Monopsony power

Monopsony is an important idea in economics but not often discussed in the media – indeed there were only six references to it in the Financial Times between 2003 and 2009!

But for economists wanting to understand changes in the balance of power between buyers and sellers in different markets and how this affects prices, profit margins and incentives, it is important to have an understanding of monopsony and its effects.

What is monopsony power?

• A monopsony has buying or bargaining power in their market.
• This buying power means that a monopsony can exploit their bargaining power with a supplier to negotiate lower prices.
• The reduced cost of purchasing inputs increases their profit margins
• Monopsony exists in both product and labour markets – in this chapter we focus on buying power in the markets for goods and services
Examples of industries where monopsony power exists and persists:
1. Electricity generators can negotiate lower prices for coal and gas supply contracts’
2. Food retailers have power when purchasing supplies from farmers, milk producers, wine growers and other suppliers. Tesco, Sainsbury, Wal-Mart-Asda and Cooperative-Somerfield have oligopsony power when it comes to purchasing products from businesses at earlier stages of the supply-chain.
3. A car-rental firm seeking a contract to a manufacturer to supply new cars for their fleet
4. Low-cost airlines getting a favourable price when purchasing a new fleet of aircraft
5. British Sugar buys almost the entire sugar beet crop produced in the UK year
6. Amazon’s buying power in the retail book market – it gets a better price than other booksellers and this gives it a significant competitive advantage.
7. The increasing buying power of countries – for example China – in securing deals to buy mineral deposits from other countries – often in less developed nations in Africa.
8. The government is a major buyer e.g. in military procurement – and might be able to use this bargaining power when confirming contracts for new military equipment and supplies. The National Health Service is another example of a dominant buyer – in this case as a purchaser of prescription drugs from the pharmaceutical companies.

Evaluating the economic welfare effects of monopsony power in markets

In evaluation it is important to remember some of the possible advantages from monopsony power:
1. Improved value for money – for example the UK national health service can use its bargaining power to drive down the prices of routine drugs used in NHS treatments and ultimately this means that cost savings allow for more treatments within the NHS budget. THE OPPOSITE HAPPENS!
2. Producer surplus has a value as well as consumer surplus – lower input costs will raise profitability that might be used to fund capital investment and research.
3. A monopsony can act as a useful counter-weight to the selling power of a monopolist e.g. the NHS versus the global pharmaceutical companies.
4. In most supply chain relationships – for example between supermarkets and their suppliers – the long term sustainability of an industry requires that both benefit – if there are no mutually beneficial gains from trade, ultimately trade and exchange will break down.
5. The growth of the Fair Trade label and organisation is evidence of how pressure from consumers can lead to improved contracts and prices for farmers in developing countries. For example if tea producers in Rwanda get a stronger price for their output, the increased income and profit will have important economic and social benefits for the exporting industry and the wider economy.
Key evaluation point – it is often difficult to assess the strength of monopsony power

RyanAir to buy 175 new aircraft – Low-fare airline RyanAir is to buy nearly £10 billion-worth of new planes in a move that will create more than 3,000 jobs. The no-frills Irish carrier is purchasing 175 of Boeing’s new 737-800 aircraft, which will be delivered over the period up to 2019. The new planes will allow RyanAir to grow its fleet to more than 400 aircraft, serving more than 100 million passengers a year across Europe by 2019.Source: News reports, June 2013

BBC Premier Foods and monopsony power. The video clip explains how Premier Foods has been abusing it’s monopsony power