Tuesday, 29 July 2014

The End Of The Experiment? Part 3

The Foundational Economy: A different starting point

If the exhibits in Part II show that the market experiment had many unpredictable and unanticipated outcomes, how does that register in the UK’s core sectors? ‘The End of the Experiment?’ develops three case examples of ‘foundational economy’ activities that demonstrate what’s gone wrong over the past 30 years and how we could do things differently for better economic and social outcomes.
Our starting point is that is that all markets are embedded in politics and that we currently have a problem with political planning. The cases of i) telecoms and broadband, ii) supermarkets and dairy, and iii) retail banking are services most of us use every day. The cases show the increasing prevalence of ‘point value’ calculations and trader mentalities within large, quasi-monopolies, where cashing out often comes at the expense of national outcomes and social objectives. All reveal different fault-lines in their business models that work against societal interests as well as the limits of a generic ‘competition and markets’ framework.

Let’s follow the money and find the faultlines

The End of the Experiment?’ cases show how, in different ways, we have ended up with socially and economically dysfunctional outcomes. This is unsurprising when much of the foundational economy is dominated by shareholder value driven business models. There are some generic overlaps such as confusion marketing but all in all three cases the key drivers are financial because giant PLCs compete on two dimensions: (1) the product market to win customers; (2) the capital market to generate the narratives and numbers expected by stock market investors.

The former publicly owned BT in its modern guise shows a marked reluctance to invest in a national network of fast broadband. This unsurprising result is the legacy of privatisation where BT demonstrates a preference for distributing dividends - £20 billion distributed since 1984 – and buying back its shares. The outcome is that its super-fast fibre optic broadband terminates at the cabinet adjacent to, rather than on, the premises. The government’s aim of rolling out super-fast broadband nationally meets BT’s corporate requirements, but does it necessarily meet social needs, particularly when the company expect the state to subvent an extension of the network to rural areas?

Supermarkets present themselves as supporters of British farmers, but a point value mindset often harms stakeholders as suppliers are squeezed upstream. In dairy farming the farmers are visible and vocal complainants, but the invisible and silent victims are often the milk processors in the middle of the chain. In the decade since 2001, processors’ share from a litre of milk has declined from 35% to 19% while supermarkets have maintained margins through a form of predatory contractualism.

Retail banks’ rely on the pressure selling of products to customers where the proceeds are applied to cover branch costs. This is a necessity under a shareholder value driven model in the context of free banking. This often results in numerous mis-selling scandals – the fines for which are treated as a basic cost of doing business. The policy response is nearly always to encourage new entrants, without any understanding of either the destructive competition in the product market or the unreasonable capital market demands for high returns on equity which underlie the dysfunctional business model.

Is this the outcome of market competition?

All three cases play out in different ways but all have socially and economically dysfunctional outcomes. All manage to deliver acceptable stock market returns (although some supermarkets are under pressure). But all crucially depend on their supply chain positioning at key pinch points which gives them power over suppliers or customers. The pursuit of ‘point value’ strategies means that position is exploited to extract value immediately at the expense of a stream of benefits over time. Value is maximised at the point of transaction to benefit the shareholder; profits are levered on suppliers and customers without regard to the social/national interest.

The 30-year experiment has above all enshrined generic competition as its mantra. And to varying degrees, with governments of different hues, this is the principle that has underpinned policy. So within this context, how, in such a large portion of the economy, have these PLCs maintained return on equity and profit margins?  Equally, how have PLCs limited the effects of competition when firms are competing amongst themselves inside each sector?

The key features that have prevented the erosion of margins and returns are (a) the companies avoid direct price competition through confusion marketing which is actively used in all three sectors (e.g. bundling to make comparisons difficult); (b) PLCs inside sectors operate using similar business models –often narrated to emphasise differences –that create an opera of stereotyped competition with emphasis on a part e.g. service, plus (c) PLCs using ‘point value’ as a means of exploiting local power relations to take margins off other stakeholders.

There are alternatives but they require vision and framing

The normal treatment of corporate excess and scandal is to claim that it is the result of ‘market failure’ which requires ‘more competition’. These framing devices dominate the rhetoric of Select Committees, policy reports and other outputs. The recommendations are always generic: encourage new entrants, educate consumers, limit monopoly excess. In doing so, the frame narrows our field of the visible and limits our imagination about what alternatives are possible.

The success of this framing has been overwhelming. But there are many other experiments beyond the free market that perhaps meet social and economic need more successfully. These experiments focus on co-operation and co-ordination to rebuild fragile or fragmented supply chains that resulted from the 30 year experiment. They include modest innovations by local authorities in the UK trying to re-glue the supply chain fragments by co-ordinating private sector partners; building agglomerations of expertise and overlapping functions in their area. These experiments also emerge spontaneously in the private sector: for example, Morrison’s vertically integrated meat supply chain secures supply and investment-driven efficiencies. Similarly Tesco’s intervene in the milk supply chain by guaranteeing, via the processors, a minimum price per litre that effectively puts a floor under competition. Alternative forms of ownership may also change the characteristics of competition: municipally owned utilities in the US compete successfully against PLCs, despite operating with quite different priorities. These different examples do not necessarily require central state planning or co-ordination since they involve the rebuilding supply chains from the bottom up.

These are all experiments related to building the foundational economy.

Looking at the three cases in the book it might be easy to conclude that these are just examples of ‘bad company behaviour’. But that would be an alibi and deny the need for something more than just the restatement of more competition and more markets with the usual bolt-ons like industrial policy. But doing something different requires a fundamental reframing of our problems that should include interventions through licensing for social objectives. However, that will require political will not generic fixes for the generic rhetoric of market failure.

Manchester Capitalism