Fig 1.
Price
An Inelastic demand curve
Quantity
Within the UK Car industry the market is positive (in the sense that it is a normal good, which can be defined as, when income increases demand increases) and elastic, fig 2, which means it is very sensitive to income elasticity of demand, and highly dependent on rising income. Generally a rise in income will shift the demand curve to the right, which means an increase in cars sold. The reason for an increase in demand of automobiles, when income increases is because cars are an expensive item, so consumers are more likely to spend when disposable income is high.
Fig 2.
Income
A Positive and Elastic (IED)
Quantity
Economic theory predicts a lot about pricing strategies in the UK Car Industry: The major pricing strategy among firms in this market is to base there pricings the same as there rivals, and compete on Non-price issues. An example of a Non-price issue is advertising. A company can increase market share, differentiate their products from others in the market, and increase barriers for other industries to entry by running a successful advertising campaign. Another Non-pricing strategy is the role of brand image. A strong brand image gives the perception of having few substitutes, thus trying to make the demand curve more inelastic, so the manufacturers can increase price by a higher percentage than they would lose in demand. For example an increase in price by 5 percent, and a decrease in demand by 2 percent, would lead to higher profits.
The UK Car industry is based on collusion between firms, and they can easily Price discrimination against the consumer. The market tends to have few price wars, thus increasing profit and avoiding the prison’s dilemma. Another benefit for the manufactures is they can limit prices low enough to make a profit, but high enough to not attract new entries, this is used in conjunction with other factors for example economies of scale. Economies of scales form a big part of the UK car industry, which has a Minimum efficient scale of 200% of production (lecture notes). This is incredibly high, and is used when determining pricing lists. As new entries cannot afford to charge the same prices and still cover their average costs like the existing firms can. (See fig 3)
Fig 3.
AC
New entry
Est. Company
Quantity
2.
It’s a complicated issue as to why UK consumers are paying more for Cars than their European counterparts. A major reason though is the EC regulation 1475/95 which is a block exemption and allows manufacturers to enter into Selective & Exclusive distribution (SED) agreements with dealers. This is extremely bad news for UK consumers as the dealers that the manufacturers choose to sell their cars in affect have a monopoly over there selected area. The Manufacturers have power over the dealers to set price lists and determine sales targets just to name a few, which means the market is continuously driven by manufacturer supply rather than customer demand.
Another reason why consumers in the UK are paying more for cars than in Europe is because many manufacturers continue to place obstacles in the way of people trying to buy their cars more cheaply in Europe. Consumers' Association Director, Sheila McKechnie, says "By continuing to give consumers misleading and inaccurate information about the availability of grey imports' for individual customers, UK car dealers are able to keep the price of cars in UK higher than anywhere else in Europe". This is affect price fixing. Sheila also states "One of the barriers created by manufacturers to deter consumers from buying a 'grey import' is to make servicing or sourcing of spares difficult. Other tactics include frightening consumers by exaggerating minor technical differences or performance problems that can be fixed very easily." (Which, website)
Consumer’ Associations like ‘rip off Britain’ feel that the higher discounts given to fleet buyers, normally between 17 and 35% of recommended retail price (PPR) is pushing up prices for the average consumer. As they feel that the normal consumer only receives a 7-8% discount because they are in affect subsidising the fleet companies within the UK. (Mintel Car retailing 2002).
When Manufactures set their price lists there is a number of factors that influence their decision, but the most important was the prices of their competitor’s cars. No manufacturer wants to undercut each other, and start a price war. As this would not benefit anyone apart from the consumer. Manufacturers tend to compete on non-pricing issues, like creating a strong brand image, or offering discounts to customers, like stated in question one.
Consumers are misled and pay higher prices as a result of pre-registering. Pre-registrations are used to enable suppliers to achieve sales targets without setting a true market-clearing price for their new cars, thus helping to sustain high wholesale prices. (Competition Commission report.)
Currently in general terms, transfer prices of imported cars to the UK are higher than between EU members, this is due to manufacturers basing the cost of importing on their prices list within the UK. The differences could also be to do with the higher distribution costs in the UK or higher costs of producing right hand cars. For example some manufacturers add an addition costs to there prices. Like Vauxhall add between £200-£300 per car of producing right hand cars (RHD), which is an extra cost for the UK public have to pay (Competition Commission report.)
Manufacturers also price discriminate against the UK consumers.
Other influences that effect the difference are: exchange rates, differences in taxation between countries, relative levels of discounts and financial benefits, differences in specifications, and differences in the prevalence of trade-ins and in residual values of used cars.
3.
The pricing strategies would change if the UK were to withdraw from the European Car block exemption because competition would increase, and the market would become completely different. Instead of having an inelastic demand curve the market would turn more elastic, (fig 4). Meaning that if the customer wasn’t completely happy with the price or service they were getting they could simply switch manufacturers. The pricing strategies manufacturers could adopt would then be more competitive, and price related instead on focusing on non-pricing strategies like marketing and brand image.
Fig 4.
Price
An elastic Demand curve.
Quantity
Some of the pricing strategies could be: -
-
Penetration pricing, which is used by new firms to get a foothold in the market, and gain market share.
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Expansion pricing, which using factors such as economics of scale to enable low prices to be charged while securing profits.
-
Destruction pricing, this could be used by existing firms but is unlikely. The strategy includes deliberately pricing at a lose-making price in order to destroy the competition. Thus trying to make the market more of a monopoly by limiting the number of suppliers.
Because of the variety of strategies that could be used Game theory and especially the prisons dilemma would be harder for the manufacturers to predict, as they would not have a tacit collusion over the market like before and be able to fix prices. New firms entering the market would want to offer lower prices in order to gain market share.
Another factor that exists in a non-collusive oligopoly the kinked demand curve, Fig5. This is where price stability is preferred. If a firm was to increase its prices, the rest of the industry would not follow resulting in the firm losing out on market share and profit as customers would just switch to the lower priced suppliers. Alternatively if the firm was to lower prices it could start a price war, and end up with lower profits because all the other firms would have to lower prices. (Business Economics 2nd Ed).
Fig 5.
Price
Elastic
A kinked demand curve
Inelastic
Quantity
The main consumer benefit would be the price cuts due to the abolishment of the Selective and Exclusive distribution channels. This would give other firms like Tescos and Virgin the chance to enter the market and buy straight from the manufacturer. Also the Manufacturer’s wouldn’t be able to demand a certain number of cars supplied to the suppliers, insist on sales targets for them to reach, create bonus structures, set price lists, and dealer margins, etc. All this means greater freedom for the dealers, which will benefit the consumer in a way that it should lead to lower price lists, and greater freedom when purchases cars within the UK. Another benefit to the consumer if the block exemption was removed would be the easy accessibility of servicing and spear parts.
The standard of quality for the cars should also increase, as at the moment manufacturers know there is not much chose on the market, but if it was made easier for new manufacturers to exist in the UK market. Quality should increase in order to keep market share, as it would be easier for consumers to switch manufacturers.
Also dealers would be able to sell more that just one manufacturers type in their showroom, thus offering more chose for the consumer under the same roof.
7. Bibliography
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Mintel (2002) Car retailing, Mintel Marketing Intelligence, 19th April.
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Mintel (2000) The UK Car Market, Mintel Marketing Intelligence, 11th September.
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http://www.competition-commission.org.uk/reports/439cars.htm, accessed on the 20th May 2002, at 7.30pm.
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Business Economics 2nd Edition. (2001) Win Hornby, Bob Gammie, and Stuart Wall. Published by the Financial Times.
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Lectures notes throughout 7508 (Business Economics). Provided by Maureen Pike.
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http://www.which.co.uk, accessed on the 30th May 2002, at 9pm I cited from an article called. Consumers' Association Takes on Car Dealers 'Fixing Market'.
