Uncharted Territory

October 23, 2009

Virgin on the Ridiculous – and All Tied Up

Filed under: Concepts, Consumer gripes, Economics, Markets, Regulation — Tim Joslin @ 8:30 pm

Richard Branson had an entertaining comment piece in the FT today. He was complaining about Sky’s dominance of the premium pay TV channels – predominantly sports and movies. Quite right too, the UK TV market is a big mess. Both the BBC and Sky stifle competition.

One point Branson made tickled me. If the market were functioning better, he claimed:

“Those who do not wish to commit to a 12-month subscription but are willing to pay for some TV channels will be more readily able to do so.”

Readers will remember that one of my whinges about Virgin Media was that they locked me into a 12-month contract. I presume Branson won’t mind if Virgin Media as well as Sky have their wings clipped in this regard.

But what really had me rolling around on the floor was the Bearded One’s description of Ofcom’s proposal, which, naturally, he wholeheartedly supports:

“Ofcom has proposed … making Sky sell its premium channels to other operators at a fair, wholesale price. This would be an excellent result for consumers because it will enable each pay-TV operator to com­pete based on its different strengths. Services will be developed that appeal more closely to the preferences of different customers. For instance, those who do not want, or cannot have, a satellite dish will not need one. … New market segments and more innovative and compelling consumer offers will appear. And they will cost less. Under Ofcom’s proposals, some operators could plan to retail Sky Sports 1 at a price more than 20 per cent below the lowest price that channel can currently be bought from Sky.” [my emphasis]

Absolutely hilarious.

Basically I support this vision – but this isn’t the way to go about changing the industry.

The point is that if Ofcom do this (and how they dream up the wholesale price is beyond me), then it makes no sense whatsoever for Sky to remain as both a service-provider and a channel-provider.

Separating these functions (for all broadcasters, BBC take note) – i.e. splitting Sky up into a service-provider and a separate channel/content-provider – should be the starting point of regulation, not a consequence of it. Breaking down vertical integration in this way is a central pillar of “managed markets”, part of my new political-economic philosophy of “constrained capitalism”.

The central argument is that if I can choose the technology that delivers my TV service and the channels I purchase as entirely separate steps, as Branson describes, then I have 2 dimensions of choice, not one.

There are numerous markets where our dimensions of choice are limited by dominant suppliers. Supermarkets is one. I gather from the hits on my rant complaining about the Cambridge Sainsbury’s misguided promotions and on my wide-ranging discussion of attempts to reduce competition by blocking Tesco in Mill Road and of self-checkout tills in supermarkets, that supermarkets are what the world wants to read about. Back in March when I wrote those pieces I meant to add some further comments complaining about how the Cambridge Sainsbury’s in particular has been gradually replacing branded products with subtly inferior own-brand goods. In my opinion, the texture of Kelloggs’ Sultana Bran is somewhat more dissimilar to that of cardboard than is Sainsbury’s equivalent product. If Kelloggs’ product is good enough for Chris Hoy, then it’s good enough for me. Besides, the Kelloggs box fit in the space in my cupboard in Cambridge and the Sainsbury’s one did not. It was very inconvenient to have to make periodic trips to Asda to stock up on Kelloggs’ Sultana Bran when Cambridge Sainsbury’s decided to just stock their own brand.

The point is that when supermarkets used to stock only branded goods, you had two dimensions of choice: where to shop and what to buy when you got there. The supermarkets specialised in the business of retailing and their suppliers in making the best products.

But what the supermarkets have done over the years is reduce the choice to one: where to shop. Larger stores, the institution of the weekly shop by car and a battle to monopolise the best locations have made it very difficult for shoppers to choose different products at different stores.

Own-brand products are a way of capitalising on “owning” the customer. Why let suppliers have some of the profits? Even if an own-brand alternative is slightly inferior shoppers are unlikely to go to a rival just for one or two items. And after a while they may forget they preferred the brand. Of course, it may not be necessary for the supermarket to ditch the branded product anyway. The threat of introducing a generic alternative may be enough. It must, surely, allow the supermarket to improve the terms of supply and increase their profits.

In the news this week, though is the OFT’s ruling in favour of the status quo on tied pubs. Clearly the practice must increase the landlords’ profits, since, as the FT reports:

“The OFT ruling on beer ties, which obliges pub tenants to buy their beer supplies from their pub landlords at often above-market prices, boosted shares in Punch Taverns and Enterprise Inns by 14 and 23 per cent respectively.”

I doubt the stockmarket is mistaken: if the practice is good for the landlords it must be bad either for the tenant (i.e. the pub manager, referred to in common parlance as the “landlord” – don’t get confused) or the customer. Probably both.

It seems to me fairly obvious that restricting the degrees of choice by the customer must allow the landlord to improve profits. Not all customers are going to go elsewhere for a different pint of beer, though they may well buy something different if it were on offer in their local.

Different industries may have the same feature – an anti-competitive form of vertical integration – but there are peculiarities to each. In the pub business, the landlord is a monopoly supplier to the tenant. It is therefore beyond me how we can find a Simon Williams, “senior director of the OFT” saying, according to the FT, that:

“… it [is] not in the pub owners’ interests to overcharge landlords for their beer. ‘Any strategy by a pub-owning company which compromises the competitive position of its tied pubs would not be sustainable, as this would result in a loss of sales. Pub-owning companies are not therefore protected from competition by virtue of the supply ties agreed with their lessees.’ ”

No, no, no! This is mindblowingly dumb. 101 economics (again): a monopolist does not maximise profits by fully satisfying “demand”. A few seconds thought verifies the sheer mindblowing dumbness of the OFT’s assertion: by their logic the pub owners would reduce beer to a fraction above cost to sell as much as possible. No. The pub owner has an incentive to increase the price of beer until the additional profit is outweighed by the sales that are lost. As I said, many people choose their pub on criteria other than the beer stocked and its price, so the tied pub owner has much more scope to increase prices than an independent beer producer. If customers don’t like it they have to go out in the rain: they can’t simply choose a beer from a different pump.

The Guardian, I now see, also reports the OFT’s decision. As well as the quote above they report some more absurd statements from Simon Williams:

” ‘The interests of the pubco and lessee are aligned.’

This is a bizarre thing to say. In any supply-chain there is competition to capture the available profits. The interests of the pubco and the lessee cannot possibly “be aligned”.

Anyway, let’s go on:

“[Williams] pointed to pub industry closure statistics, suggesting they showed the greatest number of boarded-up sites across Britain’s ailing pub industry were free houses, not ‘tied’ premises.”

Ah, but there’s an explanation for this (well, several actually – the article notes that it is easier to replace a tenant landlord of a tied pub than a free-house landlord). My different point, though, is that, because the pubcos buy in bulk from a small number of brewers you’d expect them to be able to undercut free houses, except the big chains like Wetherspoons.* Damningly, though, Williams notes that:

“…the difference in bar prices between tied and non-tied pubs was very small — lager being about 8p, or 4%, dearer per pint in a tied house — suggesting competition was working well.

Astonishing.

And finally:

” ‘The market can deliver better than any state intervention,’ he said.”

My philosophy is that the state needs to intervene to manage markets. No-one’s talking about setting prices or anything. Yet another ridiculous statement from Simon Williams.

Until recently the state of British pubs was a long way from the top of my list of the world’s wrongs to be righted. But no sooner had I noticed that the legendary Tumbledown Dick is boarded up than I saw the Paper Moon in the same sad state.

We’re losing our history.

And a large part of the reason is because we apparently don’t properly understand competition.

—-
* Note: The buyer power of large organisations is a separate problem in the pub as well as supermarket and many other industries. I’ll discuss this another time.

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