I don’t think thats the case – I think it has more to do with me being unclear with my reasoning 😛

“The issue I have with your explanation is that you don’t see peak-non peak pricing differentials.”

Good point. I don’t understand why we don’t see peak and off-peak pricing differences – maybe the first firm to introduce such a scheme would surrender a whole lot of consumer “goodwill” (as consumers may feel that changing the price over the day is “unfair”), and other firms would be able to follow costlessly.

This implies that there is a second mover advantage to flexible daily pricing. So even though it would be better for each firm to do it, each individual firm does not want to be the first one to do it.

The issue I have with your explanation is that you don’t see peak-non peak pricing differentials. YOu could argue that is a market imperfection this doesn’t happen as you would expect to see discounting to attract more customers and maximise the efficiency of your business. Take a look at what happens in Australia with their weekly price cycles. The ACCC recently said they could find no logical explanation of why the cycle exists, despite having a hard look. My explanation is, it’s an entrenched habit.

Take your point on constraints. They are constrained in dispensing by size, pump capacity and locations, and on supply by the number of trucks and drivers and volume per load. Any shifts in market share are likely to be incremental. But they have occurred. There has been a major shift in the last 10 years with Mobil going from first to last and Shell moving up strongly into the lead thanks in large part to flybuys, and BP gaining with strong promotions.

The more capacity constrained business’s are then the less likely it is that market activism can lead to a full price war – as collusion could be maintained as long as the other fuel companies can keep enough customers.

I was thinking that since fuel companies are peak load companies they should have spare capacity a lot of the time – and as a result this sort of activism could work.

However, as you said the “peak” occurs during peak time every day – and so the spare capacity only exists at non-peak times and is infact a sufficiently different product.

Since the peak occurs so often, and as there is a “transaction cost” associated with buying fuel outside peak time, it is likely that “peak time” accounts for a lot of the fuel retailers revenue and that the constraint that exists in “peak time” provides a binding constraint on the amount of the total retail fuel market that BP can take.

In other words – BP doesn’t have the ability to serve a lot of customers during peak hours, and people will be willing to pay a bit more to get their fuel during peak hours, and so this market activism will not lead to a collapse in prices.

In fact it may worsen the situation by creating price discrimination between people who value peak service and those willing to wait for non-peak cheaper fuel.

Hopefully that cleared up what I meant – your capacity constraint point was actually really important!

Fair point. Actually I do believe they are a peak load business – but the fact that the peak is the same for all firm’s indicates that the capacity constraint may be strongly binding when it matters (I hadn’t thought of that!).

As a result, I would need to assume that a significant amount of revenue generation also occurs outside of peak time in order to make my argument work – that is definitely a binding assumption!

It would be the loss of custom that would drive down prices at the other retailers, who would want to recapture market share.

Your argument misses the fact about why the demand for BP petrol goes up in this model. Everyone only goes to BP if they charge a lower price than the other fuel companies – if they are capacity constrained then they can only serve a portion of the market, but they only receive that market share if they are charging a lower price then their competitors in the first place.

As long as BP can serve a large proportion of the market (as fuel retailers tend to have large amounts of excess capacity, given that they are a peak load business, I think this is a reasonable assumption) this price competition would force a response from the remaining “cartel” to lower prices to the same level as BP.

However, your capacity constraint argument is true, and extremely useful for describing the phenomenon. If the capacity constraint is strong enough you could end up with a situation where BP permanently offers a lower price and the rest of the fuel retailers agree to charge higher prices on the fringe of the market – this form of collusion could keep prices elevated and ultimately benefit BP. However, BP would also have to commit to not increasing capacity in this environment – something that it would be difficult to commit to (without getting into trouble for colluding 🙂 )

if everyone goes to BP demand increases but supply, or their capacity to manage supply, may not, assuming they have structured their business to efficiently service their expected market share. If market share drastically and suddenly increases, I suspect most businesses will find it difficult to cope.

If so, prices should rise not fall at BP to maintain continuity of supply (you don;t make any money if your site is empty). If they do rise the incentive for other companies to lower theirs then disappears as they already have a price differential. They may even be concerned about a similar run on product and so increase prices to match, or they may see the opportunity to bolster margin.

Don’t forget the benefit side – you don’t get enough satisfaction out of helping your society, if you did you would be able to solve all sorts of prisoners dilemmas 😉