Mobile Phone Providers

phones

It has come to that time again; I must renew the contract for my mobile phone. I have recently suffered at the hands of some frustrating customer service by O2, but there is not substantial enough incentive to change provider.

I had a browse around the different providers and packages available, whether it was to keep my current phone or to switch to a new phone and contract. What I soon came to realise that even though no provider would admit it there was to a degree extreme inter-dependence with the pricing and packages available. The only factors that could persuade me were additional benefits (such as O2 with priority tickets), advertising, or offering a marginally lower one off payment for the actual phone.

I was looking to change my phone to the current iPhone 5 and for a contract with at least 1 gigabyte of data, alongside unlimited calls and texts. For example (24 month contracts):

o2-customers-vent-frustration-after-network-down-hours

O2

The Cost (Per Month): £37
Phone Price: £49
Package: Unlimited Minutes & Texts, and 1GB Data
Total Cost: £937

Vodafone-logo3

Vodafone

The Cost (Per Month): £42
Phone Price: Free
Package: Unlimited Minutes & Texts, and 1GB Data
Total Cost: £1,008

ee

EE

The Cost (Per Month): £41
Phone Price: £30
Package: Unlimited Minutes & Texts, and 1GB Data
Total Cost: £1,014

three_mobile_logo_520x300x24_fill

Three

The Cost (Per Month): £34
Phone Price: £49
Package: 500 Minutes, 5000 Texts, and Unlimited Data
Total Cost: £865

Now it is evident that each package is different in its own way, and but it really comes down to the preference of the consumer, whether they want to pay a large monthly bill, or have little or no one payment for the device. Currently, it can be noted that this market is a great example of oligopoly.

It is clearly difficult for the consumer to decide which package offers the best all-around service, and the advantage EE have with 4G service is only temporary as the other providers are going to catch up. These are currently the four biggest firms, with other small firms still operating offering alternatives such as Tesco mobile, and the inter-dependency defines the oligopolistic nature.

The firms don’t heavily compete on price, but tend to increase advertising campaigns, or offer a range of benefits. O2 offers customer’s priority tickets to music and sport events alongside general offers from brands and food stores. Vodafone also creates offers from high street brands, and food stores, but also has the best roaming packages. EE has their current 4G network coverage, and most diverse coverage as a result of connection with T-Mobile and Orange. Three is the only to offer unlimited data in their packages, but then restricts minutes and texts and questionable coverage abroad.

Although I do not feel customer loyalty towards O2, I feel like it is more convenient to stay with O2 so keeping my number won’t be a difficulty, and I have already become accustomed to their online services. One factor which I have not yet covered though is the surcharges as a result of exceeding the data limit, currently it can be noted that the mobile providers are making the most profit out of data services as a result of the popularity of smart phones.

There is also the age long issue of small print. Currently providers seem to subsidise the cost of smartphones to an extent that it makes it attractive to switch to a new one every year. What consumers most often don’t realise is that there are various service charges, and unbelievable surcharge rates. It can be increasingly frustrating as you are told rather clearly the monthly bill and the upfront cost but they fail to directly mention the actual long term operating cost.

The industry in itself can be seen as a huge bundle of inter-dependence which in no way is really benefitting the consumers, the firms don’t want to compete on price, so they try to persuade with consumer benefits and advertising. O2 (under Telefonica) and Vodafone are an example of two aggressive advertisers and they currently fight for market share in the UK, this can be seen as a classic example of game theory where they have reached the Nash equilibrium where they both advertise.

This market is particularly frustrating as it seems that with your choices that you are in a scenario where you pick the lesser of two evils, rather than one standing out as the clear best choice. I can complain but the situation in the United States seems to be far worse, there is the situation where a consumer looking for the best coverage for a smartphone is forced into a duopoly between Verizon and AT&T. They not only have high initial payments for the devices, but then continue to have confusing plans which are separate for data and calls. The packages fail to offer a middle ground for consumers, meaning that if there are certain requirements such as more data the consumer jumps to a higher price level.

For now it looks like I will stick with O2 and an iPhone as after searching through different phones and different plans, nothing seems to incentivise me to move away. I already know how to deal and put up with customer services, although I wish that paper billing was not a part of the past, as it was great to see a breakdown of calls, texts, and data usage.

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Barriers to Entry, Profit, & Price

Examine The Impact of an Increase in Barriers to Entry on Prices & Profits:

Barriers to Entry: The inability for a firm to enter the market due to infrastructural, legal, cost, financial, and brand barriers. If there is a high cost to enter the market it discourages smaller firms from entering, therefore limiting competition. This is why high barriers to entry are a signal of the existence of monopoly or oligopoly power.

Normal Profit & Abnormal Profit: Normal profit covers the average total cost of the firm, whereas the existence of abnormal profits means the firm can reinvest the profits into R&D, increase the wages of workers, and pay-out dividends to shareholders. Abnormal profit identifies the existence of monopoly or oligopoly market structure.

If there is an increase in the barriers to entry for a given market it may mean that the market becomes:

  • Less competitive
  • Greater representation of monopoly or oligopoly structure
  • Possible increase in profits for firms
  • Possible increase of prices, since less competition or substitute goods means that the firm could become a price setter rather than taker.

A comprehensive example of increasing barriers to entry having an effect on prices and profit can be identified in the car industry for hatchbacks within Europe. Volkswagen is notable for their immense economies of scale, therefore posing a high barrier to entry for their share of the market. Volkswagen is able to offer affordable hatchbacks and still maintain a high quality product without incurring a loss and maintaining the majority of the market share. However, their main rival PSA Peugeot Citroën is able to create cars of a similar standard but at a marginally higher price.  These are the two biggest firms in the hatchback market, since they already have a foothold in the market, and successful brand recognition it makes it difficult for firms like Kia to enter the market.

Due to the existence of market power through the high barriers to entry Volkswagen and PSA have an oligopoly like relationship within the hatchback market. Therefore, both firms have abnormal profits and tend to have similar prices while pushing out possible foreign competition. Shown below is a graph exhibiting a kinked demand curve and the market of hatchbacks.

Picture1

The above shows limited competition on price. The higher marginal cost of PSA can be justified by the lack of economies of scale similar to Volkswagen, meaning they will not be as efficient or productive with given resources. Shown on the graph is the hypothetical point at which Kia were to operate, they would suffer from high marginal costs at a restricted quantity of units due to export/import fees and the cost involved in the transport of the cars. There is also the issue that Kia does not have the same brand recognition as PSA or Volkswagen.

If the barriers to entry were to increase there would be a greater difficulty for the firms such as Kia to enter the European market. This is what establishes the oligopolistic relationship between Volkswagen and PSA. Barriers to entry are what ultimately cause the formation of monopolies or oligopolies. This then has a consequent impact on the prices of products in a certain market (a possible increase) and a greater opportunity to reach a point of abnormal profit through profit maximisation.

Evaluation:

There are various methods of getting around the high barriers to entry, but it would require a firm to either innovate or be able to obtain investors to help launch it into the market. Kia could offer cars with newer technology, better engines, and greater fuel efficiency in an attempt to win market share within Europe. Kia would probably have to compete on price and offer more in a car than the firm’s rivals. Kia will benefit from cheap East Asian production, but there are still issues surrounding the transport of the vehicles. To circumnavigate the high barriers to entry the firm must be willing to take on debt to attempt to pay high fixed costs, or attract investors which would usually require innovation to persuade investors away from the dominant firms.

The diversification of the market for hatchbacks would benefit the consumer, as the firms are more likely to compete on price as well as offer cars with better base packages (i.e. included option in the car such as xenon headlights). However this may create an unsustainable loss for firms like PSA who suffer from a high fixed cost of wages due to its central production being based in France. PSA has already begun to lose its position as the main competitor of Volkswagen as Ford has vigorously entered the market.

Overtime the high barriers to entry may fall as there is greater symmetry of information in the market, as well as the reduction of the impact of economies of scale through the development of new technologies and tools that can produce cars more efficiently. There will always remain however the high fixed cost of the factory, but over time the issue that will affect firm’s profits and the prices of cars will be the variable costs such as where materials are sourced.

This is why the example of the car industry is good for displaying the effect of barriers to entry, and their entailing effect on the price of the good; as well as the potential for normal or abnormal profit within the market.

Oligopoly Vs. Monopolistic Competition Air Berlin Case Study

Case Study: Air Berlin

Theory of the Firm Analysis

Fixed Costs:

  • Airplanes
  • Labour (salaries)
  • Airport Facilities

Variable Costs:

  • Fuel
  • Landing Fees

Define Fixed Cost: A cost that does not vary with output

Define Variable Cost: A cost that varies with output

The airplane is a fixed cost as once it is paid for the only variance in cost is through its operation. In the article it is mentioned that they look to sell 8 airplanes in the interest of reducing fixed costs as to reintroduce capital into the firm. An airplane in the majority of cases is bought outright, and this is established by the firm’s ability to sell it.

The fuel is a variable cost due to the possible change in price of fuel supplied to the airlines. The price of fuel is dependent on the microeconomic relationship of supply & demand, as the more routes an airline runs the more fuel it will need to purchase. In the article it identifies that jet fuel prices are “highly volatile” suggesting that this cost changes dependent on output.

The second variable cost is the landing fees, as more airplanes fly the greater the landing fees, as more airplanes have to pay the fee. There is also the nature of the cost of landing fees which may change; this is identified in the article through competition with Lufthansa for a central hub.

Case for Oligopoly:

Main Factors:

  • Interdependency
  • Competition
  • Etihad (market power)
  • Sustained Losses
  • Abnormal Profit & Reserves

Interdependency is a clear signal of oligopolistic competition, this is identified in the article as the need to develop a new airport. To continue competition both Air Berlin and Lufthansa must expand and open new routes, which is why there is the development of another central airport in Berlin. Currently, Lufthansa have an advantage as they have more docks for airplanes at “Tegel Airport”

There is clear evidence of competition with Lufthansa, as Air Berlin is stated to be the second-largest airline in Germany. This means that domestically the two big players are Lufthansa and Air Berlin, but the article goes on to mention the involvement of Etihad Airlines. The article also identifies that there is the intention of competition in the long run against alternative airlines, as Mehdorn states that “We want to strengthen our profile as an airline company… we need long-haul flights.”

The fact that the losses of the firm are being sustained provides clear evidence that Air Berlin is part of an oligopoly. Firstly, losses being sustained shows that the firm is not part of perfect competition, in perfect competition the firm will stop production the moment losses are being made as it is “easier” to stop producing rather than leave the market altogether. Secondly, the sustaining of losses means that at point in time the firm was making abnormal profit to build cash reserves, a firm that operates with abnormal profit is at a point of monopoly, but Air Berlin still has its competitors.

Due to the various competitions in the domestic sector mainly between Air Berlin and Lufthansa it can be argued that a kinked demand curve is in play in the German airline sector (as displayed below).

Picture2The above graph shows that they are not competing on price, this is clearly identified in the article as there is only the mention of reducing costs, introducing more routes, greater output (new airport), and airline unions (i.e. One-world Alliance). Lufthansa is shown to have a lower marginal cost due to economies of scale, as Lufthansa is a considerably bigger airline globally and in Germany in comparison to Air Berlin.

In the long run Air Berlin may be able to cut its costs down so that there is a return to normal profit, and with the eventual opening of BER the firm will be able to effectively expand and possibly compete at the same level as Lufthansa. However further delays in the opening of the new airport may mean that Air Berlin will continue to eat into their cash reserves, as stated by the article the costs per month are approximately €5 million will slowly degrade the €100 million in cash reserve. In the article it is stated that Air Berlin is selling airplanes to reduce their fixed costs, while this is appropriate action in the short run, in the long run it may mean that the firm will fail to fully utilise its new facilities of the new airport.

Case for Monopolistic Competition:

Define Monopolistic Competition: The existence of monopoly for a given firm at a given period of time in the short run. The firms in the long run will compete on price and other factors (e.g. branding, quality, etc.) eventually losing monopoly power over time as firms begin to differentiate less.

Main Factors:

  • There are Many Airlines and Consumers, and no Firm Has Total Control Over Market Price
  • Existence of Asymmetric Information
  • Independent Decision Making
  • Limited Barriers to Entry & Exit in Long Run

It is clear that there are many firms in the airline industry within Germany, and that there is a spread of consumers across the different airlines. It can be argued that no firm has clear control over market price based on external information, airlines often compete on price for specific dates or near certain events, and since there is the involvement of international airlines there is no single firm with complete control over market price.

There is clear evidence of independent decision making by Air Berlin. The first independent decision was to make a move to a new airport to act as a central hub so the firm can expand; Lufthansa had not taken any action in particular to cause this move, and it is likely that Air Berlin would have done this regardless of Lufthansa.

There is to a degree an ability to enter and exit freely into the market, this is identified by Air Berlins ability to sell airplanes, reduce unprofitable routes, and as a result reduce marginal cost. There are many competitors in the airline industry, Air Berlin could sell all of its airplanes, docks, and facilities to an international airline, or even sell parts to Lufthansa. There is the possibility of a clean exit, however in the airline industry there are many barriers to entry due to the cost of airplanes and facilities.

Picture1

The diagram above shows the short run loss of Air Berlin, it can be noted that there is a shift in marginal revenue and therefore average revenue as the article states that Air Berlin begins to lose customers. There is also the issue of high fixed costs which drives the average cost curve above average revenue, as the cost of the new airport facilities is considerable.

However, in the long run it can be argued that Air Berlin shall return to a point of normal profit. This is because there is the intention to sell eight airplanes to reduce those high fixed costs. There is also the mention of introducing long haul flights and the reduction of unprofitable routes which is the reduction of the supply to meet demand. This is shown in the diagram below as the firm returns to a position of normal profit.

Picture3