British supermarkets - oligopoly case study

The UK has had four 'big supermarkets' since the 1980's. The market changed from one where the largest retailer held just 7% of the market to one where the largest, Tesco' had more than 25%. The chart below shows the 2014 market shares (the article linked below has a more up to date set of data, which you should compare).

Note that while there is technically a 'Big Four' the relative market shares of the four vary considerably.

Economic theory tells us that in the oligopoly market structure there are significant barriers to entry and firms are highly interdependent. It also tells us that there is a strong likelihood that firms will avoid damaging price wars because they fully understand their mutual interdependence and they all loose if they compete on price.

The article below describes how Asda are loosing both sales and profits as the market fights exactly the sort of price war we have been led to believe won't happen. This is because there are several players trying to gain additional market share. This is Aldi and Lidl, who are aggressively expanding.

So what is wrong with the oligopoly theory in this case? Actually nothing. There are strong barriers to entry in this market. The existing players have strong brand loyalty and occupy many prime locations, and they have the money to fight by advertising and discounting. However Aldi and Lidl have the money to fight too.

The barriers to entry are not high enough to prevent them entering the market and engaging in a price war. Their tactic is to sell cheap, the existing supermarkets like to emphasise quality as well, but that isn't enough to stop them.

The supermarket market is contestable if you have the financial reserves to obtain the stores and accept low profit margins. 

Who are the winners? Consumers are getting lower prices as a result of this competition, also the 'monopoly power' of the biggest players is falling which will make it harder to raise prices in the future. 

Who looses? The existing firms for sure. However suppliers of the supermarkets are coming under pressure to cut their prices so the supermarkets can cut theirs due to the market power of supermarkets as buyers. There are already stories of farmers who cannot survive on the prices they receive and other firms feeling 'bullied' to cut prices or lose the contract.

The BBC covers the story here

Work out the changing four firm concentration ratio in this market. Google can provide charts that show shares that go back further than 2014.

This article is most appropriate for IB students who require a firm understanding of how oligopoly markets might work and need examples they can compare to theory. VCE students do require a knowledge of market structure and so it is still useful for them.

Collusion but not a cartel or price fixing

The ACCC is taking action to try to close down a website where petrol retailers share information about pump prices.

It would seem that the site, which is a private members site, goes as far as to share information about proposed price changes.

The ACCC believes that this is collusion and against the public interest. It prevents proper competition and so means petrol prices are higher than they would otherwise be.

It should not be a surprise that an oligopoly market structure like petrol retailing leads to some sort of interdependency. But is this collusion? The counter claim is that the information shared is available in large, neon, signs outside petrol stations. Also the nature of the market means that firms charge similar prices and those prices move together.

It is very hard to see if this is collusion or just normal oligopoly behaviour (tacit price leadership). The case will depend on if price changes are discussed in advance. Then it is collusion and there is plenty of case law to support this as the sharing of the information clearly jointly benefits firms interests and works against consumer interests.

Great example if required for the upcoming exam.

The Age covers the story here

Unfair practice? ACCC takes action against Jetstar and Virgin

When a market is an oligopoly the chances of tacit collusion is high. There are only a few airlines operating in the Australian domestic market and the ACCC believes they are operating unfairly.

The issue is the way the airlines advertise a price and then add fees as the booking progresses. The particular issue is how there is a charge for using normal methods of paying.

The ACCC is taking legal action because they feel that it is the low level of competition which is the cause of the problem. 

The ACCC argument might be this. The airlines are deliberately hiding the fees to make them look more attractive to customers. Because the airlines know that they will both make more money by doing this they don't try to compete the fees away. If there was true competition then these high fees would be reduced as an airline started to advertise 'no hidden charges'. 

It is the role of the ACCC to look for market failures due to monopoly power. In this case they may have a point. Customers are being mislead. However if the practise was stopped would the 'headline' airfare rise by the same amount?

The ABC report the story here

The protection of QANTAS raises fares for passengers

Australia likes to protect its jobs, regardless of the harm it does to the bulk of the population. This has been a hard road for politicians to travel but many barriers to competition and trade have been reduced since the Hawke/Keating governments.

But the airline industry remains an area where the government allows significant barriers to entry to remain. There are two specifically:

1. QANTAS must be at least 51% Australian owned
2. International carriers need permission to fly into Australia

The result is that an oligopoly market in air travel with high barriers remains both within Australia and flying internationally. The result is that airfares are higher and service standards lower than would otherwise be the case.

The government are considering relaxing the rule on QANTAS ownership. This would allow a foreign carrier to buy the airline and operate it. They would be less sensitive to Australian jobs, such as servicing the aircraft abroad, but passengers would benefit from lower fares due to reduced costs.

However the best thing the government can do is sign up to the 'Open Skies' policy that operates in most of the developed world. Any airline can fly to and from a country as long as there are take-off and landing slots spare. This intensifies competition and lowers fares. The evidence suggests that international  air fares in Australia are considerably higher than for comparable journeys.

Currently the government will not grant any more flights to foreign airlines, even though they ask on a regular basis.

Imagine if Etihad, Emirates, Thai, Singapore and all the other big carriers could fly into Melbourne six or seven times a day. Plenty of spare capacity and so cheaper seats available. Some jobs would be lost at QANTAS, but more would be created by other airlines and all travellers will benefit.

Competition works and its about time the government let it.

The reaction to the QANTAS proposals is reported here

Wikipedia on Open Skies here