Category: Economics for Business: Ch 16

Posted on

Vetting vets

The Competition and Markets Authority (CMA) is proposing to launch a formal Market Investigation into anti-competitive practices in the UK’s £2bn veterinary industry (for pets rather than farm animals or horses). This follows a preliminary investigation which received 56 000 responses from pet owners and vet professionals. These responses reported huge rises in bills for treatment and medicines and corresponding rises in the cost of pet insurance.

At the same time there has been a large increase in concentration in the industry. In 2013, independent vet practices accounted for 89% of the market; today, they account for only around 40%. Over the past 10 years, some 1500 of the UK’s 5000 vet practices had been acquired by six of the largest corporate groups. In many parts of the country, competition is weak; in others, it is non-existent, with just one of these large companies having a monopoly of veterinary services.

This market power has given rise to a number of issues. The CMA identifies the following:

  • Of those practices checked, over 80% had no pricing information online, even for the most basic services. This makes is hard for pet owners to make decisions on treatment.
  • Pet owners potentially overpay for medicines, many of which can be bought online or over the counter in pharmacies at much lower prices, with the pet owners merely needing to know the correct dosage. When medicines require a prescription, often it is not made clear to the owners that they can take a prescription elsewhere, and owners end up paying high prices to buy medicines directly from the vet practice.
  • Even when there are several vet practices in a local area, they are often owned by the same company and hence there is no price competition. The corporate group often retains the original independent name when it acquires the practice and thus is is not clear to pet owners that ownership has changed. They may think there is local competition when there is not.
  • Often the corporate group provides the out-of-hours service, which tends to charge very high prices for emergency services. If there is initially an independent out-of-hours service provider, it may be driven out of business by the corporate owner of day-time services only referring pet owners to its own out-of-hours service.
  • The corporate owners may similarly provide other services, such as specialist referral centres, diagnostic labs, animal hospitals and crematoria. By referring pets only to those services owned by itself, this crowds out independents and provides a barrier to the entry of new independents into these parts of the industry.
  • Large corporate groups have the incentive to act in ways which may further reduce competition and choice and drive up their profits. They may, for example, invest in advanced equipment, allowing them to provide more sophisticated but high-cost treatment. Simpler, lower-cost treatments may not be offered to pet owners.
  • The higher prices in the industry have led to large rises in the cost of pet insurance. These higher insurance costs are made worse by vets steering owners with pet insurance to choosing more expensive treatments for their pets than those without insurance. The Association of British Insurers notes that there has been a large rise in claims attributable to an increasing provision of higher-cost treatments.
  • The industry suffers from acute staff shortages, which cuts down on the availability of services and allows practices to push up prices.
  • Regulation by the Royal College of Veterinary Surgeons (RCVS) is weak in the area of competition and pricing.

The CMA’s formal investigation will examine the structure of the veterinary industry and the behaviour of the firms in the industry. As the CMA states:

In a well-functioning market, we would expect a range of suppliers to be able to inform consumers of their services and, in turn, consumers would act on the information they receive.

Market failures in the veterinary industry

The CMA’s concerns suggest that the market is not sufficiently competitive, with vet companies holding significant market power. This leads to higher prices for a range of vet services. However, the CMA’s analysis suggests that market failures in the industry extend beyond the simple question of market power and lack of competition.

A crucial market failure is asymmetry of information. The veterinary companies have much better information than pet owners. This is a classic principal–agent problem. The agent, in this case the vet (or vet company), has much better information than the principal, in this case the pet owner. This information can be used to the interests of the vet company, with pet owners being persuaded to purchase more extensive and expensive treatments than they might otherwise choose if they were better informed.

The principal–agent problem also arises in the context of the dependant nature of pets. They are the ones receiving the treatment and, in this context, are the principals. Their owners are the ones acquiring the treatment for them and hence are the pets’ agents. The question is whether the owners will always do the best thing for their pets. This raises philosophical questions of animal rights and whether owners should be required to protect the interests of their pets.

Another information issue is the short-term perspective of many pet owners. They may purchase a young and healthy pet and assume that it will remain so. However, as the pet gets older, it is likely to face increasing health issues, with correspondingly increasing vet bills. But many owners do not consider such future bills when they purchase the pet. They suffer from what behavioural economists call ‘irrational exuberance’. Such exuberance may also occur when the owner of a sick pet is offered expensive treatment. They may over-optimistically assume that the treatment will be totally successful and that their pet will not need further treatment.

Vets cite another information asymmetry. This concerns the costs they face in providing treatment. Many owners are unaware of these costs – costs that include rent, business rates, heating and lighting, staff costs, equipment costs, consumables (such as syringes, dressings, surgical gowns, antiseptic and gloves), VAT, and so on. Many of these costs have risen substantially in recent months and are reflected in the prices pet owners are charged. With people experiencing free health care for themselves from the NHS (or other national provider), this may make them feel that the price of pet health care is excessive.

Then there is the issue of inequality. Pets provide great benefits to many owners and contribute to owners’ well-being. If people on low incomes cannot afford high vet bills, they may either have to forgo having a pet, with the benefits it brings, or incur high vet bills that they ill afford or simply go without treatment for their pets.

Finally, there are the external costs that arise when people abandon their pets with various health conditions. This has been a growing problem, with many people buying pets during lockdown when they worked from home, only to abandon them later when they have had to go back to the office or other workplace. The costs of treating or putting down such pets are born by charities or local authorities.

The CMA is consulting on its proposal to begin a formal Market Investigation. This closes on 11 April. If, in the light of its consultation, the Market Investigation goes ahead, the CMA will later report on its findings and may require the veterinary industry to adopt various measures. These could require vet groups to provide better information to owners, including what lower-cost treatments are available. But given the oligopolistic nature of the industry, it is unlikely to lead to significant reductions in vets bills.

Articles

CMA documents

Questions

  1. How would you establish whether there is an abuse of market power in the veterinary industry?
  2. Explain what is meant by the principal–agent problem. Give some other examples both in economic and non-economic relationships.
  3. What market advantages do large vet companies have over independent vet practices?
  4. How might pet insurance lead to (a) adverse selection; (b) moral hazard? Explain. How might (i) insurance companies and (ii) vets help to tackle adverse selection and moral hazard?
  5. Find out what powers the CMA has to enforce its rulings.
  6. Search for vet prices and compare the prices charged by at least three vet practices. How would you account for the differences or similarities in prices?
Posted on

A body blow to Body Shop?

On 12 February, it was announced that The Body Shop UK was entering administration. With 199 shops across the country, if this leads to the collapse of the business, some 2000 jobs will be lost. The business has been struggling since 2020 and poor sales this last Christmas led the new owners, the pan-European alternative investment firm, Aurelius, to appoint administrators.

This could potentially begin an insolvency process that could result in the closure of some or all of the shops. This would spell the end of an iconic brand that, since its founding in 1976, has been associated with natural, ethically sourced and environmentally friendly products. Aurelius has already sold The Body Shop business in most of mainland Europe and in parts of Asia to an unnamed buyer. It is unclear what will happen to the approximately 2800 stores and 8000 employees in 70 countries outside the UK.

Origins of The Body Shop1

The Body Shop was founded in 1976 and shot to fame in the 1980s. It stood for environmental awareness and an ethical approach to business. But its success had as much to do with what it sold as what it stood for. It sold natural cosmetics – Raspberry Ripple Bathing Bubbles and Camomile Shampoo – products that proved immensely popular with consumers.

Its profits increased from a little over £1m in 1985 (€1.7m) to approximately £65m (€77.5m) in 2012. Although profits then slipped, falling to €65.3m in 2014 and €54.8m in 2015, its profit growth in new markets over that same period was 12.4%.

Sales revenue, meanwhile, grew even more dramatically, from £4.9m in 1985 to approximately €967.2m in 2015. By 2015, Body Shop International had over 3100 stores, operating in 61 countries.

What made this success so remarkable is that The Body Shop did virtually no advertising. Its promotion stemmed largely from the activities and environmental campaigning of its founder, Anita Roddick, and the company’s uncompromising claim that it sold only ‘green’ products and conducted its business operations with high ethical standards. It actively supported green causes such as saving whales and protecting rainforests, and it refused to allow its products to be tested on animals. Perhaps most surprising in the world of big business at the time was its high-profile initiative ‘trade not aid’, whereby it claimed to pay ‘fair’ prices for its ingredients, especially those supplied by people in developing countries who were open to exploitation by large companies.

The growth strategy of The Body Shop focused upon developing a distinctive and highly innovative product range, and at the same time identifying these products with major social issues of the day, such as the environment and animal rights.

Its initial expansion was based on a process of franchising, where individuals opened Body Shops which were then supplied by the company with its range of just 19 products. Then, in 1984 the company went public. Following its flotation, the share price rose from just 5p to a high of 370p in 1992.

In the 1990s, however, sales growth was less rapid. By 1998, earnings had collapsed by 90% and the share price fell to 117p. Shareholders forced Anita Roddick to step down as Chief Executive, but for a while she and her husband remained as co-chairs. In 2002, they stepped down as co-chairs, by which time profits had fallen to £20.4m. In 2003 she was awarded in knighthood and became Dame Anita Roddick. Sales then grew rapidly from 2004 to 2006 from €553m to €709m.

Acquisition of The Body Shop by L’Oréal

A dramatic event, however, occurred in 2006 when The Body Shop was sold to the French cosmetics giant, L’Oréal, which was 26% owned by Nestlé, The event resulted in the magazine Ethical Consumer downgrading The Body Shop’s ethical rating from 11 out of 20 to a mere 2.5 and calling for a boycott of the company. Three weeks after the sale, the daily BrandIndex recorded an 11 point drop in The Body Shop’s consumer satisfaction rating from 25 to 14.

There were several reasons for this. L’Oréal’s animal-testing policies conflicted with those of The Body Shop and L’Oréal was accused of being involved in price-fixing with other French perfume houses. L’Oréal’s part-owner, Nestlé, was also subject to various criticisms for ethical misconduct, including promoting formula milk rather than breast milk to mothers with babies in developing countries and using slave labour in cocoa farms in West Africa.

Anita Roddick, however, believed that, by taking over The Body Shop, L’Oréal would develop a more ethical approach to business. Indeed, it did publicly recognise that it needed to develop its ethical and environmental policies.

L’Oréal adopted a new Code of Business Ethics in 2007 and gained some external accreditation for its approach to sustainability and ethics. It was ranked as one of the world’s 100 most ethical companies by Ethisphere in 2007 and, in 2016, it was again part of this list for the seventh time.

L’Oréal set itself three targets as part of its environmental strategy (2005–15), including a 50% reduction in greenhouse gas emissions, water consumption and waste per finished product unit. It made a donation of $1.2m to the US Environment Protection Agency to help bring an end to animal testing and, in March 2013, it announced a ‘total ban on the sale in Europe of any cosmetic product that was tested on animals or containing an ingredient that was tested on animals after this date.’ It also promised that ‘By 2020, we will innovate so that 100% of products have an environmental or social benefit.’

Sadly, Anita Roddick died in 2007 and so was not able to witness these changes.

L’Oréal also looked to inject greater finance into the company aimed at improving the marketing of products. In autumn 2006 a transactional website was launched and there have been larger press marketing campaigns. Profits continued to rise in 2006 and 2007, but fell back quite dramatically from €64m in 2007 to €36m in 2008 as recession hit the high streets. They fell by a further 8% in 2009, but significant growth was seen in the following three years: 2010, up 20.3% to €65.3m; 2011, up 4.3% to €68.1m; 2012, up 13.8% to €77.5m.

From L’Oréal to Natura to Aurelius to ?

From 2013, the financial performance of The Body Shop deteriorated. Profits fell by 38% in 2016 to just €34m, with sales falling by 5%. In June 2017, L’Oréal announced that it had agreed to sell The Body Shop for €1bn (£877m) to Natura Cosmeticos, the largest Brazilian cosmetics business. Natura was awarded ‘B Corp’ status in 2014 as it met certain standards for environmental performance, accountability and transparency. In 2019, The Body Shop was separately certified as a B Corp.

Initial indications for The Body Shop under its new owners seemed good, with net revenue rising by 36% in 2018 and 6.3% in 2019. 2020 saw strong growth in sales, with a rise in online sales more than offsetting the effect of store closures during the pandemic. Its market share peaked in 2020 at 1.4%. However, with the cost-of-living crisis following the pandemic and the Russian invasion of Ukraine, many consumers switched to cheaper brands and cheaper outlets, such as Boots and Superdrug, sacrificing environmental and ethical concerns in favour of value for money. As a result, The Body Shop’s market share fell, dropping to 0.8% in 2022 and not picking up in 2023.

This prompted Natura to sell the business to Aurelius. Aurelius hoped to revitalise The Body Shop by promoting its core values and through partnerships or concessions with major retailers, such as John Lewis or Next. However, as we saw above, after a poor Christmas and a weaker capital base and higher cost commitments than initially thought by Aurelius, the new owner filed to put The Body Shop into administration.

What will come of the administration process remains to be seen. Perhaps some of the more profitable stores will be saved; perhaps there will be an expansion of the online business; perhaps partnerships will be sought with major retailers. We shall see.

1 Some of this section is based on Case Study 9.3 from Economics (11th edition).

Videos

Articles

Questions

  1. What assumptions did The Body Shop made about the ‘rational consumer’?
  2. How would you describe the aims of The Body Shop (a) in the early days under Anita Roddick; (b) under L’Oréal; (c) under Aurelius?
  3. How has The Body Shop’s economic performance been affected by its attitudes towards ethical issues?
  4. What has Lush done right that The Body Shop has not?
  5. What will the administrators seek to do?
  6. Find out what has happened to The Body Shop outlets in mainland Europe?
Posted on

Hacking capitalism

The development of open-source software and blockchain technology has enabled people to ‘hack’ capitalism – to present and provide alternatives to traditional modes of production, consumption and exchange. This has enabled more effective markets in second-hand products, new environmentally-friendly technologies and by-products that otherwise would have been negative externalities. Cryptocurrencies are increasingly providing the medium of exchange in such markets.

In a BBC podcast, Hacking Capitalism, Leo Johnson, head of PwC’s Disruption Practice and younger brother of Boris Johnson, argues that various changes to the way capitalism operates can make it much more effective in improving the lives of everyone, including those left behind in the current world. The changes can help address the failings of capitalism, such as climate change, environmental destruction, poverty and inequality, corruption, a reinforcement of economic and political power and the lack of general access to capital. And these changes are already taking place around the world and could lead to a new ‘golden age’ for capitalism.

The changes are built on new attitudes and new technologies. New attitudes include regarding nature and the land as living resources that need respect. This would involve moving away from monocultures and deforestation and, with appropriate technologies (old and new), could lead to greater output, greater equality within agriculture and increased carbon absorption. The podcast gives examples from the developing and developed world of successful moves towards smaller-scale and more diversified agriculture that are much more sustainable. The rise in farmers’ markets provides an important mechanism to drive both demand and supply.

In the current model of capitalism there are many barriers to prevent the poor from benefiting from the system. As the podcast states, there are some 2 billion people across the world with no access to finance, 2.6 billion without access to sanitation, 1.2 billion without access to power – a set of barriers that stops capitalism from unlocking the skills and productivity of the many.

These problems were made worse by the response to the financial crisis of 2007–8, when governments chose to save the existing model of capitalism by propping up financial markets through quantitative easing, which massively inflated asset prices and aggravated the problem of inequality. They missed the opportunity of creating money to invest in alternative technologies and infrastructure.

New technology is the key to developing this new fairer, more sustainable model of capitalism. Such technologies could be developed (and are being in many cases) by co-operative, open-source methods. Many people, through these methods, could contribute to the development of products and their adaptation to meet different needs. The barriers of intellectual property rights are by-passed.

New technologies that allow easy rental or sharing of equipment (such as tractors) by poor farmers can transform lives and massively increase productivity. So too can the development of cryptocurrencies to allow access to finance for small farmers and businesses. This is particularly important in countries where access to traditional finance is restricted and/or where the currency is not stable with high inflation rates.

Blockchain technology can also help to drive second-hand markets by providing greater transparency and thereby cut waste. Manufacturers could take a stake in such markets through a process of certification or transfer.

A final hack is one that can directly tackle the problem of externalities – one of the greatest weaknesses of conventional capitalism. New technologies can support ways of rewarding people for reducing external costs, such as paying indigenous people for protecting the land or forests. Carbon markets have been developed in recent years. Perhaps the best example is the European Emissions Trading Scheme (EMS). But so far they have been developed in isolation. If the revenues generated could go directly to those involved in environmental protection, this would help further to internalise the externalities. The podcasts gives an example of a technology used in the Amazon to identify the environmental benefits of protecting rain forests that can then be used to allow reliable payments to the indigenous people though blockchain currencies.

Podcast

Questions

  1. What are the main reasons why capitalism has led to such great inequality?
  2. What do you understand by ‘hacking’ capitalism?
  3. How is open-source software relevant to the development of technology that can have broad benefits across society?
  4. Does the current model of capitalism encourage a self-centred approach to life?
  5. How might blockchain technology help in the development of a more inclusive and fairer form of capitalism?
  6. How might farmers’ co-operatives encourage rural development?
  7. What are the political obstacles to the developments considered in the podcast?
Posted on

Getting Richer: the benefits of employee ownership

Firms are increasingly having to take into account the interests of a wide range of stakeholders, such as consumers, workers, the local community and society in general (see the blog, Evolving Economics). However, with many firms, the key stakeholders that influence decisions are shareholders. And because many shareholders are footloose and not committed to any one company, their main interests are short-term profit and share value. This leads to under-investment and too little innovation. It has also led to excessive pay for senior executives, which for many years has grown substantially faster than the pay of their employees. Indeed, executive pay in the UK is now, per pound of turnover, the highest in the world.

So is there an alternative model of capitalism, which better serves the interests of a wider range of stakeholders? One model is that of employee ownership. Perhaps the most famous example of this is the John Lewis Partnership, which owns both the department stores and the Waitrose chain of supermarkets. As the partnership’s site claims, ‘when you’re part of it, you put your heart into it’. Although the John Lewis Partnership is the largest in the UK, there are over 330 employee-owned businesses across the UK, with over 200 000 employee owners contributing some £30bn per year to UK GDP. Again, to quote the John Lewis site:

Businesses range from manufacturers, to community health services, to insurance brokers. Together they deliver 4% of UK GDP annually, with this contribution growing. They are united by an ethos that puts people first, involving the workforce in key decision-making and realising the potential and commitment of their employees.

A recent example of a company moving, at least partly, in this direction is BT, which has announced that that every one of its 100 000 employees will get shares worth £500 every year. Employees will need to hold their shares for at least three years before they can sell them. The aim is to motivate staff and help the company achieve a turnaround from its recent lacklustre performance, which had resulted in its laying off 13 000 of its 100 000-strong workforce.

Another recent example of a company adopting employee ownership is Richer Sounds, the retail TV and hi-fi chain. Its owner and founder, Julian Richer, announced that he had transferred 60% of his shares into a John Lewis-style trust for the chain’s 531 employees. In addition to owning 60% of the company, employees will receive £1000 for every year they have worked for the retailer. A new advisory council, made up of current staff, will advise the management board, which is taking over the running of the firm from Richer.

According to the Employee Ownership Association (EOA), a further 50 businesses are preparing to follow suit and adopt forms of employee ownership. As The Conversation article linked below states:

As a form of stakeholder capitalism, the evidence shows that employee ownership boosts employee commitment and motivation, which leads to greater innovation and productivity.
 
Indeed, a study of employee ownership models in the US published in April found it narrowed gender and racial wealth gaps. Surveying 200 employees from 21 companies with employee ownership plans, Joseph Blasi and his colleagues at Rutgers University found employees had significantly more wealth than the average US worker.
 
The researchers also found that the participatory management practices that accompanied the employee ownership schemes led to employees improving their communication skills and learning management skills, which had helped them make better financial decisions at home.

But, although employee ownership brings benefits, not only to the employees themselves, but also more widely to society, there is no simple mechanism for achieving it when shareholders are unlikely to want to relinquish their shares. Employee buyout schemes require funding; and banks are often cautious about providing such funding. What is more, there needs to be an employee trust overseeing the running of the company which takes a long-term perspective and not just that of current employees, who might otherwise be tempted to sell the company to another seeking to take it over.

Articles

Report

Questions

  1. What are the main benefits of employee ownership?
  2. Are there any disadvantages of employee ownership and, if so, what are they?
  3. What are the main barriers to the adoption of employee ownership?
  4. What are the main recommendations from The Ownership Effect Inquiry? (See linked report above.)
  5. What are the findings of the responses to the employee share ownership questions in the US General Social Survey (GSS)? (See linked Global Banking & Finance Review article above.)
Posted on

Evolving capitalism: technology and the rise of the sharing economy

The articles below examine the rise of the sharing economy and how technology might allow it to develop. A sharing economy is where owners of property, equipment, vehicles, tools, etc. rent them out for periods of time, perhaps very short periods. The point about such a system is that the renter deals directly with the property owner – although sometimes initially through an agency. Airbnb and Uber are two examples.

So far the sharing economy has not developed very far. But the development of smart technology will soon make a whole range of short-term renting contracts possible. It will allow the contracts to be enforced without the need for administrators, lawyers, accountants, bankers or the police. Payments will be made electronically and automatically, and penalties, too, could be applied automatically for not abiding by the contract.

One development that will aid this process is a secure electronic way of keeping records and processing payments without the need for a central authority, such as a government, a bank or a company. It involves the use of ‘blockchains‘ (see also). The technology, used in Bitcoin, involves storing data widely across networks, which allows the data to be shared. The data are secure and access is via individuals having a ‘private key’ to parts of the database relevant to them. The database builds in blocks, where each block records a set of transactions. The blocks build over time and are linked to each other in a logical order (i.e. in ‘chains’) to allow tracking back to previous blocks.

Blockchain technology could help the sharing economy to grow substantially. It could significantly cut down the cost of sharing information about possible rental opportunities and demands, and allow minimal-cost secure transactions between owner and renter. As the IBM developerWorks article states:

Rather than use Uber, Airbnb or eBay to connect with other people, blockchain services allow individuals to connect, share, and transact directly, ushering in the real sharing economy. Blockchain is the platform that enables real peer-to-peer transactions and a true ‘sharing economy’.

Article

New technology may soon resurrect the sharing economy in a very radical form The Guardian, Ben Tarnoff (17/10/16)
Blockchain and the sharing economy 2.0 IBM developerWorks, Lawrence Lundy (12/5/16)
2016 is set to become the most interesting year yet in the life story of the sharing economy Nesta, Helen Goulden (Dec 2015)
Blockchain Explained Business Insider, Tina Wadhwa and Dan Bobkoff (16/10/16)
A parliament without a parliamentarian Interfluidity, Steve Randy Waldman (19/6/16)
Blockchain and open innovation: What does the future hold Tech City News, Jamie QIU (17/10/16)
Banks will not adopt blockchain fast Financial Times, Oliver Bussmann (14/10/16)
Blockchain-based IoT project does drone deliveries using Ethereum International Business Times, Ian Allison (14/10/16)

Questions

  1. What do you understand by the ‘sharing economy’?
  2. Give some current examples of the sharing economy? What other goods or services might be suitable for sharing if the technology allowed?
  3. How could blockchain technology be used to cut out the co-ordinating role carried out by companies such as Uber, eBay and Airbnb and make their respective services a pure sharing economy?
  4. Where could blockchain technology be used other than in the sharing economy?
  5. How can blockchain technology not only record property rights but also enforce them?
  6. What are the implications of blockchain technology for employment and unemployment? Explain.
  7. How might attitudes towards using the sharing economy develop over time and why?
  8. Referring to the first article above, what do you think of Toyota’s use of blockchain to punish people who fall behind on their car payments? Explain your thinking.
  9. Would the use of blockchain technology in the sharing economy make markets more competitive? Could it make them perfectly competitive? Explain.