An Open Letter To Anyone Who’ll Listen In Response To The Competition Commission’s Open Letter To Me
This is a long post. I apologise again, but feel the need to be thorough. I will try to summarise at the end if you want to skip to that. Probably after a picture of a kitten or something. If you’re going to read the whole thing, no-one would blame you for getting a cup of tea, then coming back. People have written shorter dissertations than this.
On Monday, around two weeks after it loses the legal ability to make any material difference, the Competition Commission finally issued a response to the questions that I and many others had been asking them since a day after they published their initial report on the 20th August. That date now feels a lifetime ago, and so much has happened since, that it’s starting to become increasingly difficult to disentangle the truth of the situation from the many arguments and counterarguments that have raged ever since. And by arguments, I mean the views of the general public, several MPs, an MEP, at least two Lords, the most significant independent film body in this country and several key members of the film and film journalism communities, and by counterarguments I mean the position of the Competition Commission and my local MP, James Paice, who to this date is still quite literally the only person to have agreed in any way with the Commission’s findings. If you find any more, please let me know, I’m still looking.
So let’s get something clear. In all of this, I still believe that the Commission genuinely believe they are acting in the best interests of the general public. I still think they believe that if they had not acted, that consumers would have been left at risk of a price increase. Not an actual price increase, mind you, a risk of a price increase. Those that know me and have read this blog regularly will know that I’m fond of analogies, and the only suitable one I can think of is trepanning. Sure, there are reasons and occasions why this may be a legitimate and necessary medical procedure, but you shouldn’t go drilling a hole in the head of everyone who’s got a headache; you’re liable to do far more more harm than good. I remain resolutely of the belief that the proposed course of action here will do far more harm, and is far more likely – in fact, guaranteed – to drive up prices, reduce choice and remove the quality of service, than the substantial lessening of competiton ever would have done, and I’m almost more frustrated that the Commission can’t see that than their inability to distinguish on markets.
I’ve tried to remain professional through all this, despite having had to attempt to understand hundreds of pages of documents in a short space of time, many of it written in a legal speak to which I am entirely unfamiliar, in the face of a group of people who to outside observers have seemingly gone as far out of their way as possible not to understand the arguments being made to them, and clinging resolutely to their single defence and line of argument. I am now going to attempt to respond to the points made by the Commission yesterday, and in doing so I apologise in advance if that professional demeanour slips just occasionally, as it nearly did in the title of this post. (Also, dear reader, you keep having the patience to read this stuff, so I’m sure you’ll understand my need to make this as easily readable as possible.) Finally, I’m using edited sections of the full letter here; please refer to the full letter if you need further clarity – it might be worth reading it in full first before you read this if you haven’t – and if you feel I have misconstrued any of the Commission’s points by the edits I’ve taken, please let me know, as my intention is to try to clarify my thinking, not to cloud theirs. Portions of the Commission’s letter are in italics for clarity, and any extracts from the final report are in a smaller font.
Letters from the general public
It has been suggested that we have taken no notice of the many comments from the general public we received on our provisional findings of 20 August 2013. That is not the case. We gave these comments careful consideration and indeed sought to address points made in those letters where we felt that our provisional findings had not sufficiently explained our thinking.
In particular, we explained at paragraph 6.5 of the final report how we had taken into account the differentiation between Cineworld and Picturehouse in our analysis of the impact of the merger. Similarly, we responded to your specific and interesting point on the effect of Cineworld’s Unlimited Scheme directly in the final report at paragraph 6.55.
So the first thing I did was go back to paragraph 6.5.
We recognize that the nature of competition between Cineworld and Picturehouse may be different from that between the operators of multiplexes, due to differences between the product offerings of Cineworld and Picturehouse. We take account of this differentiation between the parties’ cinemas in our analysis of the competitive effects of the transaction in each local area. This is reflected in particular in the range of evidence we examine to reach a view. For example, if Picturehouse customers are unlikely to attend Cineworld cinemas in a given area, then this should be reflected in the survey results showing low diversion ratios from Picturehouse to Cineworld in that area.
So they have recognised that the competition between Cineworld and Picturehouse is different. In other words, Cineworld and Picturehouses have an offering that is different enough to create a difference in competition between those two in isolation, but not different enough when compared to other operators: consequently they are both still in competition with all other operators. WHAT?! (There is also a point there about the diversion ratios, but I’ll come on to that shortly.)
Now to paragraph 6.55.
In carrying out our analysis, we also considered the relevance of Cineworld’s Unlimited scheme to local competition. Cineworld currently charges a price of £15.90 per month for access to all Cineworld cinemas outside London’s West End. Members of this scheme may, to some extent, be more insulated from the effects of local competition on ticket pricing. However, the margins we have used to measure the internalization effects of the transaction (see paragraph 6.53(c)) already take account of the Unlimited scheme. In addition, in the local areas that have been the subject of our detailed analysis, the internalization effect tended to be stronger for Picturehouse than for Cineworld. Finally, ticket pricing is only one of the ways in which an SLC can result in adverse effects on consumers.
OK, back to paragraph 6.53(c) then.
Analysis of pricing incentives resulting from the internalization of profits that would have been lost to Cineworld and/or Picturehouse before the merger. We used Gross Upward Pricing Pressure Index (GUPPI) calculations for this assessment. This is discussed in more detail in Appendix F.
Hooray! Another diversion. Appendix F is fifteen pages, so I’m not going to reproduce it in its entirety here – in fact, I’m applauding you for reading this much – but you can find it yourself on the inquiry home page if you fancy. Here’s the key points:
Unilateral effects may arise because a price increase becomes less costly when the products of the two companies are brought under common ownership or control. Without the merger, it is costly for one of the merger companies to raise its prices because it will lose the profit on diverted sales as a result…
After the merger, it is less costly for the merging company to raise prices because it will recoup the profit on recaptured sales from those customers who would have switched to the products of the other merging company…
GUPPIs do not attempt to estimate an actual price rise, but rather measure the strength of the internalization incentive by measuring the value of sales that is recaptured as margin post-merger. The results from the GUPPI should be seen as one piece of evidence which should be considered in the round with other evidence.
To give the Commission its due, this is all broken down in the independent research conducted by GfK which they then used to test the GUPPI calculation. Translating all of the above into English, if there’s a number of companies operating in a particular area, they each know putting their own prices up will cause customers to go elsewhere. But because they now own two properties, Cineworld could put its prices up, and while the original ticket price, food, advertising revenue, etc. would have previously gone to a competitor, Cineworld now gets to keep the money of anyone switching. The GUPPI shows how much incentive they have to do that, and the Commission believes the GUPPI is high enough in Aberdeen, Bury St Edmunds and Cambridge that Cineworld Group have an incentive to raise prices.
Still with me? Good. The Commission claim that they have taken into account the memberships when considering this, and in that they are true to their word, as GfK’s research splits down customers into those that have had a discount, and those that haven’t. (It’s worth noting that Cineworld presented their own research for some of the cinemas, but the Commission rejected it on various grounds. So the Commission’s research is final.) GfK asked a number of questions to try to get to a conclusion.
Firstly, they asked if people had bought a full price ticket, had a discounted ticket or had a free ticket. Only 33% of tickets at Cineworld and just 18% of Picturehouse tickets were bought at full price, thanks to the effects of the various memberships. But the people who paid something towards their ticket, including those with a discount, were then asked another question: if the prices at the cinema you last went to went up by 5%, and not at the other cinemas, what would you have done? Here’s the responses from Cambridge as an example:
The GUPPI calculation says, as I understand it, that where it wasn’t in Cineworld’s interest to put prices up before as customers would have gone elsewhere, 12% of Cineworld customers would have stayed within the group. Those profits that would have been lost by putting up prices previously are now protected. Hardly anyone would have changed from the Picturehouse, so we can leave that aside for now. So :
- Cineworld makes whatever extra it will charge per ticket on the 59% of people who stayed at the same cinema, plus the 2% who went to another Cineworld. But it would have gotten this had it put prices up before the merger anyway, so there’s no gain here from the merger.
- They then get to keep the money from the 10% of customers who would have swapped to Picturehouse, when previously they would have lost this money. This is their only real gain by putting prices up that exists because of the merger, and not without it.
- 30% of customers would have gone elsewhere or not gone at all. All of that revenue, including associated food and advertising money, would be lost.
The Commission maintains that the incentive of keeping that 10% which they would previously have lost is enough of an incentive to put prices up, and that feeds the GUPPI which drives why they must sell a cinema. If you only take the columns in yellow in the table, that’s a fair conclusion to come to. But it doesn’t take into account that you would lose far more money than you’d ever gain by putting prices up, which in turn shows that Cineworld have probably succeeded at setting prices at the very upper limit of what customers are willing to pay already, and that a price increase will tip them over the edge.
At this point neither the Commission, or anyone else, has answered this question, let alone to my satisfaction. If you only look at the possible gains in profit, in isolation to the losses you’d also make, then the Commission’s calculation adds up. But… if you knew that putting your prices up by 5% after the merger would allow you to keep 10% of customers you would have otherwise lost, but you’d also lose 30% of customers completely, why would you put prices up? Answer: you wouldn’t.
And we’re not even on my first question yet. Next!
1. Was there no requirement to set a suitable threshold of competition in a particular area?
The task of the CC in a merger inquiry is to decide whether there is a substantial lessening of competition in a particular case referred to it by the Office of Fair Trading (OFT), given a particular set of circumstances. Our task was not to consider the whole landscape of competition in cinema exhibition in the UK… There is no simple rule which determines how many competing cinemas could successfully operate in a given area.
I once had a girlfriend who was a student of philosophy, among other things. She and I debated whether or not people attempted to acquire wealth; my view is that people want to be happy, and gaining money is just a means to an end in that regard. No one sets out to make money purely of its own end, but to then provide something further. But getting rich is also not the only way to be happy.
To me that speaks to the question of why this investigation is necessary. Certainly, a lessening of competition would be a concern if customers then had to pay higher prices, or their choices were more restricted, or if other services from festivals to cafes were put at risk, and the Commission is required to answer this point. The question the Commission is not required to answer is if a lessening of competition is in itself a bad thing.
So on one side, the Commission is considering that a lessening of competition will mean higher prices, and is not accepting the evidence that their only proposed solution would cause all of the problems it sets out to solve, and more. This also rests with the question the Commission asked, which as I understand it is whether selling a cinema would solve the problem of lessening competition. Of course it would, but they are legally obliged to ask the wrong question and seemingly everyone else is powerless to step in and ask the right one.
2. The OFT’s initial report indicated that Cineworld and Picturehouse operate in different markets
This is not the case: paragraph 110 of the OFT’s report of June 5 referring the merger to the CC states: “The OFT has analysed the transaction against a market for film exhibition services in this case. It has considered whether it is appropriate to segment this wider market by art-house and multiplex cinema. The parties failed to provide sufficient evidence in support of their arguments that the product market should be further segmented.”
Indeed it does. Some other paragraphs from that OFT report on 5th June. Here’s paragraph 18.
The OFT notes that multiplexes are free to screen any type of content on their screens, subject to agreement with the film distributor. A third party competitor has noted that they will program a screen according to local demand characteristics. As such, if an art-house cinema is performing well in the area, they may increase the amount of specialist content they exhibit.
And paragraph 25.
The OFT acknowledges that the merging parties appear to supply a differentiated offering and service, and may have different average customer demographics who have different reasons for visiting the cinema. Nevertheless, the evidence available to the OFT, as outlined in detail as part of the competitive assessment below, despite the differentiated offering, points to the merging parties competing and, in some cases, competing to a significant degree.
So there were some fine margins in this decision in the first place. For anyone wishing to buy one of the small capacity cinemas being put on sale, paragraph 28 might give them pause for thought:
Smaller size cinemas may also, to some extent, have limited ability to exert a competitive constraint on multiplex cinemas due to possible capacity constraints at peak times. However, multiplex cinemas do not suffer capacity constraints to the same degree as smaller cinemas; their size and location do not limit their ability to exert a competitive constraint on smaller sized cinemas.
A reminder that in Cambridge, for example, the Picturehouse has around 500 seats where the two multiplexes both have over 1,700. It’s clear to everyone, except some small groups of committe members, that these cinemas are more successful the more they are able to differentiate their offering, and any potential purchasers who don’t manage to make this differentiation are likely to struggle, as previous owners in Bury St Edmunds have. It’s also clear to anyone paying attention that the potential purchasers don’t currently differentiate their offering to anywhere near this extent.
Anyway, back to the OFT report. Paragraph 48 looks interesting.
The survey results show that a high percentage of respondents would not divert to another cinema in the event that Picturehouse was closed. The OFT considers that this evidence appears broadly supportive of the merging parties’ arguments that the cinema offerings of the two are highly differentiated and the loss of Picturehouse would result in a significant proportion of their customers, rather than diverting to another cinema, choosing not to go to the cinema at all.
This represents a consistent theme throughout both the OFT and CC findings: that customers of Picturehouse would be far more likely to stop going to the cinema than to go to a multiplex. Still, no-one’s explained to me why the significant difference in customer behaviour doesn’t in any way indicate these are different markets. (Well, we know it does mean they’re different audiences, demographics and customers, but not apparently different markets. Sigh.)
Anyway, the whole OFT report, published in June, is worth a read if (a) you’re not already bored rigid by this, (b) you simply can’t get enough of this stuff, (c) you want to check my workings to ensure I’ve not been selective in the paragraphs I’ve chosen, or (d) all of the above. While the OFT’s final statement was that they needed to refer to the Commission, there were indicators in their own report that this wasn’t a simple decision. I’ll leave you for now with paragraph 54.
The greater the indicative change in incentives brought about by the merger revealed by such a calculation [GUPPI], the greater the level of the OFT’s concern is likely to be. At the same time, this concern will be weaker if the reliability or probative value of the margin or diversion ratio evidence as a guide is in doubt.
Apparently a loss of 30% of your turnover, significantly outweighing any gains in profit available, isn’t a significant enough factor to cast doubt on the use of the GUPPI. You learn something every day.
3. Why is it believed that introducing another party to these areas will have the effect of reducing prices?
The evidence discussed in paragraphs 6.14 – 6.20 and the econometric analysis of the relationship between prices and local concentration in Appendix C suggest that the extent of local competition affects prices.
Here’s 6.20 in all its glory.
Overall the evidence shows that when setting the price of cinema tickets, exhibitors take account of the prices of all types of cinemas operating in their local areas. The extent to which service quality is driven by local conditions rather than policies set by the head offices of the multi-site operators is less clear.
Again, we’re into semantics. Cinemas look at competitors when setting their prices, but this doesn’t state that they lower their prices based on that review, and everything I’ve heard from the Commission suggests to me that it’s their hope this will be the case, rather than the expectation.
Compare this to the fuel market. Anyone who puts petrol in their car knows the deal: wholesale prices go up and up, these are passed onto the consumer at the pump, then occasionally the main supermarkets will slash their prices in an attempt to shake up the market and some competitors will respond with similar discounts. Consequently you can see that market forces are impacting on prices, even if they have less of an effect than fuel duty or wholesale fuel prices.
And I think it’s the commission’s hope that cinema prices work in the same way. But for those like myself who have been buying tickets for twenty years, it’s clear that there’s no big factor such as wholesale prices to shake up the market, as the prices studios are charging to cinemas seem to be staying more static. Consequently there aren’t the same movements in the overall ticket price and there’s less reason for cinemas to be changing their prices. You can find apps and websites for the cheapest fuel prices, but you won’t find that for cinemas, because there isn’t the same internal market pressure on price, and that’s where this is likely to result in customers losing out by this change. The Commission have publicly stated that “the market will decide”, but I think they’ve added two and two and gotten five with regard to the monitoring of the market.
It’s a tricky line: I’m not trying to suggest that cinemas are colluding when setting their prices, but I do believe they have found a natural level and their checking isn’t to try to undercut the competitors, but to reassure themselves that they’re pitching themselves reasonably in the market. This behaviour, coupled with the lack of external factors likely to drive a price war, leaves customers more vulnerable to regular pricing and the likelihood that any new player in the market will add booking fees to their tickets rather than offering reductions or waiving them as Cineworld and Picturehouse do leaves customers staring down the barrel of price rises unless the new player in the market starts by significantly slashing their prices.
4. Why were membership schemes excluded from the CC’s analysis?
Membership schemes were not excluded from the CC’s analysis. In our survey, as described in 4(b) of Appendix D on consumer surveys, separate questions were asked about membership schemes. We agree that the Cineworld membership scheme effectively sets a national price for membership. However, the results of our analysis gave us more concern about future Picturehouse prices than Cineworld prices in Aberdeen, Bury St Edmunds and Cambridge. The Picturehouse membership scheme is different the Cineworld scheme and does not insulate members from local price increases. The different cinema membership schemes are described at paragraph 6.22 of the Final Report and the specific point made by you about Cineworld’s Unlimited Scheme is considered at paragraph 6.55.
I’ve published my detailed comments on the membership schemes in my previous post on economics; I can’t really add much more than that. It’s difficult to draw a direct line between the basic outline in paragraph 6.22 and the reality of these schemes, and the fact that the respondents have been asked separate questions also makes it harder to see how the conclusions have been drawn. All I can do is point to key facts such as the 58% of all respondents to GfK’s survey who were Picturehouse members and the 91% of those members who would have stayed with Picturehouse even if the membership went up by 5%.
The only statistic I can find that would give any cause for concern is the 17% of the Cineworld members in Cambridge who would have switched to Picturehouse if the membership price had gone up by 5%. However, that 17% is based on a base of 350 customers, and the other affected Picturehouses have much lower numbers. How much of a weighting that’s had on this, or any other aspect, of the decision isn’t clear to outsiders as the Commission haven’t shown their workings, due a combination of confidential information needing to be removed for publication and what I can only assume is general reticence.
5. Is there any evidence of any other part of the country where competition alone is successful in influencing prices? On inspection, the prices seem to be set at a level more related to the general cost of living than the factors used in the correlation in the report, and comparisons with local areas with both more competition and no competition do not suggest any evidence of a strong effect of competition on prices in this sector. The subsequent fear is that any competitor purchasing either of the cinemas will not be able to be restricted from raising prices from current levels, and I would be keen to understand the Commission’s powers to influence in this regard.
As explained in the CC’s merger assessment guidelines, competition between firms is generally expected to create incentives for firms to cut price, increase output, improve quality, enhance efficiency, or introduce new and better products.
In relation to cinemas specifically, our econometric analysis found local competition effects after allowing for local cost effects. It is the strength of local competition which will restrict a purchaser of the cinemas to be divested from raising prices.
Going back to the petrol price analogy, prices are lower in areas such as London where there’s more competition. If you fill up on the motorway or in a rural area you’re a captive market, but in larger towns and cities there’s more price competition going on. This isn’t how cinemas work, even in the areas where there’s more competition. Bear in mind here that some of the other areas, such as Greenwich, the competition has fallen from 10 to 9 cinema operators, where in Cambridge and Aberdeen it’s fallen from 3 to 2. So if 2’s not enough competition but 3 is, then surely there will be historical evidence that prices were fluctuating based on that level of competition? They’ve both had that many operators for some years. But there is no evidence to this fact, because the previous market conditions haven’t fluctuated, and the Commission haven’t been able to guide me to any direct evidence in their report that putting competition back up to 3 will have a demonstrable effect on prices.
While we’re on the petrol analogy, over 90% of respondents to the GfK survey gave choice of film as a key factor in their decision to go to the cinema, more than any other reason. You generally get either two types of petrol at most a a garage for your own vehicle; this has all missed that Picturehouse offer 2 – 3 times more choices of film per week in these cinemas than the multiplexes, and that’s what’s at risk as no other chain operator of any size in similar markets has that range, and the independent model is desperately precarious to set up and current economic conditions may make it impossibe. If you had a garage that sold six or seven different types of specialist petrol, had regular petrol festivals so you could try rare and exquisite types, had special live petrol events and you were allowed to have a drink if you didn’t drive off immediately, you’d probably fight to hang on to that too, wouldn’t you?
6. What controls will the CC put in place to prevent price increases as a result of a change in ownership?
The CC is not proposing price controls and we see no reason why a change in ownership should result in a price increase.
Again, not sure how much simpler I can make this. Cineworld and Picturehouse both currently offer a wider range of discounts and have either discounts for booking online or no booking fee online. Other current operators offer less discounts and charge booking fees. Cineworld and Picturehouse both currently charge less than the competition in these areas before the discounts. Any new purchaser is going to have to slash their standard prices if consumers aren’t going to end up paying more. It’s all of these hidden costs that seem to be sufficiently hidden from the Commission that they can’t see them.
Either way, this is tantamount to setting light to a firework, then turning your back so you can’t see whether it’s gone off or not. The Commission have no interest if their proposed remedy is actually damaging and seemingly no power to control the market once the sale’s happened. So if they do end up raising prices, reducing choice and cutting services, they will still have done their job to the letter of the law. My local MP has offered to attempt to ensure a purchaser meets some of these criteria, and of course I will take him up on this offer, but how much anyone can stiplulate this within the non-existent framework the Commission have put in place is anyone’s guess.
Nearly there now.
You entitled a blog of October 13 “A request for the Competition Commission to explain basic economics to me”, and particularly asked about “GUPPI”.
GUPPI calculations, described and used in Appendix F to the Final Report, on Pricing incentive analysis, are a standard tool for considering the effects of reduced competition following a merger in markets, like cinema exhibition, where sellers offer products which are differentiated from the products of their competitors. It is perhaps worth adding that the GUPPI calculations were only one element which went into the judgements about whether there would be a substantial lessening of competition.
Seriously?! The GUPPI was ONE ELEMENT?!?! IT’S THE ONLY ONE YOU’VE LISTED IN YOUR REPORT, AND YOU SET OUT TO MAKE THIS MORE TRANSPARENT. SAYING THERE’S OTHER ELEMENTS AND THEN NOT GIVING ANY INDICATION AS TO WHAT THEY WERE IS LESS TRANSPARENT. ALSO, YOU STILL HAVEN’T ANSWERED WHY THE GUPPI IS A BETTER METHOD THAN ONE THAT WOULD HAVE INCLUDED THE ENTIRETY OF YOUR RESEARCH, INCLUDING LARGER NUMBERS THAT WERE TWO COLUMNS AWAY ON THE SAME SPREADSHEET. DO YOU EVEN READ WHAT YOU’VE WRITTEN BEFORE YOU PUBLISH IT?
Primacy of the Final Report
We hope this open letter goes some way to help you and other critics of the CC come to a better understanding of our findings on Cineworld’s acquisition of Picturehouse.
I’m going to go with no. I’m presuming you’re thinking yes as you’ve now started directing people who’ve complained about this decision to my blog so they can read your letter. For the love of…
We must stress again in conclusion that these one-off comments are intended solely to help you and the wider public understand our reasoning; and the CC’s final report remains the definitive legal statement of our reasoning.
And this is what it comes down to: even if at some point, say after reading this, the Commission have a sudden epiphany and decide they’re wrong, they legally can’t change their own mind now.
- The Commission have written a letter attempting to explain a decision that they now can’t change even if we convince them they’re wrong, and claiming that the correct time for a response was before the final report was published, even though my letter with these questions in sent to them before the final report is published on their own website.
- The Commission state in two paragraphs that they’ve listened to public opinion. On that basis, I now stake my claim to be a ninja and it must be true because I’ve just said it.
- The Commission still haven’t answered my questions about economics. They maintain GUPPI is a standard, good and sufficient measure, I maintain that it uses a selective sample of their data and a measure that used all of their data would come to the opposite conclusion.
- The Commission were required to answer if competition had gone down, which it had (by 33 – 50% in the three areas). They still haven’t given strong arguments that competition is needed, is effective or will even exist to a sufficient level with a new operator, mainly because they are not legally required to answer these questions according to the process.
- This decision was referred from the Office Of Fair Trading to the Competition Commission on the basis that there’s competition, but some other statements in their own report appear to make this slightly less black and white and the Commission reviewed it anyway and agreed.
- The understanding of the Commission and myself as to the question of considering membership schemes remains very different. There is still no clear statement, within the context of not being able to publish certain confidential information, of how these factor into the calculations.
- The Commission apparently used a number of factors to come to the final decision, not just GUPPI, but I’ll be damned if I can find any evidence of explanation of these other factors in their report. (Not too late to point them out, Commission.)
- They have chosen not to comment on the reasoning why they favoured information solely from three competitors with a direct commercial interest over unsolicited testimony from industry leaders and prominent public figures. While there is no suggestion of any impropritety on the part of either the Commission or the other operators (and I can’t stress that enough because lawyers are expensive), the very fact that the three groups most likely to buy a cinema don’t understand the market and the offering themselves is cause for concern.
- The Commission hope this has cleared up their thinking. I’m going to go with “sorry, no, it’s actually now more confusing in some cases” if that’s OK. But hey, points for trying.