Category: Economics: Ch 07

There has been a 38% increase in profit margins made by energy companies in the last 2 months and it is this which has prompted an investigation by Ofgem, the electricity and gas market regulator in the UK. Alistair Buchanan, Ofgem’s chief executive, said:

“With Britain facing an investment bill of £20bn over the next 10 years, consumers have the right to expect that the energy retail market is providing them with value for money. Our analysis published today shows an increase in company margins from £65 to £90 at a time of rising energy prices, which causes Ofgem to rightly ask if companies are playing it straight with consumers.”

Three of the big six suppliers have recently announced price rises and the fast-track review by Ofgem will consider whether consumers should be better protected. Scottish Power has increased gas prices by 2% and electricity prices by nearly 9%, meaning some customers may pay an extra £138 per year. British Gas is also planning on raising prices from December 10th, with gas and electricity bills expected to increase by 7%. Scottish and Southern Energy said it will increase domestic gas tariffs by 9.4%. EDF has promised a price freeze – at least until after the winter and nPower and E.ON are yet to announce their plans, but we can expect some form of a price rise.

While the review won’t make any difference to customer bills in the short term, Ofgem does have the power to make some changes to the way the companies are run. It is also expected that Ofgem will ask for more legislative support from the government and the Competition Commission. Although there are several suppliers in the energy market, each has market power and their dominance is preventing new firms from entering. As Adam Scorer, Director of Reputation and Impact at Consumer Focus, said:

“They do not feel the hot breath of competition on their necks.”

Articles

Energy firms facing gas and electricity price review BBC News (26/11/10)
Energy firms face new Ofgem enquiry over price rises and increased profits Telegraph, Andrew Hough (26/11/10)
Ofgem promises review as energy firms boost profit margins 38% Guardian, Jill Treanor (26/11/10)
Fuel bills: turning up the heat Guardian (27/11/10)
Energy firms face profit rise probe The Press Association (26/11/10)
Scepticism greets energy price probe Financial Times, David Blair (26/11/10)
UK utilities face review after recent price hikes Reuters (26/11/10)
UK to review retail energy market after price rises Bloomberg, Business Week, Kari Lundgren (26/11/10)
Has the toothless energy regulator learnt how to bite? Independent on Sunday, Julian Knight (28/11/10)
How to beat the energy price rise Telegraph (20/11/10)
Ofgem must mean business this time Herald (27/11/10)

Ofgem Press Release
Ofgem to review the effectiveness of the retail energy market to see if further action is needed to protect consumers Ofgem (26/11/10)

Questions

  1. What type of market structure is the UK energy market?
  2. The BBC News article talks about barriers preventing new competitors from entering the market. What types of barriers exist in this sector?
  3. What is a profit margin?
  4. What is likely to be the impact on family income following such price rises? Illustrate this on a diagram.
  5. Britain faces a £200 billion bill to invest in updating the energy network. What sort of updates are being referred to?
  6. What power do regulators such as Ofgem actually have? Why won’t they be able to change the amount that consumers pay?

Last week, I posted an article about a price discriminating tactic in operation by a few firms, whereby they were charging different prices to different consumers, depending on whether or not people could speak the language. (See Entrance this way!). Following this, I had a look around to find some other pricing strategies in practice by firms. These ranged from simple price discrimination to a well-known supermarket, which, following the failure of its till system, decided to trust consumers: estimate the value of the goods in your trolley/basket, deduct 20% and that’s the amount you pay. Also, a strategy being adopted by a number of restaurants – ‘pay what you think it’s worth!’ An advertising gimmick that increased sales.

So, what’s the best pricing strategy for a firm to adopt and which factors affect this? Is it really a rational decision to offer meals, with the possibility that the guests may only be prepared to pay 1p?!

You decide how much meals are worth, restaurants tell customers Telegraph, Nina Goswami (12/06/05)
Panera café says pay what you want Associated Press, Food Inc, Christopher Leonard (18/5/10)
Pound shop forced to close after 99p store opens across the road Daily Mail Online (12/1/09)
Low cost? Not with these extras Times Online, Richard Green (17/8/08)
Cheap hotels: budget accommodation for visits to London Telegraph (25/10/10)
Budget customers call the hotel Tune BBC News, Susannah Streeter (30/8/10)

Questions

  1. Is it a rational decision to trust consumers and ask them to estimate the value of what’s in their trolleys?
  2. Why would a restaurant offer consumers the chance to pay ‘what you think it’s worth’? Under what circumstances would this incrrease the firm’s revenue?
  3. What are the key factors that determine the price a firm will charge for its product?
  4. How can we use the case in Poole, with the new 99p shop, to analyse the model of perfect competition?
  5. What pricing tactic is being used by the 99p shop? How could we argue that this is an example of tacit collusion?

You might think that small environmentally-friendly companies would be moving into the green energy market: that setting up a wind farm, for example, would be a perfect business opportunity for a small company. In fact, the big companies are taking over this market. As the Der Spiegel article below states:

Europe’s wind energy sector is currently experiencing a major transformation. New massive offshore wind parks are soon expected to crop up off Europe’s coastline. Big companies like Siemens and General Electrics are increasing their stakes in a market worth billions. But experts warn that a new energy oligopoly may soon emerge.

So what is it about the wind energy market that makes it suitable for an oligopoly to develop? The two articles explore this question.

Winds of Change Der Spiegel, Nils-Viktor Sorge (1/11/10)
GE and Siemens Outpacing Wind Pioneers, Becoming Clean Energy’s “New Oligopoly” Fast Company, David Zax (2/11/10)

Questions

  1. What market failures are there in the wind energy market?
  2. What barriers to entry are there in the wind energy market?
  3. What economies of scale are there in this market?
  4. How are changes in this market affecting the minimum efficient scale of companies?
  5. Would there be room in the market for enough competitors to prevent collusion?
  6. How might the authorities prevent (a) open and (b) tacit collusion in the wind energy market?
  7. Do small wind energy companies have any market advantages?

Blockbuster US has become the latest in a long line of companies filing for bankruptcy. With huge debts and a need to restructure the business, given the huge competition in America, Blockbuster has made agreements with its creditors to cut its debts from $1 billion to $100 million. Blockbuster has suffered from mail-order and online film rental services, in particular in America.

Blockbuster is a worldwide phenomenon with stores ranging from the UK to Mexico. However, as legally separate entities, the non-US branches of Blockbuster are protected from the bankruptcy. While the UK branches will remain unaffected, there are concerns that they may suffer from a lack of new DVD stock, especially with the approach of Christmas.

As news of Blockbuster’s bankruptcy spread, Netflix – a key competitor – saw its shares soar. Netflix was a catalyst in the demise of Blockbuster US and it has seen its market share increase rapidly over the past few years, with subscribers increasing from 1 million in 2002 to 15 million in 2010. Blockbuster responded by ending late fees and started its own online services, but it has been unable to compete effectively in this competitive market. Although restructuring of Blockbuster has begun, only time will tell what the future is for this once dominant movie rental firm.

Blockbuster files for Bankruptcy in US BBC News (23/9/10)
Blockbuster fizzles in US, but renters overseas haven’t switched to Netflix – yet The Christian Science Monitor, Stephen Kurczy (23/9/10)
Blockbuster files for Chapter 11 protection Guardian, Richard Wachman (23/9/10)
Blockbuster wins Court’s approval to draw $20 million from bankruptcy loan Bloomberg, David McLaughlin and Tiffany Kary (23/9/10)
Fitch lowers debt rating on Blockbuster Bloomberg BusinessWeek (23/9/10)
Netflix shares hit high after Blockbuster bankruptcy Reuters, Sue Zeidler (23/9/10)
Debt, changing media habits topple Blockbuster The Associated Press, Mae Anderson (23/9/10)

Questions

  1. What are the key factors behind Blockbuster’s decline?
  2. New competitors have entered the market for movie rental. Illustrate this on a diagram. How can we use this to explain Blockbuster’s problems?
  3. Online services and mail-order have become increasingly popular services in this market. Is the extra competition in the market in the best interests of consumers?
  4. What type of market structure is the rental movie industry? Explain your answer.
  5. What type of legal structure does Blockbuster operate under? What are the key advantages and disadvantages of this?
  6. Why are the non-US chains not affected by the bankruptcy of Blockbuster US?
  7. Have a look at the share prices of Blockbuster and Netflix. What has happened to them over rthe past year? Is this consistent with recent developments?

There has been talk for some time about the possibility of standing room on flights, but it is hardly surprising that this has been rejected by the Civil Aviation Authority. Not the safest option, you might say, nor the comfiest – certainly not for a long haul flight to the other side of the world! However, this could be coming closer to reality, as we see The Skyrider, which is a new saddle-style airplane designed by Avioninteriors. It has yet to be snapped up, but Ryanair could be top of the list with their plans for a new style of flying.

It may not be quite what you imagine – you don’t literally stand up in the stalls at the front of the aircraft. Passengers will have seats, but these seats give a completely new meaning to ‘upright seats’. Seats would be 23 inches apart (some 10 inches closer than we’re used to), but they would only be available for flights up to 3 hours. Despite the publicity, the design is yet to be approved. Ryanair believe that such a design would increase passenger capacity by some 40%. However, passengers remain rather skeptical, as many struggled to fit in to the seats when it was unveiled in New York.

Technological development is vital in any dynamic industry, but is this one step too far? One day, it could be a game of sardines when packing passengers into a plane!

New airline seat for Ryanair resembles a saddle Irish Central, Molly Muldoon (18/9/10)
New plane ‘saddle’ would pack in passengers Edmonton Journal (19/9/10)
Ryanair one step closer to fulfilling dream of getting more people on each plane Travel News, Natalie Cooper (16/9/10)
Budget airlines love bad new stories about how cramped their planes are Telegraph, Harry Mount (15/9/10)
Behold! The world’s most cramped airline seat Reuters, Charlie Sorrel (13/9/10)

Questions

  1. Is it a rational decision for a passenger to travel in a new upright seat?
  2. Is it a cost-effective strategy for Ryanair or any other airline to adopt? Explain (a) why it is, but also explain (b) why it may not be cost-effective.
  3. Using a diagram, illustrate the opportunity cost to an airline of providing more upright seats.
  4. If successive airlines adopt the new saddle style seats, what is likely to happen to the price of such seats?
  5. As passengers become aware of these cheaper seats, what is likely to happen to the market price? Illustrate this on a diagram.
  6. If Ryanair were the only airline to offer such seats, does this mean it would have a monopoly? Explain your answer.