A Request For The Competition Commission To Explain Basic Economics To Me

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It’s been four days since the Competition Commission published its final report and since then those who find the decision baffling or unprincipled, including myself, have been on the campaign trail. On Wednesday a group of protesters gathered outside the Cambridge Arts Picturehouse to protest the decision, with the local media in attendance. Julian Huppert, Liberal Democrat MP for Cambridge, also attended and has now started his own petition as a wider protest against the action and inaction of the Commission, which you can sign here.

Mr Huppert then raised the issue in Parliament on Thursday, and received this response from Andrew Lansley, another Cambridgeshire MP and also Leader Of The House:

“The Competition Commission’s job is to identify markets and act to restrict monopoly in the markets it identifies… I do not think this is the same market.”
“I feel the point [Mr Huppert] makes is a good one. Speaking purely personally and not for the government, I share with him his view that there is no case for the Competition Commission to seek to intervene in the ownership of the Arts Picturehouse.”

Except it already has intervened. As it presently stands, the Belmont in Aberdeen and the Abbeygate in Bury St. Edmunds must be sold, and one of the two cinemas in Cambridge, which is a decision which Cineworld Group itself is allowed to make.

Julian Huppert is intending to speak to Vince Cable this week, but further activity is clearly required and those of us working to overturn this decision continue to explore all avenues, and will hopefully have further news on our next steps in the next couple of days.

But most of the debate this week has centred on the nature of what the cinemas offer, and the fact that they exist in different markets. When the initial report was published, the Commission published a large amount of detailed research they had conducted to determine the economics. I finally have some definitive research of my own to be able to publish.

Economics 1

Those four people in the right hand column are the members of the Commission’s panel on the Cineworld merger:

Alisdair Smith, deputy chairman of the Competition Commission, professor of economics at the University Of Sussex for thirty-two years.

Rosalind Hedley-Miller, managing director of Commerzbank AG, where she has worked for over 30 years.

Jon Stern, a founder member of the Centre for Competition and Regulatory Policy in the Department of Economics at City University London.

Jon Wotton, retired solicitor who during his career had a principal focus on EU and competition law, public procurement law and media regulation, and two years ago was the President of the Law Society Of England and Wales.

The first person in the left hand column is:

Mark Liversidge (me), call centre planning manager who has been helping to prepare call centre budgets for call centres of up to 3,000 people for over 10 years and who has a degree in mathematical sciences, and who visited 28 different cinemas in 2012.

So assume for one moment that the cinemas operate in the same markets, in the face of 14,108 people who believe they don’t. Actually, it should be at least 14,113, as in addition to those who signed the petition you can find letters here on the Commission’s own website from Lord Puttnam and David Heyman, producer of the Harry Potter films, stating that these are separate markets and that judging them in the same market would be damaging to the industry as a whole. We also need to add the two MPs and also a Labour MEP for the East Of England.

For those keeping score, that’s a Lib Dem and a Conservative MP, a Labour MEP and a Labour member of the House Of Lords opposed to this on general principle. If you need any further evidence (really? OK), the BFI also wrote to the Commission here, stating their concerns that consumer choice will be damaged by the proposed sale. In the interests of balance for the other column, the final report has three other organisations who support the commission’s views: Cineworld’s competitors.

By contrast, Vue and Odeon did not draw such clear distinctions between the positioning of multiplexes and independent cinemas. Odeon told us that it was constantly evolving its cinema offer and attempting to ensure that each cinema catered for the widest demographic and taste and gave examples of refurbishments and upgrades it had carried out to meet specific needs. Vue stated that ‘a cinema is a cinema’. These views were echoed by Curzon: it believed that there was a large overlap between cinema types, with 60 per cent of customers willing to go both to multiplexes and independent cinemas.

The problem with this definition is that an independent cinema is defined purely as a cinema with less than five screens, not what most people would describe as an art house cinema. Based on every single documented criteria except price, a clear divide emerges between Picturehouse and other art house cinemas and all of those listed above, including Curzon to a certain extent. It’s also worth noting that Odeon support the findings, but also claim that the same finding should have been made about Southampton, Brighton and Greenwich as well (letter in the same link as the BFI link). They already operate in each of those areas, so wouldn’t be looking to take on a cinema in those areas, but presumably one less cinema in each area wouldn’t harm their current operations. [EDIT: While I am not suggesting their lack of understanding of the market is anything other than innocent, it should at least concern customers that they don’t understand what Picturehouse offers to differentiate itself and may be poorly positioned to replicate it.] But I digress.

Let’s assume that these cinemas are in competition. The Commission’s process consisted of two things: conducting a survey with a large sample of customers, both members and non-members, and then asked them a series of questions to determine what they’d do in the event of various scenarios, including both Cineworld and Picturehouse raising their prices by 5%. They then looked at a calculation called the Gross Upwards Pricing Pressure Index, or the fantastically named GUPPI. The GUPPI is a measure of how much their margin, or profit, would increase based on customers swapping between Cineworlds and Picturehouses. The Commission’s argument is that, by owning two cinema chains, when prices went up the benefit of anyone switching cinemas would have previously gone to their competitors, but now Cineworld would reap some of the benefit.

I struggle to get my head round that without something to base it on, so I’ve produced a worked example. To keep the maths simple, I’ve taken a sample day – Thursday, in this case – and then looked at the pricing in the Cambridge cinemas on that day. I’ve also assumed that reductions for children, families and other special groups would apply in the same broad proportions, and assumed the Silver Screen isn’t running in Picturehouse that particular Thursday, and also excluded the surcharge for VIP seats that Vue levy. I feel safe in doing this as factoring them in would reduce Cineworld group’s turnover and margins, while increasing that of Vue, making this a best case position. So I’ve attempted to work out the turnover of each of the cinemas – the total for the two Cineworld Group cinemas and for Vue – for a typical Thursday.

Economics 2

So the Commission’s logic is that by raising prices, Cineworld Group get to keep more of the profits, and as there’s less competition, there’s less to stop them raising prices. They then get to keep more of the profits, so there’s a direct incentive for them to do it. Forcing the sale of one of the cinemas is designed to counteract that by retaining the same level of competition.

But does it work that way? In theory, Cineworld Group could raise its prices to any level, and the more they raise them the more they keep; but every single cinema operator when asked confirmed that there is a local level of pricing to which they must adhere, at least in part. Besides, the Commission’s research was based on a price increase of around 5%, so we have to assume that increase in our worked example. Let’s then see what happens if both Cineworld cinemas put their price up by 5%, and we then extrapolate the results using figures taken from the independent research company used by the Commission to gather data.

Economics 3

What’s happened here is that Cineworld’s turnover has gone down slightly, and Vue’s has gone up sharply. This might not be an issue for Cineworld in isolation – shareholders will generally take a favourable view if your turnover has decreased if you’ve managed to increase your profit – but to do so by handing an advantage to your direct competitor would be a lot less palatable.

So Cineworld have increased profit, but in the process they’ve reduced their overall attendance by around a quarter. This is then likely to have a further impact which doesn’t appear to have been accounted for in the calculation, although the report isn’t totally clear. Vue’s original submission indicated that 70% of their revenue comes from the box office receipts, 25% from food and concessions and 5% from advertising revenue. Assuming that a similar ratio holds for other operators, with attendances down by a quarter that will also reduce the concessions by a quarter – with no extra margin on them as the price wasn’t factored into the survey – and the cinemas will now be less appealing to advertisers.

What it appears the Commission have done is to conduct an incredibly valuable piece of market research for Cineworld Group, which indicates that a price rise of 5% will cause 30% of non-members / online bookers, or 24% of their total audience, to divert to their nearest rival or to stop coming completely. This would appear to be a strong and compelling argument to them not to raise their prices and effectively capping them to raising prices in line with the competition, and would suggest that not selling a cinema in Cambridge would still be effective in controlling prices.

But that scenario isn’t going to happen now, as one cinema must be sold. We can now be slightly more certain about the permutations of that outcome. If the Cineworld is sold, then it will be to another multiplex. The other three major chains charge the following prices in their cinemas nearest to Cambridge:

Economics 4So for customers paying on the day, Empire would be cheaper. Showcase offer a free Insider scheme which gives discounts from Sunday evening to Tuesday evening inclusive, making Sunday evening and Monday cheaper than Cineworld. Odeon offer a points scheme which is the equivalent of one free film for every 12 seen at peak times. The customers set to lose out most significantly are the 8% of customers with Unlimited memberships, as there is no direct equivalent operating in any other chain at present, and currently that allows as many films as a customer can watch for £15.90 a month, unless they wish to travel to Huntingdon or Bury St. Edmunds.

From an economic standpoint, the potential Picturehouse sale is unsurprisingly more concerning. The Commission’s decision will force the cinema into doing what it isn’t currently, and competing on equal terms if it is to survive. Except when your cinema is in the city centre in an older building with higher running costs – a reason quoted by Vue as to why they had no interest in taking over Picturehouses – then your margins will be lower before you start. Given that the new owners will only have a capacity of 512 seats against the 1,700+ competitors in the city, any hope of showing more diverse films will be lost. In Norwich, the smaller independent cinema, run by the Hollywood chain, attempts to compete against three chains (Odeon, Vue and Picturehouse) and has to charge around £2 less than any of them. Lower running costs will make margins yet more precarious and any services such as the bar which add to the running costs may need to be dispensed with to protect enough profit to run the business as a going concern. In 2010 another Hollywood cinema failed, and was rescued by Picturehouses in – you guessed it – Bury St. Edmunds.

Bury St. Edmunds is the one area with no competition, but the findings of the original survey did demonstrate that for full price paying customers, 15% of Cineworld customers would switch to a competitor or stop coming completely on a 5% price increase and 2% of Picturehouse customers would make a similar decision. Notably, the 11% looking for another cinema would most likely end up at the Vue in Cambridge, the nearest competitive multiplex. Even with no direct competition in the immediate area, it would be to Cineworld group’s financial detriment to put up prices. So setting aside the discussions of programming, it would appear that the better option from an economic standpoint would be to not sell the cinemas, based on the Commission’s research. But that’s just my view, based on calculations and estimates I’ve had to make without the benefit of confidential information removed from the reports. It must be wrong, because the only reason this is happening is that this is supposed to be in the customer interest, but the most likely option to control costs and protect choice appears to be not doing anything.

But I’m just a lowly cinema buff, with only a statistics background and a basic knowledge of the fundamentals of business. I invite someone – anyone – whether it be the Competition Commission members, with their combined experience of over 100 years, or indeed any member of the public, to highlight the flaw in my thinking or my numbers, because this is only going ahead on the basis of increasing competition and in turn controlling costs. If the numbers don’t stack up, then surely this decision has to be set aside or overturned?

4 thoughts on “A Request For The Competition Commission To Explain Basic Economics To Me

    Anthony Davis said:
    October 13, 2013 at 3:09 pm

    13 October 2013     You’ve been busy !   I haven’t finished yet, but I have been having a read…       Take care         Anthony

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