Category: Essential Economics for Business: Ch 02

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His Master’s Voice is fading

Comet, Peacocks, Woolworths, JJB, Jessops and now HMV – they all have one thing in common. The recession has hit them so hard that they entered administration. HMV is the latest high street retailer to bring in the administrators, despite insisting that it does have a future on the UK’s high streets. With debts of £176m and huge competition from online retailers, the future of HMV is very uncertain.

Over the past decades, companies such as Amazon, ebay, LoveFilm, Netflix and apple have emerged providing very stiff competition to the last remaining high street seller of music and DVDs. People have been turning more and more to the internet to do their shopping, with cheaper prices and greater choice. The speed of delivery, which in the past may have been a disadvantage of buying from somewhere like Amazon, is now barely an obstacle and these substitute companies have created a difficult environment for high street retailers to compete in. Despite going into administration, it’s not necessarily the end of the much-loved HMV. Its Chief Executive said:

We remain convinced we can find a successful business outcomes. We want to make sure it remains on the high street … We know our customers fell the same way.

While the recession has undoubtedly affected sales at HMV, is this the main reason for its demise or are other factors more relevant? As discussed, online retailers have taken over the DVD and music industry and with downloading increasing in popularity and CD/DVDs on sale in numerous locations, including supermarket chains, HMV has felt the competitive pressure and its place on the high street has come into question. As Neil Saunders, the Managing Director of Conlumino said:

By our own figures, we forecast that by the end of 2015 some 90.4 per cent of music and film sales will be online. The bottom line is that there is no real future for physical retail in the music sector.

Further to this, prices have been forced downwards and HMV, having to pay high fixed costs to retain their place on the high streets, have been unable to compete and remain profitable. Another contributing factor could be an outdated management structure, which has not responded to the changing times. Whatever the cause, thousands of jobs have been put at risk. Even if buyers are found, some store closures by the administrators, Deloitte, seem inevitable. Customer gift vouchers have already become worthless and further losses to both workers and customers seem likely. It is thought that there will be many interested buyers and huge support from suppliers, but the former is likely to remain a relatively secretive area for some time.

This latest high street disaster will undoubtedly raise many questions. One theory about recovery from a recession looks at the need for many businesses to go under until the fittest are left and there is sufficient scope for new businesses to emerge.

Could it be that the collapse of companies such as Woolworths, HMV, Comet, Jessops and Blockbuster is an essential requirement for economic recovery? Or was the recession irrelevant for HMV? Was its collapse an inevitable consequence of the changing face of Britain’s high streets and if so, what does the future hold for the high street retailers? The following articles consider the demise of HMV.

HMV: a visual history BBC News (15/1/13)
Chief executive says ‘HMV still has a place on the high street’, as customers are told their gift vouchers are worthless Independent, James Thompson (15/1/13)
Potential buyers circle stricken HMV Financial Times, Andrea Felsted (15/1/13)
HMV and independents to urged to work together to save in-store music market BBC News, Clive Lindsay (15/1/13)
HMV record chain was besest by digital downloads and cheap DVDs The Guardian (15/1/13)
The death of traditional retailers like HMV started when we caught on to one-click and the joy of owning DVDs wore thin Independent, Grace Dent (15/1/13)
HMV shoppers: ‘I’m disappointed, but it’s understandable why they went bust The Guardian, James Brilliant (15/1/13)
HMV: Record labels could take HMV back to its 1920 roots The Telegraph, Graham Ruddick (15/1/13)
HMV’s future seen as handful of stores and website Reuters, Neil Maidment and James Davey (15/1/13)
HMV leaves social gap in high street BBC News, Robert Plummer (15/1/13)
Is there good news in HMV’s collapse? BBC News, Robert Peston (15/1/13)
Is it game over for UK retail? The Guardian, Larry Elliott (18/1/13)
High Street retailers: Who has been hit hardest? BBC News (16/1/13)

Questions

  1. What are the main reasons behind the collapse of HMV?
  2. Use a diagram to illustrate the impact the companies such as Amazon and Tesco have had on costs and prices in the entertainment industry.
  3. Has the value we place on owning DVDs truly changed or have other factors led to larger purchases of online entertainment?
  4. Why is online retail providing such steep competition to high street retailers?
  5. Explain why it can be argued that economic recovery will only take place after a certain number of businesses have gone into administration.
  6. To what extent do you think HMV’s collapse is due to its failure to adapt to changing social circumstances?
  7. Briefly outline the wider economic implications of the collapse of a company such as HMV. Think about managers, employees, suppliers, customers and other competitors, as well as other high street retailers.
  8. In which market structure would you place the entertainment industry? Explain your answer. Has this contributed to the demise of HMV?
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The end of bargain booze?

Ministers are considering introducing a minimum price of 45p per unit of alcohol on all drinks sold in England and Wales. The Scottish government has already passed legislation for a minimum price of 50p per unit in Scotland. This, however, is being challenged in the Scottish courts and is being examined by the European Commission.

As we saw in a previous blog, Alcohol minimum price, the aim is to prevent the sale of really cheap drinks in supermarkets and other outlets. Sometimes supermarkets sell alcoholic drinks at less than average cost as a ‘loss leader’ in order to encourage people to shop there. Two-litre bottles of strong cider can be sold for as little as £2. Sometimes they offer multibuys which are heavily discounted. The idea of minimum pricing is to stop these practices without affecting ‘normal’ prices.

The effect of a 45p minimum price per unit would give the following typical minimum prices (depending on strength):

Strength Size Minimum price
Wine 12.5% 750ml £4.22
Beer/lager (normal) 4.5% pint (568ml) £1.15
Beer/lager (strong) 7.5% pint (568ml) £1.92
Beer/lager (normal) 4.5% 2 litres £4.05
Beer/lager (strong) 7.5% 2 litres £6.75
Cider (normal) 5% pint (568ml) £1.28
Cider (strong) 8% pint (568ml) £2.04
Cider (normal) 5% 2 litres £4.50
Cider (strong) 8% 2 litres £7.20
Whisky 40% 700ml £12.60
Vodka 37.5% 700ml £11.81

The hope is that by preventing the sale of really cheap drinks in supermarkets, people will no longer be encouraged to ‘pre-load’ so that when they go out for the evening they are already drunk.

But how successful will such a policy be in cutting down drunkenness and the associated anti-social behaviour in many towns and cities, especially on Friday and Saturday nights? The following articles discuss the issue and look at some of the evidence on price elasticity of demand.

Articles
Alcohol minimum price plan to be unveiled BBC News, Dominic Hughes (28/11/12)
Multi-buy alcohol deals face ban under minimum price plans The Telegraph, James Kirkup (28/11/12)
Alcohol at 40p, 45p or 50p a unit to be Cameron choices for minimum price The Guardian, Juliette Jowit (25/11/12)
Minimum price plan to end cheap alcohol sales BBC News, Nick Triggle (28/11/12)
Minimum pricing having a difficult birth in Scotland BBC News, James Cook (28/11/12)
Cameron to set minimum price for alcohol Independent, Brian Brady (25/11/12)
Minimum Alcohol Price: Doubts Measures Will Cut Binge Drinking Huffington Post (25/11/12)
An industry divided: Pubs set against brewers and retailers in battle for cheap booze This is Money, Rupert Steiner (26/11/12)
A minimum price per unit of alcohol BMC Public Health, Adam J Lonsdale, Sarah J Hardcastle and Martin S Hagger (23/11/12)

Home Office alcohol policy
Alcohol strategy (23/3/12)

Questions

  1. Draw a diagram to illustrate the effect of a minimum price per unit of alcohol on (a) cheap cider; (b) good quality wine.
  2. How is the price elasticity of demand for alcoholic drinks relevant to determining the success of minimum pricing?
  3. Compare the effects of imposing a minimum unit price of alcohol with raising the duty on alcoholic drinks? What are the revenue implications of the two policies for the government?
  4. What externalities are involved in the consumption of alcohol? How could a socially efficient price for alcohol be determined?
  5. Is imposing a minimum price for alcohol fair? How will it effect the distribution of income?
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A 3p delay?

Increases in the cost of living over the past few years have put many families under financial pressure. One of the main factors that has been hurting households is the price of petrol and diesel. Road fuel duty was due to be increased last August, but the Chancellor delayed it in June. However, a planned 3p rise in duty by the Coalition, which has faced rebellion from numerous MPs may now be delayed further, following a hint from the Treasury.

The government has said that it will do everything it can to support struggling families with the cost of living and this has led many to conclude that in the Autumn Statement, the Chancellor will delay the planned 3p rise. Labour was defeated in its efforts to force a delay of the proposed 3p duty rise, as Tory bankbenchers were given this hint that the Treasury would decide to delay the increase anyway. The Economic Secretary to the Treasury said that fuel duty is part of the government’s strategy to help cut the cost of living. He commented that fuel duty was 20% lower in real terms compared to March 2000, when it was at its peak.

If we had continued with the policies of the previous government, quite simply prices would be higher, fuel would be 10p more expensive per litre. I know some will call for a further freeze in fuel duty today. I can assure them this government understands the financial pressures hard-working families are facing. Subject to the constraints of the public finances, this government is determined to help families with the cost of living.

A key economic question to consider is why is fuel one of the products that is frequently taxed? When a tax is imposed on a product, its price will rise and as the law of demand tells us, this will cause people to purchase less of it. But, what is so special about petrol? Why do people continue to purchase petrol even when its price rises? The following articles consider the concerns surrounding the 3p fuel duty rise.

Treasury to defer planned increase in fuel duty The Guardian, Nicholas Watt (13/11/12)
Asda chief Andy Clarke urges scrapping fuel duty rise BBC News (15/11/12)
Fuel Duty: Labour to force vote to delay 3p rise The Guardian, Helene Mulholland (12/11/12)
Fuel duty delay called for by Which? BBC News (11/11/12)
Fuel Duty: Government may still axe increase Sky News (13/11/12)
Chancellor heads off fuel duty rebellion Financial Times, George Parker (12/11/12)
Osborne pressed to shelve fuel duty rise Financial Times, George Parker (8/11/12)
Planned 3p petrol increase could be abandonedThe Telegraph, Christopher Hope (11/11/12)

Questions

  1. Why is petrol a good that is taxed so heavily?
  2. Illustrate the impact of a tax on petrol using a demand and supply diagram. Explain what happens to the equilibrium price and quantity.
  3. Which factors will make the change in price and quantity relatively larger or smaller? Think about how elasticity is relevant here.
  4. What other factors have contributed towards the increased cost of living over the past few years?
  5. Which factors in particular would make a January rise in fuel duty especially painful for many families?
  6. What are the arguments both for and against delaying the 3p rise in duty?
  7. According to the Economic Secretary to the Treasury, fuel duty is 20% lower in real terms. What does this actually mean?
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Taxing fatty products

The problem of obesity and healthy eating is a growing problem in many countries and governments have long been looking into designing policy to tackle this issue.

Some have gone for healthy eating campaigns and policies to encourage pregnant women to eat better, but one government took it a step further and introduced a Fat Tax. In October 2011, the Danish government introduced a tax on foods that are high in saturated fat in a bid to reduce consumption of these goods. However, this policy is now to be abolished.

The Fat Tax introduced by the government imposed a surcharge on foods that contained more than 2.3% saturated fat. Numerous products were affected, including meats, dairy and as expected – processed foods. The policy was criticised by scientists who said that saturated fat was the wrong target and perhaps they were proved right, but the government’s u-turn, which will now see the tax being abolished. The tax had gradually increased food prices throughout the country and authorities said that it had even put Danish jobs at risk.

With food prices much higher in Denmark with the tax, consumers switched from buying domestically produced goods to crossing the border into Germany and purchasing their cheaper food. This undoubtedly had an adverse effect on the Danish economy, as it represented a cut in consumer expenditure. Perhaps it also helps to explain Germany’s strong economy – it was feeding 2 nations! The Danish tax ministry said:

‘The fat tax and the extension of the chocolate tax — the so-called sugar tax — has been criticised for increasing prices for consumers, increasing companies’ administrative costs and putting Danish jobs at risk … At the same time it is believed that the fat tax has, to a lesser extent, contributed to Danes travelling across the border to make purchases … Against this background, the government and the (far-left) Red Green Party have agreed to abolish the fat tax and cancel the planned sugar tax’

Once the tax is abolished, other policies will need implementing to tackle the problem of obesity and encourage healthy eating, as it continues to be a big problem in this and many other countries. The following articles consider this problem.

Denmark to scrap world’s first fat tax Associated Press (10/11/12)
Denmark to abolish tax on high-fat foods BBC News (10/11/12)
Fat tax repealed The Copenhagen Post (10/11/12)
Businesses call fat tax a failure on all fronts The Copenhagen Post, Ray Weaver (10/11/12)

Questions

  1. Illustrate the effect of a tax being imposed on a diagram. What happens to equilibrium price and quantity?
  2. According to Danish authorities, consumers didn’t change their consumption habits with the tax. What does this suggest about the PED of these products?
  3. How does the amount of tax revenue generated vary with the price elasticity of demand and supply?
  4. What other policies could be implemented to encourage healthy eating?
  5. Why did this fat tax lead to higher food prices?
  6. Explain the way in which such a tax could adversely affect the Danish economy. Does this justify its removal?
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Comet fall from the sky

For those looking to buy larger electrical appliances at cheaper prices, things might be looking up, as Comet have begun heavy discounting after entering administration. Deloitte, as the administrator, will now begin the search for a buyer for this retailer, while Comet aims to raise the funds to rescue the company.

Comet was bought by OpCapita last year, but with poor performance continuing across the 200+ stores, we could be about to see the demise of this retailer. Over 6,000 jobs are now at risk, although Deloitte has maintained that stores will continue to trade and that redundancies will not be made. One of the administrators said:

‘Our immediate priorities are to stabilise the business, fully assess its financial position, and begin an urgent process to seek a suitable buyer which would also preserve jobs.’

The retail environment has inevitably suffered over the past few years, with well-known companies such as Woolworths, Optical Express and JJB Sports (to name a few) entering administration. Comet, therefore seems to be the latest in a long line of sad trading stories. So, which factors have contributed towards the collapse of this giant retailer?

Over the past few years, online retailers have gained a larger and larger market share. These internet retailers do not have the same overhead costs that Comet and other high street retailers face. To open a store in an area where customers are in high supply, premium rents must be paid and this adds to the cost of running any given store. In order to cover these higher costs, higher prices can result and this, together with consumers facing tight budgets, has led many customers to look at the cheaper alternatives online. Deloitte has also said that Comet has been suffering from a lack of credit, which has meant that it has not been able to purchase stock in the run-up to Christmas. Deloitte commented that:

‘The inability to obtain supplier credit for the peak Christmas trading period means that the company had no realistic prospect of raising further capital to build up sufficient stock to allow it to continue trading.’

Concerned customers are naturally emerging, wondering whether items they have ordered and paid for will actually turn up. However, Deloitte’s reassurance that trading will continue may go some way to relieving their concern. The following articles consider how Comet has fallen from the sky.

Comet officially enters administration, stores re-open for expected firesale The Telegraph, Graham Ruddick and Helia Ebrahimi (2/11/12)
Comet calls in Deloitte as administrators BBC News (2/11/12)
Apple sky-high as Comet falls to earth The Guardian, Zoe Wood (2/11/12)
Comet enters administration, Deloitte seeks buyer Reuters (2/11/12)
Comet electricals administrators formally begin search for saviour The Guardian, Zoe Wood (2/11/12)
Comet goes into administration Financial Times, Andrea Felsted (3/11/12)
Comet collapse: Deloitte blames internet and lack of first-time home buyers The Telegraph(2/11/12)
Collapse of Comet puts 7000 jobs in danger Independent, James Thompson (2/11/12)

Questions

  1. Why does the retail environment remain very weak?
  2. Explain why Deloitte suggest that a lack of first time home buyers has played a part in the demise of Comet.
  3. Why has a lack of credit contributed towards Comet’s downfall?
  4. Should customers be concerned about how Comet’s demise (if indeed a buyer is not found) might affect prices in other retailers such as Currys, given that they will now have a larger share of the market?
  5. Why has online trading contributed towards the harsher retail environment for the high street stores? You should think about fixed and variable costs in your answer.
  6. Why are companies such as Apple doing so well relative to other companies, such as Comet and JJB Sports? Is there a secret to their success?
  7. What impact might this collapse have on local labour markets, given Comet employs so many people? Think about the effect on wages, unemployment and on claimants of benefits.