Sharing the school uniform surplus
The Commerce Commission appears to have found an unusual source of anti-competitive behaviour: schools forcing parents to use a monopoly supplier of school uniforms. Apparently schools often accept payments from clothing manufacturers in exchange for exclusive rights to sell the school’s uniform. Then the manufacturers extract large rents from their monopoly position by charging high prices to parents.
The Commerce Commission is concerned about the monopoly position that the manufacturers have but, recognising the convenience of a single contractor, recommends that the schools use a tender process to ensure value for the parents. The problem with this suggestion is that the school’s incentives are not aligned with the parents’ incentives. Schools place a higher weight on the revenue received by the school, while the parents place a high weight on having low priced uniforms.
What I don’t understand is why the schools choose to raise revenues by selling monopoly rights to their uniforms. Surely the school and the parents both want high quality, well funded schooling and are natural allies here. The parents also want cheap uniforms, but neither of them have an incentive to pass surplus to the clothing manufacturer. The obvious solution would be for the parents to pay the school the money that it would have received from the most ‘generous’ clothing manufacturer, and for the school to then award the clothing contract to the cheapest manufacturer. That way the school would be no worse off, the parents would be better off and they would not have passed surplus on to the manufacturer.
Copyright tvhe.wordpress.com ©
“The obvious solution would be for the parents to pay the school the money that it would have received from the most ‘generous’ clothing manufacturer, and for the school to then award the clothing contract to the cheapest manufacturer”
Or for the school to accept the manufacturer that offers the highest payoff, and then pay any “excess” back to parents. Doing it this way prevents any hold up issues post contract by the manufacturer (unless the price of the garment could get contracted).
Why is a single contractor ‘convenient’?
They want all the uniforms to look the same, but that can be achieved by having a single design.
Matt:
I just don’t see why the school would want to give the money to parents, though. Since the school has all the bargaining power when it comes to uniforms I’d expect them to keep any surplus that they can.
Nigel:
I presume that is why schools award it to a single contractor: to ensure that uniforms are of a consistent quality and appearance. Do you think otherwise?
“I’d expect them to keep any surplus that they can”
And do what with it? Presumeably the more money the school pulls in the less it has to ask parents for? They don’t have to write the parents a check for the children to benefit from the money they get from the supplier
Well, I’d think they’d use it for school related stuff that would benefit the students. However, I’d guess that the parents don’t get as much utility from that expenditure as they would from having it in their pockets. Just look at how much trouble schools have extracting ‘donations’ from parents!
I think my point was that it would have the same net effect, you could write a check for $5 or lower fees by $5.
This acutallly being the case probably relies on all sorts assumptions which may not be correct, the obvioius one being that some people don’t actually pay the donation:)
That’s true, they may well be equivalent. However, I don’t see the incentive for the school to do either. Parents, on the other hand, do have a private incentive to pay the school to contract the cheapest supplier. That’s why I don’t think the parents paying the school and the school paying the parents are the same thing.
“Since the school has all the bargaining power when it comes to uniforms I’d expect them to keep any surplus that they can.”
I thought the presumption was that the school and parents were co-operating insofar as the school has a “target level” of funding it wanted and the rest was provided by parents. In this case, if they cross the target they would redistribute back.
If there is an adversarial relationship, then why would we bother with this. Surely competition between manufacturers would lead the manufacturer who will charge more to parents to pay more to the school in the first place – as a result, the set of transfers you have in mind will not actually change the final outcome of the game.
A transfer system in this sense will have the same ultimate outcome as a system with just straight effective competition, as in either case the manufacturer will not make a supernormal profit, the school will receive the funds offered by the manufacturer that offers the highest amount, and the parents will pay the associated fee.
Hmmm, so you’re saying that the manufacturer will charge a monopoly price but then pay their entire surplus to the school? I wonder if this is actually the case. I would have thought that manufacturers would be making some supernormal profits and paying a portion of it to the school. In that case the parents could save money by paying that portion to the school and paying less for uniforms.
I don’t know about a target level. My assumption was that more funding is better for schools. I guess this just shows how sensitive policies are to the assumptions we make. is it really true that clothing manufacturing is so competitive that they wouldn’t be making supernormal profits on $1000 school uniforms?!
“Hmmm, so you’re saying that the manufacturer will charge a monopoly price but then pay their entire surplus to the school? I wonder if this is actually the case. I would have thought that manufacturers would be making some supernormal profits and paying a portion of it to the school. In that case the parents could save money by paying that portion to the school and paying less for uniforms.”
But if there is a competitive tender for the manufacturing contract, won’t the competing firms talk up the fee they pay to the school until they reach their reservation level – normal profits.
The policy you are suggesting simply offers the contract to the manufacturer that offers lower prices and a lower fee, but then the parents pay the difference in the fee – which because of competition will be the same as the difference in prices!
Well, yes, it will be if the firms get no surplus either way because they bid up the price. I don’t know anything about how schools negotiate these contracts beyond what’s in the article, so I don’t know whether firms do earn supernormal profits. I wouldn’t be confident guessing either way, but perhaps you have some data or specific knowledge???
BTW this is what’s refered to as “competition for the market” rather than “competition in the market”.
The reason the NZCC is suggesting they run tenders for the exlusive contract is to help ensure that most of the surplus goes to the schools and that the most effcient producer is chosen. In the absence of a tender the firm with the exclusive contract would probably earn super normal profits.
So is it usual for the successful firm not to earn supernormal profits following a tender process?
“So is it usual for the successful firm not to earn supernormal profits following a tender process?”
It is effective competition isn’t it – so in the absense of some type of collusion or cost differences for the firms I don’t see any reason for supernormal profits.
If the cost structures are different then we would still need to look at the combination of “fees” and “prices charged” in order to work out which firm has the competitive advantage. In such a case the method you are suggesting could, at best, get us to the same outcome as normal tendering methinks.
To be clear, In the case of a competitive tender, the firm with a cost advantage will slightly undercut other firms – so they will have supernormal profits but they will be restricted by effective competition. In the scenario you have suggested the tender will lead to the same result, just with transfers from parents to the school, from the school to the firm, and then from the firm to the parents.
I totally agree, Matt. I’m aware of the theoretical predictions and the difference that those small assumptions about the level of competitiveness for the market make. That’s why I was hoping that agnitio, as an industrial economist, could provide some observational evidence that the tender process usually results in no supernormal profits 🙂
Just do a dirty old second price sealed bid auction:)
“could provide some observational evidence”
Evidence? Huh? 😉
lol Matt
The way the auction is setup is key, you only need to look at the spectrum auctions in the EU to see that some have performed very well (the UK from memory) while some have peformed very poorly. I would suggest that the evidence shows that a properly set up auction will generally be efficient (most efficient providers selected) and result in low supernormal profits for the winner.
There have been some spectacualr failures in sepctrum auctions, but when you look at how they were set up it is no surprise. My personal favorite was one where there were 4 liceneses and 4 bidders. Really not surprising that the auction wasn’t competitive…