Monday, December 21, 2009

Costa Coffee's Acquisition of Coffee Heaven

Just few days ago, Costa Ltd, the wholly-owned subsidiary of Whitbread had made a significant breakthrough into the Central and Eastern European (CEEC) market via the acquisition of Coffee Heaven. Costa sealed the deal with an attractive amount of £36 million, which is small compared to Whitbread’s annual capital spending of more than £ 300 million. But there are more to be gained by Costa:

(1) Greater supernormal profits. The acquisition of Coffee Heaven (CH) allows Costa to enlarge the scale of its operation into other parts of Europe. As in this case, CH owns chains of coffee shops in Poland, Czech Republic, Bulgaria, Hungary and Latvia. There are 90 outlets in total. No doubt CH is making losses in recent years. But if the management team of Costa were to be able to turn the fortune around, the economic benefits would be great. A larger supernormal profit is expected in near future.

(2) Faster way to grow. Basically a firm can choose to expand via both internal and external. Internal growth is normally slow. This is because a company may need years or even decades to build a reputation for the good or service it is selling. Once it successfully develops a brand loyalty, through spread of words and marketing campaign it will then enlarge its market pie. However, by acquisition of another brand, the company is almost certain to increase its market share in no time

(3) Easy to penetrate a market. To some extent, the coffee market in CEEC could have low contestability. This means certain high barriers are there. For instance, Costa may need to advertise aggressively to break the customers’ loyalty and also to promote itself since it is not a household brand there. Also Costa needs to consider the pricing policy of its rivals. They might use limit pricing to deter Costa from entering the market. This is a policy of reducing the price of a cup of coffee to a level where new firms may find it unprofitable to enter into the market. Through the acquisition of CH, Costa can immediately win the trust of consumers. Also it can leverage on the expertise of CH when it comes to exquisite taste of Polish people

(4) Saturated market in UK. Costa has more than 1000 stores in UK alone and this could be a sign that coffee market in UK has entered into a saturation stage. It is difficult for them to further grow their market share, unless there is a significant turn in tide for instance, collapse of rival firms, new brand of coffee drinks that take the market by storm or lowering down of business tax

(5) Rising income. At the moment of writing, there are tentative signs that CEEC economies are heading for the better. For instance, Poland showed a surprising economic growth in the second quarter of 2009 and wage growth is picking up again. Meanwhile Czech Republic’s real GDP is bouncing back in 3rd quarter, lifted by the performance of export. Most important of all, the number of middle income earners is rising substantially over the years. As such this will fuel the demand for high street coffee shops (better classified as luxury good with YED greater than 1). In other word, there is still plenty of room to expand

(6) Economies of scale.
It is associated with the fall in long run average costs due to rise number coffee drinks sold. Costa will be purchasing more coffee beans, sugar and related equipments in a bigger scale. This will place them in a better position to negotiate for discounts. Also it is now much easier for them to borrow larger sum of money to expand their operations (if they want to). Banks will normally charge lower interest rates due to solid financial position and better ability to repay. Coffee house with no significant reputation will find it difficult to raise cash. Banks will demand higher rates for the risk they assume

Saturday, December 19, 2009

List of Most Important Definitions For Unit 3: Business Economics and Economic Efficiency

Useful definitions for Edexcel candidates sitting for Economics Unit 3 in January 2010,

(1) Horizontal integration: When two firms in the same industry and at the same stage of production process merge

(2) Vertical integration: When two firms in the same industry but at different stage of production process merge

(3) Conglomerate integration: When two firms in a totally unconnected industry merge

(4) Fixed costs: Costs that do not vary with amount of output produced

(5) Variable costs: Costs that vary with amount of output produced

(6) Average costs (AC): Total costs per unit of output

(7) Marginal costs (MC): An additional cost incurred due to extra one unit of output produced

(8) Average fixed costs (AFC): Total fixed costs per unit of output

(9) Average variable costs (AVC): Total variable costs per unit of output

(10) Marginal revenue (MR): An additional revenue due to extra one unit of output sold

(11) Perfect competition: A market with huge number of sellers, where there is perfect information, firms being price taker, goods produced are identical and there is freedom of entry and exit

(12) Monopoly: A market with only one producer/ Legally a market is considered as monopoly when there is a firm that conquers more than 25% market share

(13) Oligopoly: A market with few large firms which are highly interdependent

(14) Monopolistic competition: A market with many sellers (not as many as in perfect market) and goods produced are identical but differentiated through branding

(15) Revenue maximisation: When firms choose to produce at an output where MR = 0

(16) Sales maximisation: When firms choose to produce at an output where AC = AR

(17) Profit maximisation: When firms choose to produce at an output where MC = MR

(18) Productive efficiency: When firms choose to produce output where long run average costs curve is minimised

(19) Allocative efficiency: A situation where there is optimal allocation of goods & services & it happens where P = MC/ AR = MC

(20) Price discrimination: A practice of selling the same good but to different market at different price

(21) Concentration ratio: The percentage of total sales contributed by the top 3 to 5 firms in the industry

(22) Contestable market: A market with low barriers to entry & where costs of exit is low

(23) Sunk costs: Costs that are irrecoverable upon exiting the industry

(24) Predatory pricing: Practice of selling a good at loss making level in order to drive out competitors

(25) Limit pricing: Practice of selling a good at just below the predicted AC curve of potential entrants to make the entrance into the industry not profitable

(26) Restrictive practices: Tactics used by producers to limit amount of competition in the market

(27) Collusion: Collective agreements between producers which restricts competition

(28) Tacit collusion: When firms collude without having any formal agreement been reached or even without any explicit communication between the firms having taking place

(29) Price leadership: When one firm, the price leader sets its own price & other firms in the market se their prices in relationship to the price leader

(30) X-inefficiency: Inefficiency that occurs when a firm fails to minimise its costs of production

(31) Competition Commission: An independent body/ tribunal set up to oversee UK competition policy & enforce the monopolies, mergers & restrictive practice act

(32) Office of Fair Trading (OFT): Established to promote fair competition & deals with violations under monopoly. Mergers & restrictive practices legislation

(33) RPI-X: RPI is retail price index, a measurement of inflation while X is expected fall in costs due to gain in efficiency

(34) RPI+K: RPI is retail price index, a measurement of inflation while K is capital investment requirement

List of Most Important Definitions For Unit 1: Markets-How They Work and Why They Fail?

This will be a brief but useful guide for all Edexcel candidates sitting for Economics paper Unit 1 this January

(1) Production possibility frontier (PPF). A curve that shows the combination of two goods that can be produced in an economy shall all resources are fully & efficiently employed

(2) Opportunity cost. The value of next best alternative forgone

(3) Specialisation. Where a production process is broken into many stages each done by a small group of people or an individual

(4) Free market economy. An economy where resources are all privately owned & price mechanism will act to allocate scarce resources

(5) Command economy. An economy where all resources are publicly owned & state government will intervene to allocate scarce resources

(6) Mixed economy. An economy where resources are owned & allocated by both private sector & government

(7) Positive statement. Statement that can be testified true or false by referring to facts

(8) Normative statement. A form of value judgement & cannot be proven true or false

(9) Substitutes. Goods that can be used in place of another

(10) Complements. Goods that are jointly used with another

(11) Consumer surplus. The difference between what the consumers are willing to pay & what they are actually paying

(12) Producer surplus. The difference between the actual price a producer receives for its good & the lower price it is willing to accept

(13) Price elasticity of demand (PED). Measures the responsiveness of demand for a good to a change in price

(14) Cross elasticity of demand (XED). Measures the responsiveness of demand for a good (say Good X) to a change in the price of another good (say Good Y)

(15) Income elasticity of demand (YED). Measures the responsiveness of demand for a good to a change in income

(16) Price elasticity of supply (PES). Measures the responsiveness of supply of a good to a change in price

(17) Indirect tax. Levied by the government onto a particular good or service to discourage its production or consumption/ to raise its production costs

(18) Subsidies. Grants given by the government to encourage the production or consumption of a particular good or service/ to lower the production costs

(19) Incidence of tax. Means upon who the tax fall onto

(20) Minimum guaranteed price. Price floor set by government onto agriculture produce in order to stabilise prices and farmers’ income

(21) National minimum wage. Price floor on wages set by government, below which is illegal for employers to hire workers

(22) Private costs. Costs directly incurred by an individual consumer or producer when they engaged in an economic activity

(23) External costs. Costs incurred by a third party which is not part of an economic transaction/ divergence between social cost and private cost

(24) Private benefits. Benefits directly gained by an individual consumer or producer when they engaged in an economic activity

(25) External benefit. Benefits gained by a third party which is not part of an economic transaction/ divergence between social benefits and private benefits

(26) Public goods. Must have two characteristics, non-rivalry & non-excludability. Non-rivalry means consumption of a good by an individual will not reduce the amount available for others to consume. Non-excludability means once the good is provided, no one can be excluded from benefiting it

(27) Free rider. Someone who receives the benefits that others have paid for without making any contribution themselves

(28) Government failure. When the government intervention into an economic activity leads to net loss in economic welfare

(29) Market failure. When price mechanism fails to allocate resources efficiently

(30) Property rights. Legal entitlement to use & sell a property, plus a legal rights that others have or do not have over the property

(31) Price mechanism. The interaction between demand and supply to resolve the issue of scarcity and infinite wants
(32) Asymmetric information. Where one party, (usually the sellers) is better informed than the other (buyers)

Wednesday, December 9, 2009

Does Current Recession Improve Contestability Of Market?

Contestable market is defined as a market structure where barriers of entry and exit are low

Does the current recession increase contestability of a market?


(1) Smaller number of firms. The current Great Recession has sent many businesses big or small under administration. As such theoretically we can say that with lesser number of firms in the industry, the level of competition will become less intense. That is because there will be lesser number of firms fighting for each other’s pie.

(2) Rival firms less likely to advertise. Firms may feel that advertising and marketing campaign during recession is just a waste of money as people are reluctant to spend. It is wiser to hoard these cash for unpredictable circumstance such as unexpected drop in sales or losses. Somehow this may also have the implication of deteriorating brand loyalty towards the company. As such it is to the best interest of new entrants as they do not have to advertise aggressively to break existing customers’ loyalty. Also this means lower sunk costs

(3) Cut in investment expenditure. Falling consumer spending will have a major setback towards the level of investment. First, drop in sales will most probably translate to falling profits or losses. As such firms will have lesser cash for reinvestment. Secondly, they may lack of the incentive to invest since there might be just few who are interested with the new products launched. Again this reduces the barriers of entry as rival firms do not have to spend aggressively on R&D to compete with products from larger firms


(1) Depends on nature of industry. Not all industries suffer a blow out during recession. In fact some even strengthened such as those which produce inferior or cheap goods. This is because inferior goods have negative income elasticity of demand. This means, a fall in income will lead to a rise in demand for those goods. New hypermarkets will find it increasingly difficult to challenge stores like Tesco, ASDA, Sainsbury and Morrison which are notoriously well known for their cheap household goods

(2) Warehouse sales. To avoid further losses, most firms will be rushing to dump their stocks into the market at an unbelievably low price. This can be seen as a form of limit pricing which prevents new companies from coming in. There is little economic incentive to do so since new firms usually have higher average costs and low price means thinner margin or even losses

(3) Strengthening of existing position. Recession could be a good news for big firms. Smaller rivals which do not have substantial supernormal profits generated during good days will not be able to withstand the onslaught of recession. As such they will be driven out of the industry. Their customers will turn away towards other bigger firms that are still standing. The rise in the concentration ratio may indicate challenge for new firms

(4) Patents protection. A patent provides protection for the invention to the owner of a patent. The protection is granted for a limited time period, generally between 15 to 20 years. However this is more than sufficient to allow the incumbent firm to monopolise the entire market share and thereby creates a powerful brand loyalty. Newcomers will have to put this under serious consideration in case their ideas may be clashed with existing ones.

Sunday, December 6, 2009

The Food Crisis of India

Spiralling food price inflation associated with food crisis has became an ongoing struggle especially for the poor in India. This is nothing new. In fact it has its roots back in 1991 when neoliberal economic reforms took place. The problem somehow took a turn heading towards the worst in the recent. Various political parties and labour unions have called for a nationwide protest against the government’s failure to arrest the price rise
Food price inflation at wholesale level rose to 17.5% in the third week of November, up from the previous week of 15.6%, measured annually.

Why is this so?

(1) Malthusian theory. India is the world’s second most populous nation and the growth rate in number of people could have surpassed the growth rate of food. Most of the lands have been explored and cleared to accommodate the ever rising population, leaving not much for agriculture purposes. As such, in theory we say that the interaction between falling food supply and rising demand causes the food price to escalate

Despite the surging population, it is untrue to claim that food supply has fallen in India. In fact India is the world’s second largest producer of wheat and rice. Besides the Indian government does keep large reserves of rice and curbing rice exports should meant that food is abundance

(2) Weather uncertainty. The second half of 2009 spells the worst period for rice farmers. First food crops were hit by drought and three months after that devastated by flood. All these took place when crops are almost ready to be harvested. With such bad timing, it is of no surprise that food supplies are cut short significantly in the recent months, driving the price to all time high

There might be a possibility that areas hit by flood will suffer from more severe problem in the near future, such as fall in output per acre. This is because the structure of the soil could have been damaged by the flood. Land is no longer that fertile

(3) Government failure. Happens when government intervention to correct a market failure, not only fails to solve the problem, but instead making it worse. In this case, it is said that the action taken by the government is by imposing a curb on export to ensure self-sufficiency. Inability of domestic farmers to benefit from the high global price, will actually reduce their incentive to increase output. As such farming output will fall. The outcome will be much felt in near future. Another form of government failure is by being ignorant. For some weird reason, Indian government refused to flood the market with its large stocks of food and grain. In fact, food prices can go lower even if it is only 10 million tonnes of food released into market

It is rather difficult to tell whether government failure is present or not. On the other hand, one can also argue that if it is not because of government’s intervention, millions of domestic consumers will suffer from high rice price. This is a situation best we try to avoid since rice is a necessity and considering that big bulk of people are poor

(4) Italic Existence of black market. Black marketeer is defined as people who buy and sell certain goods in a way that violate against law such as price control and rationing. It always happens when there are shortages. These profiteers will buy rice in a large quantity and hoard it, causing an artificial shortage of rice supply. Then it will be sold off to consumers with a much higher than market price. Also, cheap rice may be smuggled into India from countries like Myanmar, Indonesia and especially China where rice production is subsidised.

(5) Traditional farming. Farmers in India are generally naïve and do not know how to employ the best production technique. They may perhaps still unaware of the existence of Genetically Modified (GM) crops which can help to raise output or might not use modern farming equipments. The combination of these factors highly likely to account for the fall in supply