The High Price Of Low Competition.

How competition is the only way to drive prices down.

Consumer choice will always lead to lower prices. This is basic microeconomics and in competition theory the more competitive the market, the lower the prices. This unfortunately does not appear to be apparent in several markets in the UK and it is especially true in markets where demand is derived. Derived demand is basically when you demand a good or service not for its own sake, but for the goods or service derived from it. Transport is an example where customers don’t especially want to sit (or probably stand) on a train to get work because they enjoy the journey, rather, they demand this service because they know it is vital for them to get to work. It is in these markets, transport, utilities, telecommunication networks, supermarkets and the like where there is little competition and thus high prices as a result. Consumers have very little choice but to pay the competitive rate for these services due to the market structure.

The industries mentioned resemble an oligopoly, and market structure with a few firms. It has very high barriers to entry, which means it is usually very difficult for a new entrant or entrants to enter the market because there are usually very high financing costs or even legal parameters preventing new entrants. The problem with oligopolies is that because there is such little competition as a customer you end up paying more or less the same for your goods or services, so firms usually have to rely on non-price competition in order to increase their share of the market.

The global economic crisis has led to a sharp increase in the rate of unemployment and in particular in the UK. This has in turn placed a huge burden on households up and down the country and when you consider inflation is stubbornly high in recent years which reduces spending power, the price you pay for goods and services that are essential has a huge impact on your disposable income. If you look at inflation for a moment (currently 2.2%), if the rate of inflation is higher than your pay rise then your pay has not actually increased because all goods and services around you have increased in proportion, so your nominal wage may have increased, but your real wage (inflation adjusted) has not.

Now if we look at the oligopolies again, take energy for example. There are six major suppliers in the UK. They are EDF, E.ON, N Power, British Gas, Scottish Power and SSE. An important feature of this market structure is collusion. Whether it is deliberate or tacit it does not matter because if one firm reduces its prices then others are likely to follow suit because they know they are selling the same good, so there is nothing stopping a customer from going elsewhere for a cheaper price. Collusion will occur in an oligopoly regardless of the good or service. Energy firms advice customers to shop around for the best rates, the savings will be marginal at best and they only work because majority of people pay above what they actually should, so it balances out.

Five of the six major UK energy suppliers will increase their prices

Even David Cameron weighed in on the debate, exclaiming that he would “force” energy firms to offer their customers lower rates. Ofgem later published a document demonstrated that the simplification of retail energy tariffs would be complicated. Moreover, whilst his intentions may have been good, it has proved futile; customers are going to face high prices regardless.

John Kay in Financial Times last Wednesday alluded to the fact that regulation may actually hamper business activity, not aide or regulate it. Regulation is a surrogate form of competition, it can never and will never guarantee low prices or optimal consumer choice because there is nothing a regulator can do about tacit or overt collusion in a market. If the government wanted lower prices for energy they could break down some the legal barriers preventing newer entrants into the market. If for example there were ten to fifteen energy suppliers firms are likely to lower prices in order to increase market share because consumers would usually go for a firm offering the same good or service at a lower price. As it remains however, the six major firms can effectively charge what they want because they know that consumers cannot go without heat or electricity so they are forced to pay.

  • SSE: 15 October, gas and electricity up 9%
  • British Gas: 16 November, Gas and electricity up 6%
  • Npower: 26 November, Gas up 8.8%, electricity up 9.1%
  • Scottish Power: 3 December, gas and electricity up 7%
  • EDF: 7 December, gas and electricity up 10.8%
  • E.On: No price rise before the end of 2012

The energy sector is not the only market that has squeezed incomes and thus reduced spending power; mobile phone networks are also high on the list. There was a time in which a twelve-month contract was readily available. Again, in a market where there is such little competition the realization that you are more or less going to pay the same rate is again apparent in this market. The fact that T-Mobile and Orange have merged into Everything Everywhere makes matters worse for the consumer because it has reduced its competitiveness even more.

I personally feel that the government needs to make it far easier for new entrants to break into what appears to be closed off markets. There are legal barriers preventing new firms entering transport, so the same firms dominate the market, to the detriment of the consumer. This was the whole point of privatisation, to remove state ownership and open it up to the market, but state ownership has been replaced by private ownership and it is very much closed off. This issue is especially poignant as we see the standard of living continue to fall as a result of high inflation and sluggish economic growth. The fact that essential goods are rising accordingly only squeezes more out of the pockets of those who struggle to keep up with the price increases. Moreover, more competition ensures lower prices, regardless of regulation.

Starbucks: The Bitter Taste Of Success.

Starbucks in hot water over conduct

Starbucks is facing growing criticism in the UK for paying no corporation tax in the last three years and only paying £8.6m in the last fourteen years of trading. Despite revenue exceeding £3bn in that time, they have managed to pay under £10m and have not paid a penny in the last three years. This does beg the question of how a large corporation, with 735 stores nationwide can manage to pay such little tax. Starbucks has announced consecutive losses from 2008 to now, yet they have managed to expand their operations. It is difficult to comprehend how a business can expand its operations, whilst making substantial losses. Starbucks has adopted a rapacious approach to the coffee market in the UK. It is the global coffee chain and it is the leading chain in the UK.

The head of Starbucks operations in the UK and Ireland is a man named Kris Engskov. Engskov was a former aide to Bill Clinton and during Clinton’s election campaign. A strategy they adopted was to highlight the shortcomings of George Bush Snr’s lassies-faire attitude towards large corporations who were avoiding tax. They used several means to draw the elctorates attention towards it, including a host of ad campaigns

“This is the $825bn question. That’s how much foreign corporations operating in the US took in one year. But 72% of them didn’t pay a dime in taxes. Not one dime …” 

The real issue however lies with what Starbucks tell Her Majesty’s Customs & Revenue (HMRC) and what they tell their investors. There does appear to some inconsistencies with what is being said. In 2008, Starbucks filed £26m loss in the UK, yet their CEO Howard Schutlz told an analysts call that the UK business had been “so successful” he planned to take the lessons he had learnt there and apply them to the company’s largest market, the United States. One does not even know where to begin to try and understand the reasoning behind such a move. Such losses would be a grave cause for concern, yet Schutlz seems adamant to replicate this model in a substantially larger market. Schultz even promoted the person who oversaw this substantial loss, a man named Cliff Burrows. Schultz said he was looking forward to Burrows “now applying the same drive and business acumen to leading our US business.” This seems very odd.

In 2009, Starbucks filed a £52m loss whilst the Chief Financial Officer Troy Alstead proclaimed that operations in the UK were “profitable.” This is clearly a contradiction, unless he does not understand what profit is, because announcing such losses that are exactly double of their previous year and to describe overall activity as “profitable” is quite frankly a farce. In 2010, £34m in losses was announced and Starbucks informed investors that sales continued to grow. And just for good measure, in 2011 they announced losses of £33m and John Culver, the President of Starbucks’ International Division told analysts on a call earlier in that year “we are very pleased with the performance in the UK.” How senior figures and investors alike within Starbucks can continue to be unreasonably optimistic despite losses of £145m since 2008 should have rung alarm bells at HMRC, it did not.

If we look at Starbucks competitors such as Costa Coffee, they actually sold less than Starbucks. 2011 sales in Costa were £377m, whilst Starbucks reported £398m. Yet despite achieving greater sales, they incurred much higher costs, £319m that was more than three times that of Costa. Consequently, Costa paid £15m in tax to HMRC and Starbucks paid nothing. Obviously, both companies are separate and would certainly have completely different balance sheets, but Starbucks are the market leader in the UK for coffee, not only have they been around for longer, but they are also have a larger proportion of the market, so how despite greater sales, it cannot pay tax may be beyond the scope of this piece. Moreover, if we look at McDonalds sales since 2008 they exceed £3.5bn, they paid £80m in tax. KFC paid £36m in tax, with sales of £1.1bn; Starbucks paid £0 in tax despite generating sales of £1.2bn.

This episode does raise key questions that may not receive the attention it may ought to have. George Osborne gave a stern assessment of what a lot of people in the UK thought of the benefit system in his speech two weeks ago at the Conservative Party conference. Whilst he is entitled to his opinion on the matter, it would be refreshing to see the same energy exerted at a more comprehensive check on all corporations with regards to tax avoidance and the mechanisms a lot of firms have in place to purposely avoid paying the correct fee. This is not an emotive matter; this is simply an issue of paying what is right. Moreover, this will continue to occur unless more politicians highlight it and if there are the legislative amendments that will fix what appears the loophole that many large firms can exploit.

We cannot demand transparency from a private firm, they have no obligation to disclose such information, and we can however demand transparency from the elected officials who are meant to facilitate business, whilst holding them accountable when necessary.