Welfare by Participating In Concentrated Package Delivery Markets - - PowerPoint PPT Presentation

Do State-Owned Enterprises Reduce Welfare by Participating In Concentrated Package Delivery Markets

By Michael D. Bradley, Jeff Colvin and Mary K. Perkins

A few thoughts, comments and questions from Soterios Soteri

Theoretical model Model calibration

Consumers maximise difference between utility and cost Firms maximise profit by setting prices (Bertrand-Nash competition) Parameter values

Utility functions are quadratic

• Yield linear demand equations

Consumer costs

• Prices*no. of items*no. of senders

State owned enterprise/ private parcel company – Fixed costs of running postal network (USO) – Impact of volume on marginal costs via economies of scope between mail & parcels – No product-specific economies of scale – Mail monopoly subject to price cap regulation – Prices > average incremental cost Private parcel enterprise ‒ Only delivers parcels ‒ Imperfect comp. and PPE has market power Chosen to establish relative equilibrium prices and volumes for mail and packages that mimic patterns in actual values And parameter values consistent with economic theory (e.g. own-price effects greater than cross-price effects)

Profit maximising equilibrium values under Bertrand-Nash competition , base case

Prices Mail price = cap SOE parcel c40% < private parcel enterprise (PPE) % mark-up over MC SOE: L >80% P>165% PPE: P =95% MC SOE: Economies of scope significantly lower MC for L & P PPE = calibrated value Volume Letters determined by price cap SOE share for L & P 85% & 15% Parcel share SOE & PPE 45% & 55% Revenue Letters determined by price cap SOE share for L & P 65% & 35% Parcel share SOE & PPE 30% & 70% Profit & consumer welfare SOE: $2,098 (23% of revenue, is this consistent with price cap reg.?) PPE: $3,656 (49% of revenue) Consumer welfare: 21,927 utils

Comments and questions

• Is it reasonable to assume PPEs have significant market power in the parcel market? Or is this only reasonable in particular segments of the market?
• In the UK parcels market is highly competitive with, on average, low parcel operator margins that is more consistent with monopolistic competition models. Is

parcel competition in the USA to the UK?

Experiment 2. SOE precluded from package market

Profit maximising equilibrium values, differences relative to base case

Prices

Mail: no change SOE parcel: n.a. PPE parcel: +53%

MC

Mail: +52% SOE parcel: n.a. PPE parcel: no change

Volume

Mail: no change SOE parcel: -100%. PPE parcel: +4% Total parcels: -41%

Revenue

Mail: no change SOE parcel: -100%. PPE parcel: +60% Total parcels: +10% Profit & consumer utility SOE profit: ? (Assume decline) PPE profit: +119% Consumer welfare: -36%

Notes and comments on results

• Lower parcel competition leads to a sharp increase in parcel prices, lower volumes and a decline in consumer welfare
• SOE letter MC increases due to absence of economies of scope

Conclusion Delivery of packages by the SOE limits the market power and profitability of the PPE which leads to lower prices, higher package volumes and raises consumer welfare Questions – Directionally results seem sensible, but over long-term would new firms enter and erode much higher profit margins of PPE? – If new firms did enter, with, say, operational costs similar to the PPE and reduced profit to something similar to the base case, would this change the conclusion? I am not sure it necessarily would, as the existence of economies of scope between mail and parcels seems to be the main factor driving lower SOE prices, higher parcel demand and consumer surplus in the model. This question may be worth considering in future research. – What happens to SOE profit? Presumably it would decline? Helpful to include results in paper – Should the base case price cap remain unchanged in the experiment or change as a result of lower mail profit

Experiment 3: SOE is less efficient than the PPE

Profit maximising equilibrium values, differences relative to post precluded from package market (experiment 2) Prices

Mail: no change PPE parcel: -34% (Note: SOE price 16% <PPE in expt 3)

MC

Mail: -10% PPE parcel: no change (Note: SOE MC 43%> PPE in expt 3)

Volume

Mail: no change PPE parcel: -1% Total parcels: +22% (due to additional but small amount of SOE parcels)

Revenue

Mail: no change PPE parcel: -34% Total parcels: -22%

Profit & consumer utility

SOE profit: ? Assume increases as parcel volumes generate revenue that cover MC & letter MC declines PPE profit: ? Assume decline Consumer welfare: ? Increase

Notes and comments on results In comparison to experiment 2, where the SOE is precluded from delivering parcels: ‒ The SOE now delivers some parcels but a relatively low number compared to base case (e.g. market share half of base case) ‒ Presence of SOE in package market significantly constrains pricing behaviour of PPE ‒ Economies of scope between L&P lowers letter MC and suggests SOE profit increases Conclusion Although the SOE is less efficient than the PPE, competition from the postal operator constrains market power of the PPE and their ability to raise prices. Overall this results in lower package prices and higher volumes than in experiment 2 and increases consumer welfare. Questions

• Is it reasonable to assume PPE has significant market power in the parcel market?
• If yes, then allowing the less efficient SOE to compete with the PPE, subject to parcel prices covering their incremental costs,

would be a sensible economic outcome

• What are the equilibrium SOE & PPE profit and consumer values for experiment 3 in the paper? Helpful to include in paper