16 September 2013

Of Consumer Ownership and Regulatory Intervention


This Paper considers the potential rationale for regulatory intervention in an industry and the alternatives that are available. The concept of pareto-efficiency is introduced, and then some of the real world conditions which prevent this optimal state from being achieved are discussed. Alternatives for overcoming problems of consumer bargaining power are discussed, focussing on consumer ownership options and regulatory intervention.


The gold standard of welfare economics is the pareto-efficient allocation of resources. Pareto efficiency occurs when it is impossible to make any one individual better off without making at least one other individual worse off. This may require that anyone who is made worse off is compensated by those who are made better off: if the loss is less than the gain then an improvement in pareto efficiency will occur.

Absent transaction costs and with equal bargaining power, all potential pareto-improvements can be expected to occur, meaning that there are no further ways to make any one individual better off without making at least one other individual worse off. In such a world, politics and regulation are solely concerned with the redistribution of income and wealth. This conclusion is also implied by the Coase Theorem, which effectively states that the distribution of property rights has no effect on production, and by implication that the only effect of regulatory intervention is the redistribution of wealth.

The Real World

The assumptions of no transaction costs and equal bargaining power are important to the conclusion that regulatory intervention only redistributes wealth (and hence is a political issue). Bargaining power is often unequal, and if that is the case the proper role of regulatory intervention is to ensure that parties have equal bargaining power so that they can effectively negotiate the distribution of wealth.

A monopoly exists when only one firm produces a product that consumers demand, and it is not possible for other firms to enter the market and provide competing products. Compared to the pareto-optimal level of output and price, the monopoly can restrict output and drive up prices. In the real world, true monopolies seldom exist, but there are many situations which have monopoly characteristics (a “near monopoly”). A common example is that of energy supply networks: within a certain price range, energy is more cheaply delivered by a given network rather than relying on alternative energy sources. Not dissimilar to the near-monopoly problem is the imbalance of bargaining power between a large firm and many small consumers. Individually the consumers may have little or no bargaining power, because the impact of their actions on the firm is small, and they incur transaction costs because the time and effort involved in such negotiations cannot be used for other purposes. [These purposes may include income earning, leisure, or information search, all of which have economic value.]

Just as Coase observed that the firm as an entity exists because a hierarchical system of control can be lower cost than relying on the market to co-ordinate production, some form of collective organisation may be required to overcome the transaction costs and lack of bargaining power that impedes consumers ability to negotiate effectively.

Various arrangements can overcome these bargaining problems:
  • consumer ownership
  • consumer representation
  • regulatory intervention

Consumer Ownership

In the first instance, transaction costs and monopoly behaviour can be overcome if consumers self-organise and own the company, so any trade-offs are internalised because the owners of the firm and the consumers are the same individuals. This form of organisation gives rise to the co-operative company.

Co-operative companies are very popular within rural industries, where the returns to the agricultural producer are heavily influenced by the performance of the party directly purchasing the agricultural product. In New Zealand co-operative companies are also prevalent where there are significant economies of scale to be realised by having a centralised wholesaler, such as with the Foodstuffs chain of supermarkets and the Mitre10 chain of hardware stores. A list of New Zealand's 40 largest co-operatives is provided in Table 1: this list includes some of New Zealand's best known companies.

In New Zealand a further form is the Consumer Trust-owned company, which is prevalent in the electricity distribution industry. The Consumer Trust specifies the powers of the Trustees and the requirement to act in the interest of consumers. Trustees are elected by consumers.

Both versions of consumer ownership effectively rely on the election of representatives who then act on behalf of the larger group. There are transaction costs involved in the co-ordination among consumers, e.g. the cost of publicising and running elections for Directors or Trustees.

Consumer Representation

An alternative is for various representative groups to negotiate on behalf of consumers; this model is often employed in utility regulation in the United States, with agreements subject to approval by a regulatory body. This model has not generally been adopted in Australia, New Zealand, or the United Kingdom.

Regulatory Intervention

A further alternative for overcoming the problem of co-ordination among consumers is for a regulatory agency to intervene and “represent” consumers. In the United States this model often involves the adoption of an “Office of the Consumer Advocate” within the regulatory body, but separate from the decision-making authority. In Australia, the United Kingdom, and New Zealand, this function is often subsumed within the decision-making authority.

The problems of a regulatory agency representing consumers include the standard problem of a bureaucratic organisation justifying its own existence: staff within the bureaucratic body will argue that the role of the body is essential, and even if “consumers” of its “service” do not hold that view, that is only because they do not know what they are being saved from. This is particularly problematic when the consumer advocacy function is subsumed within the decision making authority in the regulatory agency. Particular care must be taken to avoid conflicts of interest in the decision-making process, with consumer advocacy and analysis potentially being conflated within any given decision or report.

Under this model consumers will normally bear the costs of the regulatory agency, either by direct levies or consumers, or by levies on the regulated firms which are then passed on to consumers. Consumers also lack a direct means to influence the regulator, thereby giving rise to agency problems and potentially higher costs.

Concluding Comments

In addition to the issues identifie above, a regulatory agency cannot solve the problem of information asymmetries: neither consumer owners nor regulators are likely to have full information about the firm, its costs, and the opportunities available. Regulators can hire professional consultants to provide advice, but so too can a consumer-owned Board of Directors or a Consumer Trust. If there are any benefits to the firm from the information asymmetries, those benefits ultimately accrue to the consumers when there is consumer ownership, and if the firm has been pushed too hard, then under consumer ownership the costs are born by the consumer owners who made the decisions. But if the model is one of reliance on a regulator, any benefits and costs will accrue to someone else, and there are insufficient incentives for discovering an optimal outcome.

As a final concluding thought, in the New Zealand electricity distribution industry, ownership by Consumer Trusts and the regulatory model represented by the Commerce Commission are at opposite ends of a spectrum of potential ways to address the problem of organising a large number of small consumers to effectively bargain with a large supplier. A rise in one necessarily implies a decline in the other. Given the tendency of bureaucratic organisations to justify their own existence, we should expect that over time the Commerce Commission will seek to curtail the independence of Consumer Trust owned companies, and seek to find reasons to further regulate these entities.

Table 1: New Zealand's 40 Largest Co-operatives by Turnover 2010-11*

1 Fonterra Cooperative Group19,871,000,000
2 Foodstuffs (Auckland)3,490,823,000
3 Foodstuffs South Island Cooperative2,399,141,000
4 Foodstuffs (Wellington) Cooperative Society2,270,945,000
5 Silver Fern Farms2,096,672,000
6 Alliance Group1,498,385,000
7 Combined Rural Traders Society (CRT)1,093,000,000
8 Ravensdown Fertiliser Cooperative933,152,000
9 Ballance Agri-Nutrients760,148,000
10 Southern Cross Medical Care Society684,279,000
11 Farmlands Trading Society683,279,000
12 Westland Cooperative Dairy Co514,979,000
13 Mitre 10 (New Zealand)504,161,000
14 Market Gardeners t/as MG Marketing277,462,000
15 NZPM Group283,083,000
16 Ashburton Trading Society (ATS)210,000,000
17 Tatua Cooperative Dairy Co200,000,000
18 Rabobank New Zealand198,000,000
19 Capricorn Society180,000,000
20 CDC Pharmaceuticals175,995,000
21 Livestock Improvement Corporation (LIC)165,600,000
22 Pharmacy Wholesalers (Bay of Plenty)128,364,551
23 The Co operative Bank122,000,000
24 New Zealand Association of Credit Unions119,640,126
25 Farmers Mutual Group (FMG)117,138,000
26 Dairy Goat Cooperative88,000,000
27 Pharmacy Wholesalers (Central)81,821,287
28 World Travellers41,000,000
29 Eastpack40,000,000
30 Electricity Ashburton33,700,000
31 Composite Retail Society27,800,000
32 Independent Timber Merchants Cooperative23,640,000
33 Health 200022,100,000
34 Credit Union North t/as NZCU North20,636,835
35 Paper Plus New Zealand17,161,000
36 New Zealand Honey Producers Cooperative15,016,000
37 New Zealand Hops12,000,000
38 Seasonal Solutions Cooperative11,500,000
39 Fruit Packers (HE) Cooperative11,207,754
40 Provelco Cooperative7,500,000

* Source: Cooperative Business New Zealand, New Zealand Cooperative and Mutual Top 40