Tag: profit

No matter the product or service, price is always a key factor and never more so than in tough economic times. In most cases, prices are allowed to be determined by the forces of demand and supply, which gives the equilibrium price. However, in some cases, the government may choose to intervene with a price control, for example rent controls and the national minimum wage. Another market where there is also regulation is the airline industry and the Civil Aviation Authority have recently been criticized by Heathrow Airport for its price control plan.

Whenever we go on holiday, the price we pay for an airline ticket will depend in part on the airport we are taking off from and landing at, as they will charge the airline for landing fees, security, terminals etc. Heathrow airport had proposed that annual rises to its tariffs charged to airlines would increase by 4.6% above RPI inflation. However, this plan has been rejected by the CAA, which has said that the annual tariff rise between 2014 and 2018 should not be above the RPI. Though Heathrow are criticizing the CAA about this restriction, it is an improvement from the initial proposal which would have capped price rises at the RPI minus 1.3%.

Controversy has naturally been created, with the CAA arguing that such price controls are needed to keep prices down and thus benefit consumers and retain the competitiveness of Heathrow airport. But, in contrast, Heathrow has argued that such a cap will put its competitive position under pressure and will risk future investment in the UK. But this isn’t the only criticism of the CAA. Airlines aren’t happy with the ruling either, arguing that the CAA has bowed to the pressure of Heathrow. The contrasting positions of the CAA, Heathrow and airlines are evident in the following quotes, firstly from the Chairwoman of the CAA:

The proposals will put an end to over a decade of prices rising faster than inflation at Heathrow. Tackling the upward drift in Heathrow’s prices is essential to safeguard its globally competitive position. The challenge for Heathrow is to maintain high levels of customer service while reducing costs. We are confident this is possible and that our proposals create a positive climate for further capital investment, in the passenger interest.

Secondly, from Heathrow’s Chief Executive:

This proposal is the toughest Heathrow has ever faced. The CAA’s settlement could have serious and far-reaching consequences for passengers and airlines at Heathrow … We want to continue to improve Heathrow for passengers. Instead, the CAA’s proposals risk not only Heathrow’s competitive position but the attractiveness of the UK as a centre for international investment. We will now carefully consider our investment plans before responding fully to the CAA.

And finally from the IAG Chief Executive, who said:

[The CAA] neglected its new primary statutory duty to further the interests of passengers by endorsing a settlement that allows the UK’s monopoly hub to ignore its inefficiencies and over-reward investors by imposing excessive charges … It is a bad day for customers who have been let down by the CAA.

Any price rise from the airports will be passed on to airlines and these in turn will translate into higher prices for customers. However, is there any truth to Heathrow’s claims that investment will be adversely impacted? As costs rise, profit margins and profit will fall, unless the revenue generated can increase. Price controls restrict the amount that prices can rise and thus unless demand increases by a significant margin, profits will decline. With lower profits, there will be less money for investment and arguably the service that customers face will also decline. However, the CAA suggests that Heathrow will be able to cut its costs and thus protect investment into the future, while retaining its competitive position globally by charging lower prices to airlines. This is unlikely to be the end of the journey, but for the moment, the CAA appears to have put its foot down. The following articles consider the battleground between the CAA and Heathrow.

Regulation in the passenger’s interest, support investment and driving competition The Civil Aviation Authority (3/10/13)
Passengers at Heathrow ‘face £1bn fares hike’ Independent, Matthew Beard (4/10/13)
Heathrow airport attacks regulator’s price control plan BBC News (3/10/13)
CAA proposed Heathrow charges rise in line with inflation The Telegraph, Rebecca Clancy (13/10/13)
Passengers face fare increases as Heathrow and Gatwick are allowed to up landing fees Mail Online (3/10/13)
Heathrow and airlines enraged by CAA price proposals The Telegraph, Alistair Osborne (3/10/13)
Heathrow attacks Civil Aviation Authority over airport charges Financial Times, Andrew Parker (3/10/13)
BAA considers life outside Heathrow as CAA backtracks on charges The Guardian, Gwyn Topham (3/10/13)
Heathrow charge plan disappoints all round Wall Street Journal, Peter Evans (3/10/13)

Questions

  1. What is the role of a regulator?
  2. Explain how the price control outlined by the CAA will affect Heathrow.
  3. If Heathrow is unable to cut costs, what is the likely effect? Using a diagram illustrate the impact on profitability if costs (a) can be reduced and (b) cannot be reduced.
  4. Why are the CAA being criticised by airlines and airports?
  5. How will customers be affected by Heathrow’s planned price rises and the CAA’s proposal?
  6. ‘Regulation in the airlines industry is essential to retain competitiveness.’ Evaluate the validity of this statement.

If you ask most people whether they like paying tax, the answer would surely be a resounding ‘no’. If asked would you like to pay less tax, most would probably say ‘yes’. Evidence of this can be seen in the behaviour of individuals and of companies, as they aim to reduce their tax bill, through both legal and illegal methods.

Our tax revenues are used for many different things, ranging from the provision of merit goods to the redistribution of income, so for most people they don’t object to paying their way. However, maintaining profitability and increasing disposable income is a key objective for companies and individuals, especially in weak economic times. Some high profile names have received media coverage due to accusations of both tax avoidance and tax evasion. Starbucks, Amazon, Googe and Apple are just some of the big names that have been accused of paying millions of pounds/dollars less in taxation than they should, due to clever (and often legal) methods of avoiding tax.

The problem of tax avoidance has become a bigger issue in recent years with the growth of globalisation. Multinationals have developed to dominate the business world and business/corporation tax rates across the global remain very different. Thus, it is actually relatively easy for companies to reduce their tax burden by locating their headquarters in low tax countries or ensuring that business contracts etc. are signed in these countries. By doing this, any profits are subject to the lower tax rate and are thus such companies are accused of depriving the government of tax revenue. Apple is currently answering questions posed by a US Senate Committee, having been accused of structuring its business to create ‘the holy grail of tax avoidance’.

Many may consider the above and decide that these companies have done little wrong. After all, many schemes aimed at tax avoidance are legal and are often just a clever way of using the system. However, in a business environment dominated by the likes of Google, Apple and Amazon, the impact of tax avoidance may not just be on the government’s coffers. Indeed John McCain, one of the Committee members asked:

…Couldn’t one draw the conclusion that you and Apple have an unfair advantage over domestic based corporations and companies, in other words, smaller companies in this country that don’t have the same ability that you do to locate in Ireland or other countries overseas?

The concern is that with such ability to avoid huge amounts of taxation, large companies will inevitably compete smaller ones out of the market. Local businesses, without the ability to re-locate to other parts of the world, pay their full tax bills, but multinationals legally (in most cases) manage to avoid paying their own share. With a harsh economic climate continuing globally, these large companies that aim to further increase their profitability through such means as tax avoidance will naturally bear the wrath of smaller businesses and individuals that are struggling to get by. It’s likely that this topic will remain in the media for some time. The following articles consider some of the companies accused of participating in tax avoidance schemes and the consequences of doing so.

Is Apple’s tax avoidance rational? BBC News, Robert Peston (21/5/13)
Apple’s Tim Cook defends tax strategy in Senate BBC News (21/5/13)
Senator accuses Apple of ‘highly questionable’ billion-dollar tax avoidance scheme The Guardian, Dominic Rushe (21/5/13)
Apple’s Tim Cook faces tax avoidance questions Sky News (21/5/13)
EU leaders look to end Apple-style tax avoidance schemes Reuters, Luke Baker and Mark John (21/5/13)
Apple Chief Tim Cook defends tax practices and denies avoidance Financial Times, James Politi (21/5/13)
Apple CEO Tim Cook tells Senate: tiny tax bill isn’t our fault, it’s yours Independent, Nikhil Kumar (21/5/13)
Miliband promises action on Google tax avoidance The Telegraph (19/5/13)
Google is cheating British tax payers out of millions…what they are doing is just immoral’: Web giant accused of running ‘scandalous’ tax avoidance scheme by whistleblower Mail Online, Becky Evans (19/5/13)
Multinational CEOs tell David Cameron to rein in tax avoidance rhetoric The Guardian, Simon Bowers, Lawrie Holmes and Rajeev Syal (20/5/13)
Fury at corporate tax avoidance leads to call for a global response The Guardian, Tracy McVeigh (18/5/13)

Questions

  1. What is the difference between tax evasion and tax avoidance? Is it rational to engage in such schemes?
  2. What are tax revenues used for?
  3. Why are multinationals more able to engage in tax avoidance schemes?
  4. Is the problem of tax avoidance a negative consequence of globalisation?
  5. How might the actions of large multinationals who are avoiding paying large amounts of tax affect the competitiveness of the global market place?
  6. Is there justification for a global policy response to combat the issue of tax avoidance?
  7. What are the costs and benefits to a country of having a low rate of corporation tax?
  8. How would a more ‘reasonable’ tax on foreign earnings allow the ‘free movement of capital back to the US’?

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

  1. Explain how a multinational company can use transfer pricing as a means of reducing its overall tax liability.
  2. Why may transfer pricing lead to an inefficient allocation of resources?
  3. What policies can governments adopt to clamp down on the use of transfer pricing to limit their tax liability in their country?
  4. 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?
  5. 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?

Oligopoly: it’s a complex market structure and although closer to the monopoly end of the ‘Market Structure Spectrum’, it can still be a highly competitive market. The characteristics are well-documented and key to the degree of competition within any oligopoly is the number of competitors and extent to which there are barriers to entry.

The greater the barriers and the fewer the competitors the greater the power the established firms have. This can then spell trouble for pricing and hence for consumers. The following articles are just some examples of the oligopolies that exist around the world and some of the benefits and problems that accompany them.

Articles

Oligopoly of PSU oil cos reason for high ATF prices The Indian Express, Smita Aggarwal (30/4/12)
Group energy buying hits the UK headlines Spend Matters UK/Europe(18/1/11)
German cartel office probes petrol companies on pricing Fox Business (4/4/12)
Gov’t unveils steps to lower fuel prices Yonhap News (19/4/12)
How big banks threaten our economy Wall Street Journal, Warren Stephens (29/4/12)
UK Governance: Call for Whitehall to simplify the landscape for SME suppliers to win more government contracts The Information Daily (26/4/12)

Other blogs
Pumping up the price: fuel cartels in Germany April 2012
Energy profit margins up by over 700% October 2011
Every basket helps October 2011
The art of oligopoly December 2010

Questions

  1. What are the assumptions of an oligopolistic market structure?
  2. Consider (a) the energy sector and (b) the banking sector. To what extent does each market conform with the assumptions of an oligopoly?
  3. In the ‘Spend Matters’ article, a group of people in a Lincolnshire village formed a local buying consortium to negotiate deals for heating oil. What could we refer to this as?
  4. To what extent is an oligopoly in the public interest?
  5. Explain how barriers to entry in oligopolies affect the competitiveness and efficiency of a market.
  6. Illustrate how an oligopolistic market structure can fix prices and hence exploit consumers.
  7. How have the actions of the big oil companies in both the UK and Germany been against independent retailers and the consumer interest?
  8. What action can governments take to break up oligopolies? Will it always be effective?

You’ve probably heard of Groupon. If you join its emailing list, the company will send you daily details of deals in your area that it has negotiated with local retailers. If you want to take advantage of any particular deal, you sign up for it online and if enough people do so to reach a minimum number agreed with the retailer, Groupon will bill your credit card. You then download the voucher and use it to purchase you discounted item or service. Discounts are often substantial – 50% or more.

But are these deals as good as they seem? On 2 December, the UK’s Advertising Standards Authority took the decision to refer Groupon UK to the Office of Fair Trading, following 48 breaches of the advertising code of practice in eleven months. It referred complaints about Groupon’s:

• Failure to conduct promotions fairly, such as not making clear significant terms and conditions
• Failure to provide evidence that offers are available
• Exaggeration of savings claims

And it was not just consumers who had complained. Many retailers found that so many people signed up for certain deals and the discounts were so great, with Groupon often charging the retailer half the discounted price, that retailers made substantial losses on the deals. One example was a cupcake maker, Rachel Brown, who runs the Need a Cake bakery in Reading, Berkshire. She had to bake so many extra cupcakes below cost that profits for the year were wiped out.

So what is the nature of this market failure and how appropriate are the competition authorities for dealing with it? The following webcasts and articles look at the issues. They also consider the growing problems Groupon faces in the market from new competitors.

It has not been good news recently for Groupon and it’s hardly surprising that, following Groupon’s flotation on the Nasdaq stock exchange in the USA last month, and an initial surge in the share price, its shares have since fallen by over 40%.

Webcasts

Groupon investigated by OFT Channel 4 News on YouTube, Benjamin Cohen (2/12/11)
Time to Jump Off Groupon Bandwagon? Newsy (24/11/11)

Articles
Groupon to be investigated by Office of Fair Trading Guardian, Mark Sweney (2/12/11)
OFT launches investigation into Groupon advertisements BBC News (2/12/11)
UK regulator launches Groupon probe Financial Times, Michael Stothard (2/12/11)
Groupon investigated by UK advertising authorities ZDNet, Eileen Brown (5/12/11)
Deal with it: Groupon ponders its future Independent, Stephen Foley (6/12/11)
Groupon’s Business Model Doomed To Fail Seeking Alpha, Mazen Abdallah (5/12/11)
Small Businesses Hate Groupon LiveOutLoud, Loral Langemeier

Competition authorities sites
ASA refers complaints about Groupon to OFT Advertising Standards Authority (2/12/11)
Investigation into the trading practices of MyCityDeal Limited (trading as Groupon UK) Office for Fair Trading (2/12/11)

Questions

  1. What market failings are there in the discount voucher market?
  2. What to retailers gain from dealing with companies such as Groupon?
  3. Do small businesses have anyone other than themselves to blame if they make a loss from doing a deal with Groupon?
  4. What should be the role of the competition authorities in the discount voucher market?
  5. Is Groupon’s business model ‘doomed to failure’ and if so why?
  6. Does Groupon have a ‘first-mover advantage’?
  7. Are there any barriers to entry of new firms into the discount voucher market? If so, what are they? What are the implications of your answer for the future of Groupon?