The UK car market

If there was only one car dealer in an area then it would be a pure monopoly and the dealer can charge a price which includes a high profit margin.

Economic theory shows that a profit maximising monopolists will produce up to the point where MC=MR in other words where the cost of the last unit produced is just covered by the revenue of the sale of the last unit produced. In the diagram below at the output level q the price is P and cost is C total revenue is OPAq while total cost is OCBq. This means that the monopoly is making a profit of CPAB. This is described as abnormal profit. It is also not the most efficient level of output because costs are not minimised.

Diagram 1

In most local areas there will be several different dealerships with none of them having a monopoly. What would be expected here is that as other dealerships set up they compete for part of the market and the demand curve for the original one dealer will shift to the left reducing abnormal profits eventually to zero as in Diagram 2 where it can be seen that price is equal to average cost and the firm is making normal profits.

Diagram 2

The market however is in fact more complex because what seems to happen is that dealerships in the context of their agreement with the manufacturer continue to make large profits by accepting the recommended retail price (RRP) set by the carmaker. Dealerships then go on to compete on the basis of other aspects of the product apart from price. Dealerships are known to have a margin of around 10% on the price in which to offer discounts, extras and better trade in deals but local dealers have no other flexibility because the price is determined by the maker.

The only part of the market where competition seems more intense is the small car market which have seen prices fall by nearly 16% but all other sectors remain overpriced.

II

According to European commission when reported on car prices in 1990's carmakers unofficially referred to the UK as "Treasure Island" because they could charge some of the highest prices in Europe to their UK dealers. In 1998 for example the commission found that the UK was responsible for the highest prices in 57 of the 76 models surveyed. At the time the prices were in some cases 45% higher than in the cheapest EU countries.

In a recent article in The Observer Geoff Seymoure of Alliance and Leicester which publishes the monthly car price index with What Car Magazine pointed out that the difference in price has now risen as high as 50% for some models. Consumers have been getting a better deal only for small cars but not at all for the rest of the ranges. The reason for this is not just the Block Exemption alone but also such factors as exchange rates, taxes and geography. These four factors together make UK car prices much higher.

The Block Exemption is seen by many as the main problem in getting lower prices for the UK buyer. The manufacturers are able to charge dealers in different countries different prices. In economics it is called price discrimination. The following diagram 3 shows how a monopolist can make different profits for the same product in different countries.

Diagram 3

In market A demand is more inelastic than market B and so the price manufacturer can charge is much higher. The UK is treated as such a market by carmakers. While it is more difficult for them to separate other European countries in this way.

Price discrimination requires markets to be separable before it can work otherwise the product sold at a cheaper price in one market will find it's way in to the other market where the products are more expensive.

Exchange rates have also played a role in price differences. The European commission has reviewed the car prices every six months since 1993 and when studied showed that following the appreciation of Sterling in 1996 and 1997 contributed to widen the difference in prices. Dealers were not passing on the advantages of a stronger pound to consumers. there is another side to exchange rates and that is that it confuses consumers. The recent adoption of the Euro apart from UK has meant that buyers can see clearly the differences in price. This is known as price transparency. While the UK buyer still faces the barrier of exchange rates.

Taxes differ from country to country but it is known that the British motorist is taxed among the highest in Europe. New cars of all makes are subject to car tax while imported cars also pay import duties. This should mean that cars made in Britain should be cheaper than cars made else where but this is also affected by differences in exchange rates and cost of manufacturer. In Europe however prices have been seen to become similar despite all these differences, not so in the UK.

Carmakers have also exploited the geography of the UK in two ways. The first is the difficulty that a UK buyer faces when trying to buy a car on the continent and bring it to the UK. The carmakers have always discouraged their continental dealerships from exporting cars into the UK market. This allows them to continue to price discriminate. Secondly the UK is the only right hand drive country in Europe and so car makers restrict availability of right-hand models making the left hand models less desirable to British consumers.

III

The Block Exemption creates local monopolies and the carmaker through dealerships controls the wholesale price, the retail price and servicing package. That leaves dealerships to compete with other car dealerships in a limited way. If the Block Exemption is removed it would mean that car dealers could in theory sell more than one make of car that car suppliers would be less able to charge higher prices in the UK because dealers would be free to buy cars from European based car dealers.

The Block Exemption in economics is described as a barrier to entry. It restricts competitors from entering the market and selling the same product. It's removal would allow for instance two garages in the same region if not several all choosing to sell the same makes of cars.

The economic model of competition shows that not only do firms in the competitive market make lower profits but the prices are driven down and the firms themselves are more efficient driving cost to their lowest level. In diagram 4 below it can be seen that when profits exist new firms enter the market and price comes down.

Diagram 4

In the diagram the BEFORE situation is a firm making abnormal profits of PBXYC. This attracts new firms to enter the market. As they do so the price eventually falls from PB to PA. The AFTER diagram shows the firm making in economic terms normal profits which is the minimum level of profits needed to keep the firm in the industry.

Competition in the real world is more complex than the model. Removing the Block Exemption will open up the car industry to more competitive practices and help to achieve what the Department of Trade and Industry (DTI) has been trying to do that is get cheaper cars.

With the abolition of exclusive dealerships arrangements more car dealers will set up multiple brands both in local and regional areas as well as national retailers like supermarkets and internet companies. A number of supermarkets such as Tesco and Sainsbury are keen to enter the car market which would increase the source buyers can use. Virgin Cars already offer an Internet service to car buyers.

The UK consumer will also be free to use other dealers for servicing allowing them to be less tied to the supplier's recommended dealer. The Guardian 1999 found that most new car buyers were dissatisfied with the service provider and would have preferred to choose non-franchised service providers who offered cheaper service.

Carmakers would also have to allow suppliers on the continent to enter the UK car market. This would remove their ability to discriminate in terms of price in the UK. Since UK consumers would be more exposed to the whole European market manufacturers would have no choice but to reduce prices.

Competition would then intensify between car producers and the benefits that fleet buyers (car rental companies) benefit from at the moment, in some cases getting cars cheaper than dealers pay for cars, that they buy to sell to private customers.

To summarise prices will fall through out the industry in terms of the car price and the removal of complex selling packages which between finance deals, insurance, servicing etc hide the true price of the car. Consumers will be able to buy a no frills car as they do on the continent. They will also get to choose cheaper servicing. They could go to any car dealer anywhere in the country or in Europe. Suppliers recommended retail prices would become impossible to enforce allowing free competition.

Anton Bayanov 01234374