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
- Why does the retail environment remain very weak?
- Explain why Deloitte suggest that a lack of first time home buyers has played a part in the demise of Comet.
- Why has a lack of credit contributed towards Comet’s downfall?
- 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?
- 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.
- 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?
- 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.
Two of the biggest publishing companies, Pearson of the UK and Bertelsmann of Germany are to form a joint venture by merging their Penguin and Random House imprints. Bertelsmann will have a majority stake in the venture of 53% and Pearson will have 47%.
The Penguin imprint, with a turnover of just over £1bn, has an 11% share of the English language book publishing market. Random House has a 15% share, with turnover of around £1.5bn. The new ‘Penguin Random House’, as it will be called, will have nearly 26% of the market, which should give it considerable market power to combat various threats in the book publishing market.
One threat is from online retailers, such as Amazon, Apple and Google, which use their countervailing power to drive down the prices they pay to publishers. Another threat is from the rise of electronic versions of books. Although e-books save on printing costs, competition is driving down prices, including the prices of paper books, which may make publishers more reluctant to publish new titles in paper form.
There has been a mixed reception from authors: some are worried that an effective reduction in the number of major publishers from six to five will make it harder to get books published and may squeeze royalty rates; others feel that an increased market power of publishers to take on the online retailers will help to protect the interests of authors
The following videos and articles look at the nature of this joint venture and its implications for costs, revenues and publishing more generally.
Videos and webcasts
Penguin and Random House merge to take on digital giants Channel 4 News, Matthew Cain (29/10/12)
Penguin and Random House confident merger will be approved BBC News, Will Gompertz (29/10/12)
Penguin Books and Random House to merge BBC News, Matt Cowan (29/10/12)
Articles
Random House and Penguin merge to take on Amazon, Apple Reuters, Kate Holton (29/10/12)
Pearson’s Penguin joins Random House Independent, Amy Thomson and Joseph de Weck (29/10/12)
Penguin and Random House sign merger deal Financial Times, Gerrit Wiesmann and Robert Budden (29/10/12)
March of the Penguin The Economist, Schumpeter blog (29/10/12)
Penguin chief: News Corp can’t derail Random House deal The Guardian, Mark Sweney (29/10/12)
Penguin and Random House confident merger will be approved BBC News, Anthony Reuben (29/10/12)
And so I bid Penguin a sad farewell Independent, Andrew Franklin (29/10/12)
Questions
- How does a joint venture differ from a merger?
- What types of economies of scale are likely to result from the joint venture?
- How are authors likely to be affected?
- Will the joint venture benefit the book reading public?
- The relationship between publishers and online retailers can be described as one of ‘bilateral oligopoly’. Explain what this means and why it is impossible to determine an ‘equilibrium’ wholesale price of books in such a market.
- What criteria would the competition authorities use to assess whether or not the joint venture should be permitted to proceed?
- What is likely to be the long-term outlook for Penguin Random House?
- Assess the benefits and costs of a News Corporation takeover of the Penguin division? This was an alternative offer to Pearson had it not gone with Bertelsmann. (News Corp. has the Harper Collins imprint.)
Most real-world markets are a long way from the perfect information setting assumed in perfectly competitive markets. Many industries therefore rely heavily on word of mouth to increase demand. This is especially true in the digital age where information can spread extremely rapidly and many websites encourage consumer ratings and reviews. Here, information becomes more and more valuable as it is shared with other people.
However, the economist Joshua Gans has suggested that traditional business models are not well suited to fully exploiting the benefits of the sharing of information. This is because, whilst enthusiastic consumers spread the word, the seller has traditionally acted as a gate-keeper, maintaining complete control over who obtains the product. The problem is that this creates a friction which can dampen momentum for the product from building.
In contrast, Gans describes a novel alternative strategy that was used by the band the XX when they released their second album earlier this year. As is becoming more and more common, the band premiered the album as an online stream. However, what was unique about the XX’s approach was that they gave the stream to a single superfan. They hoped that this chosen fan would initiate the spreading of the stream amongst other fans. After a worrying delay in which he enjoyed his monopoly ownership, this is what he eventually did. Just 24 hours later the stream had been player millions of times and the site crashed under the burden.
Of course, one reason why suppliers may need close control is to be able to charge for the product. If the sharing information must involve giving something away for free, it typically makes no commercial sense. However, Gans also points out that recommendations are more credible if the information has been costly to obtain. Otherwise, it may simply be cheap talk and therefore carry little value.
The balancing act for suppliers is therefore to introduce a hurdle cost in obtaining the information whilst trying to ensure that, once it has been passed on, the recipient encounters as little friction as possible in making use of it. Gans suggests that alternative business models can be developed which achieve this balance. If these can profitably encourage the sharing of information a win-win situation for sellers and buyers is created.
Furthermore, Gans is experimenting with selling his new book about sharing information under an example of one such model. Having bought the e-book for $4.99 you will find a coupon at the back which you can pass on to a friend or family member which allows them to buy their own copy of the book for a mere $0.99. However, as he points out, there is a potential danger to this strategy:
“All my readers could form a collective and potentially buy one copy for $4.99 and then a million for $0.99.”
He has said that he plans to be report back on how the book has sold on his blog at a later date, so it will be interesting to see whether or not the experiment was successful.
The folly of replicating the physical world HBR Blog Network, Joshua Gans (17/11/10)
A shared pricing experiment for my book Digitopoly, Joshua Gans (05/10/12)
Information wants to be…..shared O’Reilly Tools of Change for Publishing, Joe Wikert (16/10/12)
Questions
- Why will the problems described above not arise in the model of perfect competition?
- What type of industries are most likely to rely on word of mouth?
- In what type of industries is the friction described above most likely to happen?
- Describe the dangers with the strategy Gans is adopting for selling his book?
- Explain whether you think these dangers are likely to arise in practice.
- How might the business model be modified to avoid these dangers?
The energy sector has a history of criticism with regards to prices and practices. In the past, Ofgem have tried to make the sector more competitive, by ensuring that price comparisons are easier. At the beginning of this year, many of the big six providers announced price cuts, but within the next few weeks, we will see the reverse occurring, as energy prices begin to rise.
British Gas has announced price rises of 6% from 16th November that will affect over 8 million customers by adding approximately £80 per year to the annual dual fuel bill. Npower will also put its prices up 10 days later (8.8% for gas and 9.1% for electricity), creating higher bills for 3 million people.
In January of this year, when we saw energy prices fall, it was not solely due to Ofgem’s findings. We had a relatively mild winter, which reduced the demand for energy and this fed into lower prices. As the winter now approaches once more, demand for energy will begin to increase, feeding into prices that are now higher.
Furthermore, the energy companies have said that a range of external factors are also adding to their costs and putting increasing pressure on them to increase their charges. Npower’s Chief Commercial Officer said:
“There is never a good time to increase energy bills, particularly when so many people are working hard to make ends meet…But the costs of new statutory schemes, increases in distribution charges and the price of gas for the coming winter are all being driven up by external factors, for example government policy”
Significant investment is needed in the energy sector. Energy companies are required to set aside money for maintaining and improving the national grid and investing in renewable energy, such as wind and solar power. In order for the energy companies to fund these investments, more money must be raised and the logical method is to put up prices. However, critics are simply blaming ‘these very big lazy companies’ who are passing ‘above-inflation price rises’ onto already squeezed households.
Part of this is undoubtedly to do with the market structure of this sector. A typical oligopoly creates a market which, under certain circumstances, can be highly competitive, but because of barriers to entry that prevent new firms from entering the market may charge higher prices and be inefficient. Indeed, Ofgem has plans to reduce the power of the main energy providers by forcing them to auction off some of the electricity they generate. The aim of this is to free up the market and make it more competitive.
While only three providers have announced price rises, it is inevitable that the other three will follow. The relative increases will create incentives for consumers to switch providers, but crucial to this is an ability to understand the different tariffs on offer and lack of clarity on this has been a big criticism previously levelled at the energy sector. Indeed, half of UK customers have never switched energy providers. Perhaps this is the time to think about it, firstly as a means of saving money and secondly as a means of putting the energy companies in competition with each other. The following articles consider this market.
Energy price rises: how to switch, save and safeguard your supply The Guardian, Mark King (12/10/12)
Npower and British Gas raise energy prices (including video) BBC News (12/10/12)
Energy price rises? We’re like turkeys voting for Christmas The Telegraph, Rosie Murray-West (12/10/12)
British Gas and Npower to raise prices fuelling fears of a ‘long, cold winter’ for more households Independent
, Graeme Evans (12/10/12)Wholesale prices rise as energy costs jump Wall Street Journal, Sarah Portlock and Jeffrey Sparshott (12/10/12)
British Gas raises gas and electricity prices by 6pc The Telegraph (12/10/12)
Osborne warns energy firms over price hikes Reuters (12/10/12)
Energy price hikes to take effect from next week Independent, Simon Read(13/10/12)
Questions
- What are the main reasons influencing the recent price rises? In each case, explain whether it is a demand- or supply-side factor.
- Using your answer from question 1, illustrate the effect of it on a demand and supply diagram.
- Which features of an oligopolistic market are relevant to the energy sector. How can we use them to explain these higher prices.
- How has government policy affected the energy sector and energy prices?
- Why are customers reluctant to change energy providers? Does this further the energy company’s ability to raise prices?
- Are there any government policies that could be implemented to reduce the power of the energy companies?
Virgin’s franchise to run the West Coast Main Line from London to Birmingham, Manchester, Liverpool, Glasgow and Edinburgh was due to expire in December. The Department of Transport thus invited tenders to run a new 13-year franchise, worth around £5 billion, and on 15 August announced that the franchise had been awarded to FirstGroup. It had bid substantially more than Virgin.
Virgin immediately challenged the decision, arguing that FirstGroup’s figures were flawed. According to the second BBC article below:
It argued that FirstGroup’s revenue projections were wildly optimistic – that passenger growth of 6% a year was unlikely given that Virgin had seen growth of 5% a year from a much lower base. This level of passenger growth would have seen FirstGroup’s revenue from the franchise grow by more than 10% a year, which was simply unrealistic, Virgin argued.
And it is not alone. “Everybody in the industry thought that this bid was not sustainable and that the risks had not been taken into account by the Department for Transport,” says rail industry expert Christian Wolmar.
If revenue targets are not met, the franchisee doesn’t have the money to pay the government the promised fee for the contract, which in FirstGroup’s case was back-loaded towards the end of the 13-year term.
After making its decision, the Transport Secretary at the time, Justine Greening, said that the process of assessing the bid was robust and fair and conducted with due diligence. Sir Richard Branson of Virgin strongly and publicly disagreed and Virgin decided to take the Department of Transport to court. The court case was scheduled to begin on 4 October.
However, in preparing its case to put to the court, the Department of Transport uncovered significant errors in the evaluation of the bids. These errors involved the overestimation of passenger numbers, the undervaluation of risk and a failure to take inflation into account. The errors stemmed from inputting the data incorrectly.
The errors were so serious that the new Transport Secretary, Patrick McLoughlin, on the day before the court case was due to begin, announced that he was scrapping the contract to FirstGroup and would invite new bids. All four of the original bidders would have their costs refunded, amounting to some £40 million.
The minister also announced that he was setting up two reviews. One would seek to establish just what went wrong in the assessment of the West Coat Main Line bids and what lessons could be learned. This is due to report at the end of October. The other review would examine the wider rail franchise programme and how bids are appraised. In the meantime, three other franchise competitions had been ‘paused’ pending the results of this second review, due to report in December.
The articles look at the problems of assessing bids and properly taking into account risks associated with both revenue and cost projections. Not surprisingly, they also look at the politics of this amazing and unprecedented U-turn
Webcasts and podcasts
West Coast Main Line rail franchise deal scrapped BBC News, Richard Westcott (3/10/12)
West coast rail franchise deal scrapped Channel 4 News, Krishnan Guru-Murthy (3/10/12)
‘Major problem’ for West Coast Main Line BBC Today Programme, Louise Ellman (3/10/12)
Philip Hammond on West Coast Main Line contract BBC News, Andrew Neil (7/10/12)
Virgin to run West Coast route ‘for at least nine months’ BBC News, Richard Westcott (15/10/12)
Articles
British transport secretary cancels West Coast franchise International Railway Journal, David Briginshaw (3/10/12)
Wrong track: Another humiliation for the government The Economist (5/10/12)
West Coast Main Line: total chaos as government scraps franchise deal The Telegraph, Alistair Osborne (3/10/12)
West Coast Main Line deal scrapped after contract flaws discovered BBC News (3/10/12)
Q&A: West Coast Main Line franchise BBC News (4/10/12)
What derailed the Transport Department BBC News, Robert Peston (3/10/12)
Transport official suspended over rail fiasco is ex-Goldman banker Independent, Oliver Wright and Cahal Milmo (5/10/12)
West Coast Main Line: Civil servant Kate Mingay speaks out BBC News (6/10/12)
Civil servant: I wasn’t to blame over West Coast bid The Telegraph, Louise Armitstead (5/10/12)
West coast rail fiasco: three government officials suspended Guardian, Gwyn Topham (3/10/12)
What does west coast shambles mean for big rail franchises? Guardian, Dan Milmo (3/10/12)
West coast mainline fiasco may claim further victims Guardian, Gwyn Topham and Dan Milmo (4/10/12)
The West Coast mainline, wasted taxes, and a secretive shambles at the heart of the Civil Service Independent, Steve Richards (4/10/12)
Why all the West Coast bids were wrong BBC News, Robert Peston (9/10/12)
Questions
- What were reasons for awarding the contract to FirstGroup back in August?
- How is discounting used to assess the value of projected future revenue and costs? How does the choice of the rate of discount impact on these calculations?
- In what way should risk be taken into account?
- Why was the FirstGroup bid particularly sensitive to the calculation of risk?
- If both costs and revenues go up with inflation, how is inflation relevant to the calculation of the profitability of a bid?
- What are the arguments for and against making franchises longer?
- Is it only at the bidding stage that there is any competition for train operators? Explain.
- Should full social costs and benefits be taken into account when assessing bids for a rail franchise? Explain.
