The term ‘Google it’ is now part of everyday language. If there is ever something you don’t know, the quickest, easiest, most cost-effective and often the best way to find the answer is to go to Google. While there are many other search engines that provide similar functions and similar results, Google was revolutionary as a search engine and as a business model.
This article by Tim Harford, writing for BBC News, looks at the development of Google as a business and as a search engine. One of the reasons why Google is so effective for individuals and businesses is the speed with which information can be obtained. It is therefore used extensively to search key terms and this is one of the ways Google was able to raise advertising revenue. The business model developed to raise finance has therefore been a contributing factor to the decline in newspaper advertising revenue.
Google began the revolution in terms of search of engines and, while others do exist, Google is a classic example of a dominant firm and that raises certain problems. The article looks at many aspects of Google.
Just google it: The student project that changed the world BBC News, Tim Harford (27/03/17)
Questions
- Is Google a natural monopoly? What are the characteristics of a natural monopoly and how does this differ from a monopoly?
- Are there barriers to entry in the market in which Google operates?
- What are the key determinants of demand for Google from businesses and individuals?
- Why do companies want to advertise via Google? How might the reasons differ from advertising in newspapers?
- Why has there been a decline in advertising in newspapers? How do you think this has affected newspapers’ revenue and profits?
The Competition and Markets Authority (CMA) has imposed a record fine of £84m on the American pharmaceutical manufacturing company Pfizer and of £5.2m on its UK distributor, Flynn Pharma. The CMA found that the companies charged unfair prices to the NHS for phenytoin sodium capsules, the anti-epilepsy drug.
The price was previously regulated, but Pfizer deliberately de-branded the drug in September 2012 and immediately raised the price to Flynn Pharma by between 780% and 1600%, which, in turn, raised the price to the NHS by nearly 2600%. This made the drug many times more expensive than in any other European country.
The cost to the NHS rose from around £2m per year to around £50m in 2013. Although other generic drugs are available, there would be serious health risks to patients forced to switch drugs. The NHS thus had no alternative to paying the higher price.
Pfizer claimed that the drug was loss-making before it was de-branded. However, the CMA calculated that this did not justify the size of the price increase; that the higher price enabled Pfizer to recover all these claimed losses within just two months.
The usual practice is for pharmaceutical companies to charge high prices for new drugs for a period of time to enable them to recover high research and development costs. Later, the drugs become available as generic drugs that other manufacturers can produce. The price then normally falls dramatically.
Phenytoin sodium was invented many years ago and there has been no recent innovation and no significant investment. But, unlike with many other drugs, there has been no switching by the NHS because of possible dangers to patients. This has given Pfizer and its distributor considerable market power. As the CMA states in its press release:
Epilepsy patients who are already taking phenytoin sodium capsules should not usually be switched to other products, including another manufacturer’s version of the product, due to the risk of loss of seizure control which can have serious health consequences. As a result, the NHS had no alternative to paying the increased prices for the drug.
In conclusion, the CMA found that “both companies have held a dominant position in their respective markets for the manufacture and supply of phenytoin sodium capsules and each has abused that dominant position by charging excessive and unfair prices”.
Articles
Pfizer fined record £84.2m for overcharging NHS 2600% Independent, Zlata Rodionova (7/12/16)
Pfizer fined record £84.2m over NHS overcharging The Guardian, Angela Monaghan (7/12/16)
CMA fines drug firms £90m for over-charging NHS nhe (7/12/16)
Pfizer hit with record fine after hiking price of NHS epilepsy drug by 2,600pc – costing taxpayer millions The Telegraph (7/12/16)
Pfizer, Flynn Get Record Fine on 2,600% Drug Price Increase Bloomberg, Patrick Gower (7/12/16)
CMA publications
Phenytoin sodium capsules: suspected unfair pricing Competition and Markets Authority: Case reference: CE/9742-13, Competition and Markets Authority cases (updated 7/12/16)
CMA fines Pfizer and Flynn £90 million for drug price hike to NHS CMA Press Release (7/12/16)
Questions
- What are the arguments for drug companies being allowed to charge high prices for new drugs?
- How long should these high prices persist?
- Sketch a diagram to illustrate Pfizer’s price for its anti-epilepsy drug before and after it was de-branded. Illustrate the effect on Pfizer’s profits from the drug.
- What determines the price elasticity of demand for (a) a drug which is branded and unique; (b) a drug produced by a specific producer but which is generic and can be produced by a number of producers; (c) a generic drug produced by many producers?
- How should a regulator like the CMA decide what price a firm with market power should be allowed to charge?
- Under what legislation did the CMA fine Pfizer and Flynn Pharma? What is the upper limit to the fine it is able to impose? Did it impose the maximum fine on Pfizer?
In the following article, Joseph Stiglitz argues that power rather than competition is a better starting point for analysing the working of capitalism. People’s rewards depend less on their marginal product than on their power over labour or capital (or lack of it).
As inequality has widened and concerns about it have grown, the competitive school, viewing individual returns in terms of marginal product, has become increasingly unable to explain how the economy works.
Thus the huge bonuses, often of millions of pounds per year, paid to many CEOs and other senior executives, are more a reflection of their power to set their bonuses, rather than of their contribution to their firms’ profitability. And these excessive rewards are not competed away.
Stiglitz examines how changes in technology and economic structure have led to the increase in power. Firms are more able to erect barriers to entry; network economies give advantages to incumbents; many firms, such as banks, are able to lobby governments to protect their market position; and many governments allow powerful vested interests to remain unchecked in the mistaken belief that market forces will provide the brakes on the accumulation and abuse of power. Monopoly profits persist and there is too little competition to erode them. Inequality deepens.
According to Stiglitz, the rationale for laissez-faire disappears if markets are based on entrenched power and exploitation.
Article
Monopoly’s New Era Chazen Global Insights, Columbia Business School, Joseph Stiglitz (13/5/16)
Questions
- What are the barriers to entry that allow rewards for senior executives to grow more rapidly than median wages?
- What part have changes in technology played in the increase in inequality?
- How are the rewards to senior executives determined?
- Provide a critique of Stiglitz’ analysis from the perspective of a proponent of laissez-faire.
- If Stiglitz analysis is correct, what policy implications follow from it?
- How might markets which are currently dominated by big business be made more competitive?
- T0 what extent have the developments outlined by Stiglitz been helped or hindered by globalisation?
The government plans to improve broadband access across the country and BT is a key company within this agenda. However, one of the problems with BT concerns its natural monopoly over the cable network and the fact that this restricts competition and hence might prevent the planned improvements.
Ofcom, the communications watchdog has now said that BT must open up its cable network, making it easier for other companies to access. This will allow companies such as Sky, Vodafone and TalkTalk to invest in the internet network in the UK, addressing their criticisms that BT has under-invested in Openreach and this is preventing universal access to decent and affordable broadband. There have been calls for Ofcom to require BT and Openreach to separate, but Ofcom’s report hasn’t required this, though has noted that it ‘remains an option’.
BT has been criticised as relying on old cables that are not sufficient to provide the superfast broadband that the government wants. The report may come as a relief to BT who had perhaps expected that Ofcom might require it to sell its Openreach operation, but it will also remain concerned about Ofcom’s constant monitoring in the years to come. BT commented:
“Openreach is already one of the most heavily regulated businesses in the world but we have volunteered to accept tighter regulation … We are happy to let other companies use our ducts and poles if they are genuinely keen to invest very large sums as we have done.”
Its rivals will also be in two minds about the report, happy that some action will be taken, but wanting more, as Ofcom’s report suggests that “Openreach still has an incentive to make decisions in the interests of BT, rather than BT’s competitors”. A spokesperson for Vodafone said:
“BT still remains a monopoly provider with a regulated business running at a 28% profit margin …We urge Ofcom to ensure BT reinvests the £4bn in excess profits Openreach has generated over the last decade in bringing fibre to millions of premises across the country, and not just make half-promises to spend an unsubstantiated amount on more old copper cable.”
The impact of Ofcom’s report on the competitiveness of this market will be seen over the coming years and with a freer market, we might expect prices to come down and see improved broadband coverage across the UK. In order to achieve the government’s objective with regards to broadband coverage, a significant investment is needed in the network. With BT having to relinquish its monopoly power and the market becoming more competitive, this may be the first step towards universal access to superfast broadband. The following articles consider this report and its implications.
Ofcom opens a road to faster broadband The Guardian, Harriet Meyer and Rob Davies (28/2/16)
Ofcom: BT must open up its Openreach network Sky News (25/2/16)
How Ofcom’s review of BT Openreach could improve your internet service Independent, Doug Bolton (25/2/16)
Ofcom’s digital review boosts faltering broadband network Financial Times, Daniel Thomas (25/2/16)
The Observer view on broadband speeds in Britain The Observer, Editorial (28/2/16)
Ofcom tells BT to open up cable network to rivals’ BBC News (25/2/16)
Ofcom should go further and break up BT Financial Times, John Gapper (25/2/16)
BT escapes forced Openreach spin-off but Ofcom tightens regulations International Business Times, Bauke Schram (25/2/16)
Questions
- Why does BT have a monopoly and how might this affect the price, output and profits in this market?
- Ofcom’s report suggests that the market must be opened up and this would increase competitiveness. How is this expected to work?
- What are the benefits and costs of using regulation in a case such as this, as opposed to some other form of intervention?
- How might a more competitive market increase investment in this market?
- If the market does become more competitive, what be the likely consequences for consumers and firms?
The market structure in which firms operate has important implications for prices, products, suppliers and profits. In competitive markets, we expect to see low prices, many firms competing with new innovations and firm behavior that is in, or at least not against the public interest. As a firm becomes dominant in a market, its behavior is likely to change and consumers and suppliers can be adversely affected. Is this the case with Amazon?
Much attention has been given to the dispute centering around Amazon and its actions in the market for e-books, where it holds close to two thirds of the market share. Critics of Amazon suggest that this is just one example of Amazon using its monopoly power to exploit consumers and suppliers, including the publishers and their authors. Although Amazon is not breaking any laws, there are suggestions that its behavior is ‘brutal’ and is taking advantage of consumers, suppliers and its workforce.
But rather than criticizing the actions of a monopolist like Amazon, should we instead be praising the company and its ability to compete other firms out of the market? One of the main reasons why consumers use Amazon to buy goods is that prices are cheap. So, in this respect, perhaps Amazon is not acting against consumers’ interests, as under a monopoly we typically expect low output and high prices, relative to a model of perfect competition. The question of the methods used to keep prices so low is another matter. Two conflicting views on Amazon can be seen from Annie Lowrey and Franklin Foer, who respectively said:
“Amazon relentlessly drives down prices for goods and services and delivers them fast and cheap. It ploughs its profits into price cuts and innovation rather than putting them in the hands of its investors. That benefits millions of families – full stop.”
“In effect, we’ve been thrust back 100 years to a time when the law was not up to the task of protecting the threats to democracy posed by monopoly; a time when the new nature of the corporation demanded a significant revision of government.”
So, with Amazon we have an interesting case of a monopolist, where many aspects of its behaviour fit exactly into the mould of the traditional monopolist. But, some of the outcomes we observe indicate a more competitive market. Paul Krugman has been relatively blunt in his opinion that Amazon’s dominance is bad for America. His comments are timely, given the recognition for Jean Tirole’s work in considering the problems faced when trying to regulate any firm that has significant market power. He has been awarded the Nobel Prize in Economics. I’ll leave you to decide where you place this company on the traditional spectrum of market structures, as you read the following articles.
Amazon: Monopoly or capitalist success story? BBC News, Kierran Petersen (14/10/14)
Why the Justice Department won’t go after Amazon, even though Paul Krugman thinks it’s hurting America Business Insider, Erin Fuchs (20/10/14)
Is Amazon a monopoly? The Week, Sergio Hernandez (19/11/14)
Big, bad Amazon The Economist (20/10/14)
Questions
- What are the typical characteristics of a monopoly? To what extent does Amazon fit into this market structure?
- Why does Paul Krugman suggest that Amazon is hurting America?
- How does Amazon’s behaviour with regard to (a) its suppliers and (b) its workers affect its profitability? Would it be able to behave in this way if it were a smaller company?
- Why is Amazon able to charge its customers such low prices? Why does it do this, given its market power?
- Is there an argument for more regulation of firms with such dominance in a market, as is the case with Amazon?
- The debate over e-books is ingoing. What is the argument for publishers to be able to set a minimum price? What is the argument against this?
- Should customers boycott Amazon in a protest over the alleged working conditions of Amazon factory employees?
