From April 2012, the average household water bill will rise by 5.7% to approximately £367. With households already feeling the squeeze this news is more than unwelcome. The increase in prices will not be standardized across England and Wales. Instead some households will suffer more than others, as their water providers increase prices significantly more than those in other areas.
There has been significant investment in the water industry over the past few years and if this is to continue, funding is required: hence the price hikes. More investment is taking place in some areas than in others and so this goes some way to explaining why some households will see their bills rise by a relatively larger amount. Ofwat, the water regulator, has said that if the investment that these price rises are paying for doesn’t materialize action will be taken. In the context of the current financial situation, consumer groups are understandably concerned about the impact this may have on the lowest income households. Tony Smith, the Chief Executive of the Consumer Council for Water has said:
‘We’ll be making sure that customers get some benefits from this and also that companies step up their help for customers with affordability problems’.
The following articles consider this issue.
How to cut your water bill The Telegraph, Kara Gammell (31/1/12)
Water bills rise by average of 5.7% Guardian, Jill Insley (31/1/12)
Water meter case study: ‘They have set the charges too high’ Guardian, Jill Insley (31/1/12)
Water bills to rise by 5.7 per cent Financial Times, Elaine Moore (31/1/12)
Welsh water imposes lowest increase The Press Association (31/1/12)
Questions
- Why are household incomes already being squeezed?
- Why would you suggest that the RPI and not the CPI has been used to make up the price rises?
- Why are there such wide variations in the amount that consumers are currently charged in different parts of the country? Do you think this is fair? You may find it useful to look at a previous blog on the site
- What is the role of the regulator, Ofwat?
- Can Ofwat’s decision to allow prices to rise by more than the RPI be justified?
In an earlier blog Energy profits margins up by over 700% we analysed the increasing pressure on many households as they saw their energy bills increase in price year on year. This helped the big six energy companies achieve a 700% rise in their profits.
However, it also sparked interest by the regulator Ofgem, which was looking to ensure that consumers found it easier to make price comparisons and create a more competitive market. One issue that Ofgem were looking into was how to make the energy sector more open to competition, given that the big six companies own the power stations and hence this acts as a barrier to the entry of new firms.
The latest announcements from some of the big energy companies will therefore come as a pleasant turn of events for Ofgem. On Wednesday January 11th 2012, EDF announced that it would be cutting its energy prices by 5% from 7th February in response to a fall in wholesale costs. Only a day later, Npower announced its plans to cut its tariffs by 5% from 1st February. British Gas cut its prices by 5% with immediate effect and SSE will reduce its gas prices by 4.5% from March 26th.
Is this a sign that the market is becoming more competitive thanks to Ofgem or is there another explanation? For the past 2 winters, temperatures have been consistently below freezing and hence demand for gas/electricity was at an all time high, speaking concerns of gas shortages. However, with the mild winter we are currently experiencing (I hope I haven’t jinxed it!) demand for heating etc has been significantly lower, which has reduced wholesale costs and the big six companies have begun to pass these savings on to their customers. Yet, despite this seemingly good news, are they being as ‘kind’ as we think? Most of the companies are cutting their prices by about 5%, yet wholesale prices fell by significantly more than that. Furthermore, over the past few years, customers have seen their tariffs increase significantly – by a lot more than 5%. To some extent, this confirms the criticism levelled at the energy sector – when costs rise, they are quick to pass on the full costs to their customers. But, when costs fall, they are slow to pass on only a fraction of their cost savings. The following articles consider this issue.
Npower will cut gas prices by 5% BBC News (13/1/12)
EDF cuts gas price by 5% Reuters, Karolin Schaps and Henning Gloystein (11/1/12)
British Gas readies push to promote price cut MarketingWeek, Lara O’Reilly (13/1/12)
British Gas cuts prices by 5% Independent (13/1/12)
Energy suppliers do battle in the war of modest price cuts The Telegraph, Emily Godsen (13/1/12)
British Gas and SSE follow EDF Energy price cut Financial Times, Guy Chazan and Sylvia Pfeifer (11/1/12)
British Gas cuts electricity prices, but keeps gas on hold Guardian, Hillary Osborne (12/1/12)
British gas and SSE announce price cuts (including video) BBC News (12/1/12)
More power firms cut energy tariffs The Press Association (12/1/12)
Questions
- In which market structure would you place the energy sector? Explain your answer.
- What is the role of Ofgem? What powers does it (and the other regulators have)?
- Using a demand and supply diagram to help you, explain why wholesale costs have fallen.
- Why have the energy companies only passed on about 5% of cost savings to their customers, despite falls in wholesale costs of significantly more than that?
- Do you think price wars are likely to break out in this sector? Are they in the interests of consumers?
- Why did energy prices increase so quickly last year and the year before? Use a diagram to help you.
With Christmas approaching, many high street stores will be hoping for a big increase in sales, but that seems unlikely to be enough for Arcadia, whose brands include Top Shop, BHS and Dorothy Perkins. Arcadia’s profits have decreased to £133m, which is a fall of 38% and, based on this data, it is planning on closing many stores across the country over the next few years. With leases expiring on many of their stores within about 3 years, the current plan, according to Sir Phillip Green, is to close about 250 stores. Speaking to the BBC, he commented:
‘Now, there may be other opportunities that turn up that we might want to open. But certainly, in terms of our existing portfolio, currently that’s our thinking.’
The economic climate has obviously played a key role, but so has the weather. With the hottest October and November for decades, people have been delaying their shopping and purchases of winter clothing and this has put increased strain on many high street traders (see the news item Dreaming of a white Christmas).
What is perhaps of more concern than one company’s profits being significantly lower is the impact this may have on unemployment. With over 2500 stores, Arcadia is one of the largest private employers in the UK and if 250 stores are closed, there may be severe consequences for the labour market and this may have further adverse effects on aggregate demand. A key factor that may partly determine the future of firms such as Arcadia is how much consumers spend this Christmas. Perhaps for these stores, they really may be hoping for a white Christmas – at least that may encourage people to stock up on winter clothes – if they can get to the shops!
Arcadia to close stores after reporting loss Financial Times, Andrea Felsted (24/11/11)
Arcadia and Dixons post profit loss BBC News (19/4/10)
Retail slowdown hits Arcadia stores Guardian, Zoe Wood (9/5/11)
Arcadia set to close up to 260 stores as profits fall BBC News (24/11/11)
Has Sir Phillip Green lost his Midas touch? Independent, James Thompson (25/11/11)
Arcadia suffers 40% slide in profits The Press Association (24/11/11)
Questions
- Explain why the current economic situation has caused a slowdown in retail sales.
- Illustrate the way in which a firm will maximise profits. If profits are declining, is it because sales revenue has fallen or that costs have risen? Adapt your diagram to show a fall in profits based on your answer.
- According to the article by the Press Association, margins were ‘squeezed by 1.8% as it took a £53 million hit to absorb price increases’. What does this mean?
- How might the unseasonably warm weather be an explanation for a weaker trading environment?
- If 260 stores are closed, what impact might this have on unemployment?
- If more workers lose their jobs, how might this have a subsequent adverse effect on sales? Think about the multiplier effect here.
With pressure on household incomes, many have had to forego spending on luxuries and travel is seen by many as just that – a luxury they can no longer afford. Add on to this some unexpected external shocks and it’s unsurprising to see a company such as Thomas Cook, the second largest holiday business in the world, in talks with banks. It provides some 19 million holidays per year, but has seen a relatively rapid deterioration in its finances.
Its debts total in September 2011 was some £900 million and the value of the company has declined significantly in recent times. However, the most notable decline has been since it emerged that Thomas Cook was in talks with its banks in preparation for tougher times to come. It is hoping to receive £100 million from a range of banks including HSBC and Lloyds, but on this news Thomas Cook share prices fell by some 75%. However, Thomas Cook has said that the company is simply requesting money as a cushion and that it is not in a desperate financial situation. As the Acting Chief Executive, Sam Weihagen said, ‘I think investors should have confidence in Thomas Cook’.
Many factors have contributed towards Thomas Cook’s current situation – volcanic ash clouds, political unrest and unkind weather, but also some internal strategic decisions, such as their continued focus on package holidays, despite the fact that data suggests 2 in 3 people that go to Spain (a popular package destination) are actually not on a typical package holiday. The key thing with travel is that it is very much based on confidence (as we have also seen with the banking sector). If confidence in a company declines, people stop booking holidays with them and so further financial issues are created. This issue is even more significant when a well known brand name, such as Thomas Cook is the company in trouble. Nothing else makes such great headlines as a well known brand in trouble. So, should holiday makers be concerned? The following articles consider the situation that Thomas Cook faces.
Thomas Cook makes it hard to see the funny side Telegraph, Alistair Osborne (22/11/11)
Thomas Cook dives on bank talks BBC News (22/11/11)
How Thomas Cook shares dive 75% on new of bank talks BBC News (22/11/11)
Thomas Cook reassures holiday makers after shares plunge Guardian, Simon Bowers and Patrick Collinson (22/11/11)
Thomas Cook risks customer exodus during bank talks after stock plunges Bloomberg, Armorel Kenna and David Altaner (23/11/11)
Fears for Thomas Cook after shares sink 75% Independent, James Thompson (23/11/11)
Thomas Cook shares crash after default warning Reuters, Matt Scuffham (22/11/11)
Questions
- Explain the reason why share prices have fallen for Thomas Cook. Use a diagram showing the demand and supply of shares to support your explanation.
- Distinguish between the internal and external factors that have contributed to Thomas Cook’s current position.
- Under which aspect of PEST and STEEPLE analysis would you place the above influences?
- In the Telegraph article, an industry source says: ‘In a business like this you need a very conservative capital structure because you don’t know what’s going to come and bite you.’ What is meant by ‘a very conservative capital structure’?
- What action can Thomas Cook take to try to improve its current financial position? Think about both costs and revenues.
- What type of good would you class a holiday as? Based on this, what sort of figure would you place on the income elasticity of demand for holidays?
- How likely do you think it is that other travel companies are also experiencing similar financial issues to Thomas Cook?
A weekly expense for most families is filling up their car(s) with petrol, but this activity is becoming increasingly expensive and is putting added pressure on lower and middle income families in particular. For those families on lower incomes, a tank of petrol represents a much larger percentage of their income than it does for a higher income household. Assuming that petrol for a month costs you £70 and your monthly income is £500, as a percentage of your income, a tank of petrol costs you 14%. Whereas, if your income is £900, the percentage falls to 7.7% and with a monthly take-home pay of £2000, the cost of a month’s petrol as a percentage of your income is just 3.5%. This is a stark indication of why those on lower incomes feel the burden of higher petrol prices (and indeed, higher prices for any essential items) more than other families.
The price of petrol will today be debated by MPs, following an e-petition signed by more than 100,000 people and having the support of more than 100 MPs. When in power, the Labour government proposed automatic fuel-tax increases, but these were scrapped by the Coalition. However, in January, the government plans to increase fuel duty by 3p a litre and further increases in prices are expected in August in line with inflation. This could mean that the price of unleaded petrol rises to over 1.40p per litre.
And it’s not just households that are feeling the squeeze. The situation described in the first paragraph is just as relevant to firms. The smaller firms, with lower turnover and profits are feeling the squeeze of higher petrol prices more than their larger counterparts. Any businesses that have to transport goods, whether to customers or from wholesalers to retailers etc, are seeing their costs rise, as a tank of petrol is requiring more and more money. To maintain profit margins, firms must pass these cost increases on to their customers in the form of higher prices. Alternatively, they keep prices as they were and take a hit on profitability. If prices rise, they lose customers and if prices are maintained, profitability suffers, which for some companies, already struggling due to the recession, may not be an option.
Mr. Halfon, the Tory MP whose motion launched the e-petition said that fuel prices were causing ‘immense difficulties’ and the Shadow Treasury Minister Owen Smith has said:
‘With our economic recovery choked off well before the recent eurozone crisis, we need action.’
With inflation at 5.2% (I’m writing an hour or so before new inflation data is released on 15/11/11), higher prices for many goods is putting pressure on households. This is possibly contributing towards sluggish growth, as households have less and less disposable income to spend on other goods, after they have purchased their essential items, such as groceries and petrol. A criticism leveled at oil companies is that they quickly pass on price rises, as the world price of oil increases, but do not pass on cuts in oil prices. The issues raised in the debate and how George Osborne and David Cameron respond, together with inflation data for the coming months, may play a crucial role in determining just how much a tank of petrol will cost in the new year.
MPs to debate motion calling for half in petrol prices BBC News (15/11/11)
Petrol price rise: David Cameron faces Commons revolt after No10 e-petition Guardian, Cherry Wilson (15/11/11)
David Cameron faces backbench rebellion over fuel price hike Telegraph, Rowena Mason (14/11/11)
Petrol prices may be slashed by Rs 2 per litre on November 16 The Economic Times (15/11/11)
Paying the price as fuel costs rise BBC News (15/11/10)
Oil barons the big winners from soaring pump prices, ONS figures reveal Daily Mirror, Graham Hiscott (15/11/11)
Scrap rise in petrol duty: 100 MPs demand Osborne abandon planned 3p increase Mail Online, Ray Massey and Tim Shipman (15/11/11)
Questions
- As the price of petrol rises, why do people continue to buy it? What does it suggest about the elasticity of this product?
- Why do higher prices affect lower income families more than higher income families?
- What are the arguments (a) for and (b) against George Osborne’s planned 3p rise in petrol duty?
- Do you think that higher prices are contributing towards sluggish growth? Why?
- What type of tax is imposed on petrol? Is it equitable? Is it efficient?
- Why can the oil companies pass price rises on to petrol stations, but delay passing on any price reductions? Is there a need for better regulation and more pressure on oil companies to change their behaviour?
