When costs plunge, why do we still pay more?
One of my favorite courses in graduate school was microeconomics. And within that subject, the topic that most interested me was industry structure. In a perfectly competitive industry, companies set their price in response to changes in their costs. If costs drop, so do prices.
But sadly for consumers, many industries that supply essential products and services have a different structure. They are regulated oligopolies. Somehow such entities can raise prices as soon as their costs go up and keep them high even after their costs plunge.
We consumers are living with the effects of buying products and services from both kinds of industries. After all, we are enjoying lower prices at the pump, thanks to the high level of competition in the gasoline retailing industry.
Meanwhile, the electric utility and airline industries -- as regulated oligopolies -- are gorging on fat profit margins, thanks to the power they enjoy to keep their prices high even as the costs of their raw materials have plunged.
Let's start with the good news: Gasoline prices have fallen in response to lower oil prices. Thanks to a combination of OPEC's decision to maintain high production despite falling prices and a soaring dollar -- oil is traded in dollars, so a stronger dollar buys more -- the price of oil has tumbled 54 percent since last June. Thankfully for us, gasoline prices have fallen 44 percent. Last June oil traded for $100 a barrel, there were 0.73 euros to the dollar, and regular unleaded gasoline was $3.70 a gallon. By Jan. 22, oil was down to about $46, it took over .86 euros to buy a dollar (representing an 18 percent rise in the dollar), and gasoline had tumbled 55 percent to $2.04 a gallon.
Airlines are not as consumer friendly. According to The Washington Post, "Airlines spend more on jet fuel than anything, and its price has been cut nearly in half over the last year, industry data show. But the typical domestic plane ticket over the past year actually got $10 pricier; all those added baggage, early-boarding and other fees climbed even more.''
The airlines are bragging about their ability to siphon off that price gouging for stock holders. Delta chief executive Richard H. Anderson said on a call with analysts Jan. 20, "These jet fuel savings are enormous, and we are diligent at maintaining those savings for the bottom line.''
As the Post reported, "More than $2 billion on fuel this year, though Anderson added the savings would go straight to paying down debt and funneling more cash to company shareholders -- not to lowering prices.''
Here's where it's delightful to be a business competing in a regulated oligopoly. Thanks to mergers, few airlines were left standing. No airline seems to be in a hurry to gain market share by lowering its prices to match the plunge in the cost of jet fuel.
As the Post wrote, "U.S. airlines are already flying at record capacity. The top airlines posted more than $3 billion in profit between July and September, their sixth profitable quarter in a row, federal data show.''
I am guessing that my electricity supplier, National Grid, is enjoying its 37 percent rate increase from 17.6 to 24.2 cents per kilowatt hour. Especially now that the price of natural gas -- the key raw material whose price spike National Grid used to justify that rate increase -- has tumbled by 37 percent since November, to $2.90 per million British thermal units.
Last September, National Grid said rates needed to rise because natural gas was in demand. As Marcy Reed, CEO of National Grid Massachusetts, said then, "There's too much demand for not enough gas on a cold, winter's day.''
With natural gas down 37 percent, why are rates up that much? That's the economic power of a regulated oligopoly.
Peter Cohan of Marlboro heads a management consulting and venture capital firm and teaches business strategy and entrepreneurship at Babson College. His email address is firstname.lastname@example.org.