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 Another contributing factor could be an outdated management structure, which has not responded to the changing times.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
- What are the main reasons behind the collapse of HMV?
- Use a diagram to illustrate the impact the companies such as Amazon and Tesco have had on costs and prices in the entertainment industry.
- Has the value we place on owning DVDs truly changed or have other factors led to larger purchases of online entertainment?
- Why is online retail providing such steep competition to high street retailers?
- Explain why it can be argued that economic recovery will only take place after a certain number of businesses have gone into administration.
- To what extent do you think HMV’s collapse is due to its failure to adapt to changing social circumstances?
- 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.
- In which market structure would you place the entertainment industry? Explain your answer. Has this contributed to the demise of HMV?
Last week, the European Commission imposed a record fine of almost €1.5b on a group of firms found to have been involved in price fixing. Between 1996 and 2006 these firms fixed world-wide prices of cathode ray tubes which are used to make TV screens and computer monitors.
The firms involved in fixing the prices in one or both of these markets included household names such as Samsung, Panasonic, Toshiba and Philips. As these tubes accounted for over half the price of a screen this clearly had a significant knock-on effect on the amount final consumers paid. The European competition agency only discovered the cartel when it was informed that it had been in operation by Chunghwa, a Taiwanese company that had also been involved. Therefore, under the Commission’s leniency policy Chunghwa was granted full immunity from the fines.
The cartel members held frequent meetings in cities across Europe and Asia. The top level meetings were known as ‘green meetings’ as they were often followed by a round of golf. Interestingly, this is not the first time the game of golf has featured in an international cartel. In the famous lysine cartel an informant working for the FBI used the quality of the golf courses to convince the cartel members to meet in Hawaii, where the FBI had the jurisdiction to secretly record the meeting as evidence.
The screen tube cartel is one of the most highly organised cartels the European Commission has ever detected. Different prices were even fixed for individual TV and computer manufacturers. Furthermore, compliance with the cartel agreement was strictly monitored with plant visits to audit how much firms were producing. The cartel was also clearly very aware that it was breaking the law and that information needed to be concealed as some of the documents discovered stated that they should be destroyed after they had been read. One document even said that:
“Everybody is requested to keep it as secret as it would be serious damage if it is open to customers or European Commission.”
Another interesting feature of the cartel is that it occurred at a time when the technology was being replaced by LCD and plasma screens. Therefore, the cartel appears to have been partly motivated by a desire to mitigate the negative impact the declining market would have on the firms involved.
According to the Independent newspaper:
“Philips said it would challenge what it called a disproportionate and unjustified penalty. Panasonic and Toshiba are also considering legal challenges. Samsung reserved its comment.
TV makers in record 1.47bn-euro fine BBC News (05/12/12)
TV computer makers fined $1.93 billion for price fixing Corporate Crime Reporter (05/12/12)
European antitrust fines: a new wave of deterrence? EurActiv, Mario Mariniello (11/12/12)
Questions
- What is the impact of a successful cartel on economic welfare?
- Describe the impact declining demand has on firms in a competitive market.
- Why might it have been necessary for the cartel to charge different prices to individual TV and computer manufacturers?
- Why would the cartel need to audit how much members are producing?
- Why do competition authorities offer immunity to firms that inform them about cartel behaviour?
- Based on the evidence in the articles, do you think the firms involved have grounds to appeal the fines imposed?
Original post
Starbucks’ UK sales in 2011 were worth £398m. Costa’s UK sales were worth £377m. But while Costa paid £15m in corporation tax in 2011/12, Starbucks paid nothing! In fact since opening its first coffee shop in the UK in 1998 it has paid just £8.6m in taxes on UK sales of £3bn.
How is this possible? Let’s look at Starbuck’s 2011 UK sales. Even though these were worth £398 million, its costs were recorded as £426.2m, giving a loss of £28.2m. Costa, by contrast, reported a taxable profit of £49.7m.
So is Starbucks a commercial failure in the UK, recording year after year of losses? Not at all. Starbucks regards the UK as a highly profitable part of its business. As the Independent article below states:
…in its briefings to stock market investors and analysts during the past 12 years, Seattle-based Starbucks has consistently stated that its UK unit is “profitable” and three years ago even promoted its UK head, Cliff Burrows, to run its vastly larger US operation.
So how can reported UK losses be reconciled with a profitable UK operation? The answer lies in transfer pricing.
Transfer pricing refers to the prices a company charges itself when goods or services are transferred within the company but from one country to another. By varying the transfer prices, a company can choose where to make its profits. Thus if Starbucks’ US operation charges high prices to its UK operation for various services, such as royalties for the use of branding or for management services, or lends money to its UK operation at high interest rates, Starbucks’ profits will rise in the USA and fall in the UK.
Companies employ tax advisers (see for example) and ‘transfer pricing managers’ to help them move their profits from high tax countries to low tax countries. In Starbuck’s case, by charging its UK operation high prices for such things as ‘use of its logo’ it has chosen to move all its profits out of the UK and thus avoid UK corporation tax.
Apart from denying the UK government tax revenues, the practice by Starbucks distorts competition as competing UK companies, such as Costa, AMT, Caffè Ritazza and the many small independents, do not have the same opportunity for transfer pricing and do pay UK corporation tax. As the Guardian article by Richard Murphy below states:
We do have homegrown coffee shops in the UK. A lot of them. And they have to pay their taxes in full here in the UK. They can’t make payments to offshore entities for the use of their logos or advice on how to add hot water to coffee just to avoid tax: they have to pay in full on what they earn in this country. What Starbucks is doing may be legal, but what it also shows is that business does not operate on a level playing field in the UK.
And, as some of the articles below demonstrate, it’s not just Starbucks. Amazon, Facebook and Google have also been accused of avoiding taxes in the UK by engaging in forms of transfer pricing.
Update
On 12 November senior executives from Starbucks, Google and Amazon appeared before the House of Commons Public Accounts Committee to give evidence on their non-payment of corporation tax and their apparent lack of profits in the UK. As you will see from the videos, the MPs were unimpressed by the answers they received.
At the G20 finance ministers meeting in Mexico the previous week, George Osborne, the UK Chancellor, and Wolfgang Schäuble, the German Finance Minister, called for “concerted international co-operation to strengthen international tax standards that at the minute may mean international companies can pay less tax than they would otherwise owe”.
There seems to be mounting international pressure on multinationals to cease using transfer pricing as a means of avoiding paying taxes. Whether it will be successful remains to be seen.
Further Update (June 2013)
In June 2013, After continuing criticism of its tax avoidance policies, Starbucks agreed to pay £10m in corporation tax tin 2013/14 and a further £10m in 2014/15.
Articles for original post
Starbucks UK tax bill comes under scrutiny The Telegraph, Helia Ebrahimi (15/10/12)
Good bean counters? Starbucks has paid no tax in UK since 2009 Independent, Martin Hickman (16/10/12)
Special Report: How Starbucks avoids UK taxes Reuters, Tom Bergin (15/10/12)
Business Starbucks ‘paid no UK income tax’ since 2009 Channel 4 News (16/10/12)
Starbucks ‘paid just £8.6m UK tax in 14 years’ BBC News, Vicki Young (16/10/12)
Starbucks’ tax payment is ‘unfair’ say independent cafes BBC News, Joe Lynam (16/10/12)
Starbucks ‘paid just £8.6m UK tax in 14 years’ BBC News (16/10/12)
What the Starbucks tax expose means for ordinary companies Tax Research UK, Richard Murphy (16/10/12)
Starbucks ‘pays £8.6m tax on £3bn sales’ The Guardian, Simon Neville (15/10/12)
How much tax do Starbucks, Facebook and the biggest US companies pay in the UK The Guardian Datablog (16/10/12)
Amazon: £7bn sales, no UK corporation tax The Guardian, Ian Griffiths (4/4/12)
Facebook criticised for £238,000 UK tax bill last year BBC Radio 1 Newsbeat, Dan Cairns (11/10/12)
U.S. Companies Dodge $60 Billion in Taxes With Global Odyssey Bloomberg, Jesse Drucker (13/5/10)
EBay ‘pays £1.2m in UK tax’ on sales of £800m BBC News (21/10/12)
Articles for update
Starbucks, Google and Amazon grilled over tax avoidance BBC News (12/11/12)
Companies have ‘social responsibility’ to pay tax BBC Today Programme (12/11/12)
MPs slam Starbucks, Amazon and Google on tax Reuters, Tom Bergin (12/11/12)
A highly taxing session for the men from Amazon, Google and Starbucks The Guardian, Simon Hoggart (12/11/12)
Starbucks is leeching tax revenue from UK The Telegraph, Lord Myners (12/11/12)
UK and Germany agree crackdown on tax loopholes for multinationals The Guardian, Patrick Wintour and Dan Milmo (5/11/12)
Britain, Germany target tax from multinationals Deutsche Welle (5/11/12)
HMRC unable to stop multinational tax avoidance accountancylive, Sharon Khin (6/11/12)
Starbucks ‘planning changes to tax policy’ BBC News (3/12/12)
Articles for further update
Starbucks pays UK corporation tax for first time since 2009 BBC News (22/6/13)
Starbucks pays corporation tax, promising the Exchequer £20m over two years IndependentHeather Saul (2/6/13)
Starbucks pays first tax since 2008 The Telegraph, Kamal Ahmed (22/6/13)
Report of Public Accounts Committee
Tax avoidance by multinational companies UK Parliament (3/12/12)
Questions
- Explain how a multinational company can use transfer pricing as a means of reducing its overall tax liability.
- Why may transfer pricing lead to an inefficient allocation of resources?
- What policies can governments adopt to clamp down on the use of transfer pricing to limit their tax liability in their country?
- What insights are shed by game theory in explaining why it may be very difficult to reach international agreement to clamp down on tax avoidance?
- Is it immoral for companies to seek to minimise their tax liability? What are the limits of economics as a discipline in establishing an answer to this question?
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?
