may have displaced other sales.

Many cost–benefit analyses (or simply ‘benefit analyses’) concern projects where there are strong vested interests in demonstrating that a project should or should not go ahead or, in this case, have gone ahead. The more powerful the vested interests, the less likely it is that the analysis can be seen as objective.

Questions

Distinguish between gross and net benefits; monetary and non-monetary externalities; direct costs (or benefits) and external costs (or benefits).
How should the discount rate be chosen for a cost–benefit analysis?
Give some examples of monetary and non-monetary external costs of the Games.
What are the arguments for and against including non-monetary externalities in a cost–benefit analysis?
Why might the £9.9 billion figure for the monetary benefits of the Games up to the present time be questioned?

1 April 20131 April 2013

The decline of the newspaper

Technology and the Internet have both good and bad sides, whether it’s for businesses or consumers. Many opportunities have been created, such as access to global markets, cheaper and easier transport and communication and better sources of supply. But with this opportunity comes threats, especially for businesses. We’ve seen the emergence of new online-based companies and in some cases these have contributed to the demise of other firms. In this News Item we look at the impact on the newspaper industry.

Media is one industry that has been significantly affected by technological developments. Newspaper readership has been in decline for many years and this is even the case for the most widely read UK paper – The Daily Telegraph. However, according to Seamus Dooley, Irish secretary of the National Union of Journalists, it’s not the end of the industry:

It is an industry in crisis, but I don’t accept it is an industry in terminal decline.

More and more information has become freely available online and just as we would expect in any other sector, the newspaper industry has had to respond. To keep their readers, newspapers across the world provide thousands of articles on all topics on their websites. But if news can be accessed freely, why bother purchasing a newspaper? This is the problem facing the Daily Telegraph, the Independent, the Daily Mail etc – the number of newspapers sold has declined and thus so have revenues and profits.

One option is to charge consumers for reading the news by introducing a subscription to the online articles. The Financial Times already charges a fee to view articles online beyond a certain number and The Telegraph is soon to follow suit. Back in 2010, The Times and Sunday Times launched their new websites, which charged readers for viewing articles. The model being adopted by The Telegraph is a little different, as a certain number of articles can be viewed for free before a price must be paid. International readers are already charged to view online material, but these new charges will apply to UK readers. With so much competition facing newspapers, the number of readers for The Telegraph will undoubtedly decline, but with newspaper readership falling, revenues must come from somewhere. Tony Gallagher has said:

We want to develop a closer rapport with our digital audience in the UK, and we intend to unveil a number of compelling digital products for our loyal subscribers in the months ahead.

Differentiating the product is going to be essential for any newspaper that begins charging, as with so much information available online for free, they have to ensure they keep their readers. Establishing loyalty will be crucial. The following articles consider this change.

Telegraph extends paywall to UK readers BBC News (26/3/13)
The Telegraph: subscribe to Britain’s finest journalism The Telegraph (26/3/13)
Telegraph to put up metered paywall Guardian, Roy Greenslade (26/3/13)
The sun joins Telegraph in charging website users The Guardian, Lisa O’Carroll and Roy Greenslade (26/3/13)
Oh how Times are charging Sloman News Site March 2010
Telegraph introduces UK paywall Marketing Week, Lara O’Reilly (26/3/13)
Washington Post announces porous paywall Journalism.co.uk, Sarah Marshall (19/3/13)
Washington Post latest newspaper to put faith in paywalls The Guardian, Dominic Rushe (19/3/13)
Ireland’s newspapers suffer hard times Financial Times, Jamie Smythe (24/3/13)
Washington Post to start charging for website Wall Street Journal, Keach Hagey (18/3/13)

Questions

Where would you put newspapers on the product life cycle? Explain your answer.
How would you assess the effect of the development of technology and the internet for newspapers?
Have readers of newspapers benefited from the internet?
How might estimates of elasticity have been used to make the decision to charge to view online articles?
Which consumers will be affected most by this new strategy?
How might companies that don’t charge for online access benefit from this new strategy?
Would you continue to read articles from The Times, the Financial Times, The Telegraph, etc. linked from this site if you had to pay to access them? If so, why? If not, why not?
How much would you be prepared to pay to access online articles? How are the concepts of utility and consumer surplus relevant here?
What effect will the paywall have on The Telegraph’s revenues and profits? Use a diagram to illustrate your answer.

17 February 201317 February 2013

Supply in chains

The news in many European countries has been dominated in February by the ‘horse meat scandal’. Small traces of horse meat may be the result of faulty quality control. But the significant amount of horse found in several processed meat products suggest fraud at one or more points in the supply chain from farm to supermarket or other outlet. Indeed several specific suppliers, from abattoirs to processors are facing criminal investigation.

The scandal has put the supply chain under intense scrutiny. Part of the problem is that the supply chain is often very long and complex. As the Guardian article states:

The food and retail industries have become highly concentrated and globalised in recent decades. A handful of key players dominate the beef processing and supermarket sectors across Europe. They have developed very long supply chains, particularly for their economy lines, which enable them to buy the ingredients for processed foods from wherever they are cheapest at any point, depending on exchange rates and prices on the global commodity markets. Networks of brokers, cold stores operators and subcontracted meat cutting plants have emerged to supply rapidly fluctuating orders “just in time”. Management consultants KPMG estimate there are around 450 points at which the integrity of the chain can break down.

Then there is the huge pressure on all parts of the supply chain to reduce costs.

Supermarkets use their market power to drive down the prices of the products they buy from their suppliers and this has a knock-on effect backwards down the supply chain. This pressure has intensified as real wages have fallen and consumers have found their budgets squeezed.

At the same time, beef and other meat prices have been rising as the costs of animal feed have soared. This all puts tremendous pressure on suppliers to add cheaper ingredients. Again to quote the Guardian article:

Manufacturers add other cheap ingredients including water and fat, and use concentrated proteins to bind the water and fat in. They may appear on labels as ‘seasoning’. One of the cheapest sources of these protein additives is pork rind. It is possible that horse hide is now also being used. The widespread adulteration of cheap chicken breast with pig and beef proteins and water has been uncovered in previous scandals. The beef proteins were derived from hydrolysed cattle hides. It is not illegal to use these protein concentrates so long as they are identified correctly to the manufacturer.

It is not surprising that if cheap horse meat becomes available to suppliers, such as from old horses towards the end of their working lives, some processing companies may be tempted to add it fraudulently, stating that it is beef.

The articles look at the issues of long and complex supply chains in the processed food industry and assess why they have evolved into their current form and the difficulties in regulating them.

Horsegate: heed economics of the cold chain The Grocer, Andrew Godley (16/2/13)
Horsemeat scandal: the essential guide The Guardian, Felicity Lawrence (15/2/13)
After the horse has been bolted The Economist (16/2/13)
Slavery, not horse meat, is the real scandal on our doorstep The Telegraph, Fraser Nelson (14/2/13)
Industry must take the reins on food safety Globe and Mail (Canada)Sylvain Charlebois (15/2/13)
Supply chains changed the growth model The Economist, Richard Baldwin (15/8/12)
Supply-chain management The Economist (6/4/09)
Tesco pledges to open up supply chain after horse meat scandal The Telegraph (16/2/13)
Horse meat scandal: Shoppers who buy ‘cheapest food’ at risk The Telegraph, James Quinn, Jason Lewis and Patrick Sawer (16/2/13)
Let Them Eat Horse Bloomberg, Marc Champion (15/2/13)
Scandal shows meat supply chain must be policed heraldscotland (14/2/13)
MPs push for new powers for FSA as officials seize yet more suspect meat Independent, Martin Hickman (13/2/13)

Questions

Why do supermarkets and their suppliers use long supply chains?
Explain the concepts of ‘countervailing power’ and ‘monopsony or oligopsony power’? How do they apply in the processed meat supply chain?
Identify the types of transactions costs in the processed meat industry.
In what ways do consumers (a) gain and (b) lose from such supply chains?
Why is the problem of fraud in processed food supply chains likely to have intensified in recent years?
How have supermarkets reacted to the horse meat scandal? Why has it taken the scandal to make them react in this way?
To what extent is the problem simply one of inaccurate labelling?
To what extent is there a principal–agent problem in the processed meat supply chain?

20 January 201323 January 2013

Market traders get a technology boost

Market trading has existed for centuries and in many respects it hasn’t changed very much. One thing that has developed is the means of exchange. Goods used to be traded for other goods – for example 1 pig for 4 chickens! But then money was developed as a means of exchange and then came cheques and plastic.

However, for many market traders, accepting credit and debit cards is relatively costly. It involves paying a monthly contract, which for many traders is simply not worthwhile, based on the quantity and value of the transactions. But, for many customers using debit or credit cards is the preferred method of payment and the fact that some traders only accept cash can be a deterrent to them making purchases and this therefore reduces the sales of the market traders.

But, with advances in technology a new way of paying has emerged. Small card readers can now be plugged into iphones, ipads, other tablets and smartphones. By putting a customer’s card into this device customers can then pay by card and either sign for their purchase or use the phone to enter their security details. There are plan for these companies to offer chip and pin technology to further ease payment by card on market stalls. The traders pay a small commission per transaction, but aside from that, the initial start-up cost is minimal and it is likely to encourage more customers to use markets. Jim Stewart, the Director of a firm that has begun using this technology said:

I think it’s definitely going to take off, the world is going that way … The money has always appeared in my bank account, no transactions have been declined, my accountant is happy, it’s all been good.

Some customers have raised concerns about the security of these transactions, as they have to put their cards into someone else’s ipad. However, traders have said that there are no risks and that customers can be sent a receipt for their purchase. The following few articles look at this latest (and other) technological developments.

Smartphone card payment system seeks small firms BBC News, Rob Howard (19/1/13)
POS Trends: What’s new for 2013 Resource News (17/1/13)
Payments by text message service to launch in UK in Spring 2014 BBC News (15/1/13)

Questions

What are fixed cost and why does having a traditional card payment machine represent a fixed cost for a firm?
How might this new technology affect a firm’s sales and profits?
Will there be an increase in the firm’s variable costs from adopting this technology?
Using a cost and revenue diagram, put your answers to questions 1 – 3 into practice and show how it will shift them and thus how the equilibrium may change for a market trader.
What are the properties of money that allow it to be a good medium of exchange?
How will this increased use of debit and credit cards affect the demand for money? Use a diagram to illustrate your answer.

Category: Economics for Business: Ch 09

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