LECTURE 9

TITLE: The Economic of Liner Shipping 1.0 OBJECTIVE

1.1 To introduce to the conference system in liner shipping 1.2 To introduce to the market structure in liner shipping 1.3 To introduce to the freight rate and tariff in liner

shipping. 2.0 INTRODUCTION

2.1 Liner companies operate as groups known as conferences,..

2.2 . and thus adopting a collective decision making on almost all aspect of their operation,..

2.3 which is prone to instability among members. 2.4 Liner companies provided services according to fixed

sailing schedules irrespective of whether there is any cargo along the way,..

2.5 ..thus making it costly to run. 2.6 Liner companies provide services at a predetermined

rate as laid down in their tariff book,.. 2.7 ..and this tariff will be applicable for a period of

time. 2.8 It is thus interesting to see how liner companies fixed

their price and factors of production,.. 2.9 ..in view of the basic concept of MC=MR as earlier

introduced. 3.0 LINER CONFERENCE SYSTEM

3.1 Conference is an organisation comprising of more than one liner companies,..

3.2 ..that operate with some measures of agreement among themselves.

3.3 Conference is formed for the following reason:.. 3.4 ..to prevent competition between members, 3.5 ..to reduce or eliminate outside competition , 3.6 ..by trying to secure most of the available market. 3.7 The agreement between members normally stipulates

common freight rate and tariff as well as conditions of carriage,..

3.8 ..such as cargo preference by member,.. 3.9 ..right of call at certain ports, 3.10 ..loyalty arrangement offered to shippers (the dual

rate contract and the deferred rebate system),. 3.11 ...all of which is directly related to the reason of

acceptance of a certain liner company into the conference.

3.12 ( For instance if a particular conference is at present does not have any tonnage that can carry nuclear products, it might as well accept an application by a liner company that have those capability)

3.13 Another reason might be due to political relation of a company in the region covered,..

3.14 ..or the company being strong and influential,. 3.15 ..or the companys operating cost is the highest and

should thus be given the bigger market share. 3.16 Conferences are, in the true economic term, in fact

cartels,. 3.17 ..i.e a group of suppliers who by agreement regulate

prices and other conditions. 3.18 Cartels are known to involve members in regulating the

total tonnage, 3.19 ..or number of ships which each line is allowed to

employ in the trade, 3.20 ..the ports where each line is allowed to load and

unload cargoes and,..

3.21 ..the number and frequency of sailings. 3.22 Cartels also form pools within the conference for the

purpose of sharing the cargoes or revenues among the pool participants.

3.23 Some conferences are closed,. 3.24 ..which means that new members are only admitted if

the existing members find it to be in their interest to accept a newcomer.

3.25 Most conferences are however open meaning that any shipowner capable of satisfying certain minimum technical or financial standards must be admitted to the conference upon application.

4.0 CONFERENCE AS MONOPOLIST AND

OLIGOPOLIST

4.1 The fact that conferences are in the true economic term a cartel, they behave as oligopolist when making decision,..

4.2 And they behave as monopolist when fixing price due to the fact they are in almost total control of the market.

4.3 Monopolist operates in situation where the output of the entire industry is controlled by one seller,..

4.4 ..and the seller sets a single price and supplies the entire quantity that buyers want to purchase at this price.

4.5 Monopolist thus have the power to prohibit other firms ( or liner companies) from entering the market with identical services,..

4.6 ..as practiced by conferences when admitting new members.

4.7 Since that monopolist is also considered as price discriminator, conferences are also considered so.

4.8 On whether a conference is a true monopoly it has to be looked into in relation with how it fixes prices.

4.9 On whether a conference is a true cartel it has also to be looked into in relation with how it decides on share of market and revenue among members.

4.10 On whether a conference is price discriminator it has to be looked into in relation with how it fixes prices.

5.0 MONOPOLISTIC CONFERENCE

5.1 Monopolistic conference can adopt one of the following monopolistic market structure:..

5.2 ..first monopolistic equilibrium with new entry ( by being open),..

5.3 ..second monopolistic equilibrium with price competition ( by allowing discount and rebate system),.

5.4 ..third monopolistic equilibrium with entry and price competition.

5.5 The mechanism under equilibrium with new entry is,..

5.6 ..(referring to figure on equilibrium with new entry)..

5.7 ..first, while imagining that it is operating in a monopolistic situation, the conference sets its price where MR=LMC,..

5.8 .then, external competitors come when seeing that there is excessive profit (i.e price P charge being well above LAC curve,.

5.9 ..the consequence of which is the market for the conference shrinks and thus its demand curve lessen; indicated by a slide to the left.

5.10 If its share of market falls to a point such that it is below the LAC curve,.

5.11 ..then even though MR can still satisfy LMC, the conference will now be charging below its operating cost LAC,.

5.12 ..and thus running at a lost,.. 5.13 ..which is not, of course, a monopoly. 5.14 The mechanism under equilibrium with price

competition is,..

5.15 ..(referring to figure on equilibrium with price competition)..

5.16 ..initially a member of a conference is at a certain monopolistic point with price P and services sold Q.

5.17 Realising the chance of getting more profit, it then lower the price with the intention to sell more,..

5.18 ..with the assumption that its market share and thus demand stays constant.

5.19 Competition from fellow members however reduce the market of that particular member,.

5.20 ..which forces the demand curve again to slide to the left.

5.21 If its share of the market fall below the LAC curve it will then be offering its shipping services at a lost,..

5.22 which is not of course a monopoly. 5.23 The member company is of course still safe if the

demand curve slides to the left only to a point tangential to the LAC curve.

5.24 The mechanism of equilibrium with new entry and price competition is;..

5.25 ..(referring to figure on equilibrium woth new entry and price competition)..

5.26 ..of course the combination of the above two,. 5.27 ..which is the situation describing the whole

conference as well as the member as a mopolist. 5.28 If so demand curve of the conference will slide to left

due to new entry and the demand curve of the member will also slide to the left due to internal price competition,.

5.29 ..resulting in a situation worst that before,. 5.30 ..which is of course not a monopolistic situation if

demand curve is tangential to LAC because at this point the member demand curve will already be below the LAC curve,.

5.31 ..and therefore will be operating at a lost.

6.0 DISCRIMINATING CONFERENCE

6.1 Conference can only discriminate if,.. 6.2 ..its market can be divided into sub-market,.. 6.3 ..and each sub-market is effectively separated to

prevent reselling of services. 6.4 The conference will now be working base on more that

one demand curve plotted on the same P X Q axis for the whole conference.

6.5 There will be a single MC curve for a single LAC curve but more then one MR curves matching the number of sub-market involved.

6.6 For each market, its price is set at MR for the sub-market that equals the MC for the conference ,.

6.7 ..(refer to figure on price discrimination).

6.8 ..giving a revenue of PXQ for the market.

6.9 The total revenue for the conference will be the summation of the areas under these demand curves and will of course be greater that if it has been on the basis of MC for conference against MR for the conference.

6.10 Price discrimination can be first degree when the situation is a take-it-or-leave-it,.

6.11 Or it can be a second degree is the number of sub-market is 2, 3rd. degree if its is three and so on.

6.12 A take-it-or-leave-it situation is of course when MR for the conference is the same line as its demand curve

7.0 OLIGOPOLISTIC CONFERENCE

7.1 Oligopolistic conference means its members come together and collude ( share information, discuss, and act together),..

7.2 ...adopting either as a form of cartel,.. 7.3 ..or a price leadership organisation. 7.4 Both with the assumption that members are providing

homogeneous liner services. 7.5 The cartel can be of a Joint-Profit type or a Market

Sharing type.

7.6 The mechanism for Joint-Profit cartel is such that 7.7 ..a central agency will be appointed, to decide on,.. 7.8 ..total amount of liner services to be offered and

freight rate to be charged,. 7.9 ..allocation of shipping resources, such as ships and

agents,.. 7.10 .distributing joint profit. 7.11 ..(referring to figure on joint-profit cartel)..

7.12 Price to be charged by members will be at the intersection point of the conferences MC and MR.

7.13 The amount of service for each member will be at a point where the horizontal line from MC=MR of the conference cut the MC curves of the member liner companies plotted alongside the conference man curves.

7.14 The price freight rate to be charges being already fixed; the amount of revenue for each member will automatically be indicated as area under its demand curve.

7.15 The Market Sharing cartel can be either of the:. 7.16 . non-price competition type,.. 7.17 ..or a quota system type. 7.18 ..The mechanism for Market Sharing Cartel that

adopts non-price competition concept is such that..

7.19 ..members agree on common price,..

7.20 ..but they can sell at any quantity they can afford to,.

7.21 ..and price is set by the conference by bargaining between the low cost member,..

7.22 .. who intends to maximise revenue by charging low but selling a lot,.

7.23 ..and the high cost member who is desperate to cover their cost of operation.

7.24 ..(referring to the figure on Market Sharing cartel non-price competition)..

7.25 The conference will set the freight rate to ensure that the interest of the high cost member is covered,..

7.26 ..which will of course based on the MC=MR for the high cost firm.

7.27 For the rest of the member their own MC=MR will of course not the same to the MC=MR of the high cost firmed that has been taken by the conference,..

7.28 ..and since that freedom is there to sell more services, they will offer services at their points of MC=MR,..

7.29 .thus causing unstability when market drifts to the low freight rate members.

7.30 The mechanism under the Market Sharing that adopts the quota system type is such that,..

7.31 .conference will determined the amount service that were supposed to be offered by and its freight rate, each special to one particular member.

7.32 This is determined base on each members cost level as well as its bargaining skill during the conference meeting.

7.33 The function of the conference central agency is thus ensuring that all members operate at a level where profit is maximised,..

7.34 ..which means that at least individual MC=MR is taken as reference.

LECTURE 9