Australian Retail Banking Industry: Oligopoly Structure, Economic Policies, Pricing Strategies, And Essay.

The Big Four Banks of Australia

Questions:

a. Apply your understanding and concepts from micro economics, to investigate and summarise the major features which characterise the economics of firms in this industry.

b. Which of the 4 market structures best describes this industry? Explain.

c. Describe and analyse the economic and pricing policies that you would expect to find in this industry.

d. Choose one of the banks in this industry and write your policy recommendations for the pricing of its retail banking products and services.

e. Write a Conclusion including the insights you have gained from this assessment task.

The Australian Retail Banking industry is heavily dependent on four major banks. Known as the ‘Big Four’ banks, these four dominate the 80% of the market share of Australia. Rest 20% of the market is captured by approximately 20 or so smaller banking or non-banking financial institutions. The four big banks are Commonwealth Bank of Australia (CBA), Westpac Banking Corporation (WBC), Australia and New Zealand Banking Group (ANZ) and National Australia Bank (NAB). These four banks have secured their places among the 50 safest banks of the world (Global Finance Magazine 2016). These banks also gained the sixth position in the world for providing positive consumer experience in 2015.

The Retail Banking includes various financial services such as, general banking, net banking, mobile banking, ATM, EFTPOS. The banking industry operates in the financial service center. Hence, through services, it contributes in the GDP of the nation. From the economical point of view, it can be said that, the four banks act like a group. The decision made by one bank influences the decisions of the other banks (Liu, Margaritis and Qiao 2016). The economic theory of firms relates to the economic function and objectives of the firm. The economic objectives of the firms include profit maximization, sales maximization, increased market share or gaining market dominance, profit satisficing, social and environmental concerns and non-profit or cooperative motives. These objectives sometimes overlap. For example, increasing the market share may lead to fall in the profit initially or in short run, but in the long run, the profit level will increase (Zheng and Lin-na 2015). From the above, the objectives can be explained as below.

• Profit maximization is the fundamental objective of any business. Higher profit implies higher dividend for the shareholders, reinvestment on research and development, makes the firm less vulnerable for takeover and enables it to provide higher salaries to the employees. Hence, every organization wants to make substantial amount of profit (Stonecash et al. 2015).
• Sales maximization implies the growth in two stages, firstly, capturing a larger share of the market and secondly, increasing sales by attracting consumers towards the products or services. This sometimes leads smaller firms to go out of the business.
• Growth maximization or increased market share represents the mergers and takeovers by a firm. Regional or locational expansion is also considered as growth. More market dominance generates monopoly power for the firms (Nellis and Parker 2006).
• The social and environmental concerns of the firms focus on the corporate social responsibility (CSR) and these policies aim for wellbeing of the society and sustainability of the environment.

In the context of the retail banking industry of Australia, the system is headed by the central bank, that is, Reserve Bank of Australia (RBA) and the retail banks follow the guidelines of RBA. The major banks work as per the above objectives, that is, profit maximization, rapid growth and sales maximization, as reflected in the aggregate market share, and designing the CSR policies for the benefit of the societies and environment. Hence, the economics of firms are quite applicable for the retail banks of Australia.

Market Structures of the Australian Retail Banking Industry

Market structures refer to the distinguishing features of the economy that determine the way the economy would flow. It helps in characterizing the economy. There are four basic types of market structures, namely, perfect competition, monopoly, oligopoly and monopolistic competition. Not all of the structures exist in reality, but these help in deciding the nature of the existing market.

• Hubbard et al. (2015), highlights that under perfect competition, there are numerous sellers and numerous buyers and the products are homogenous. The firms are price taker, as a single firm cannot influence the market, and there is no barrier to entry, that is, firms enjoy freedom of entry and exit. There is no supernormal profit in this market.
• In monopoly, there is single seller in the market and numerous buyers. The monopolist is a price maker and it sets the price at a level that enables it to maximize profit. There is high barrier to entry and exit and price discrimination exist in monopoly.
• Oligopolistic market structure is characterized by few large sellers dominating large number of buyers or the entire market. The products are not perfect but close substitutes. The firms act like a group and the actions of one firm affect the others. There are barriers to entry and exit and the profit is maximized as the firms can set the price.
• Lastly, under monopolistic competition, large number of small firms competes against each other and the firms are price maker, thereby maximizing profit. There is free entry and exit in the market and the firms sell slightly differentiated products. This gives the firms some level of market power to charge higher than the market price. Non-price competition is highly important in this type of market.

Going by the characteristics of the retail banking industry of Australia, it is found that, only four banks have captured the lion’s share of the market, that is, 80%. The banks offer almost similar services to the customers, that is, the banking and financial services. This implies that the services provided by these banks are not perfect but close substitutes. There are high barriers to the entry and exit in the market, which are created by these four banks (Bernanke, Olekalns and Frank 2014). Hence, for a new bank, it is very difficult to enter the banking industry of Australia and make profit. Since, the four banks are operating in the country for a long time, people have more faith in them than on a new bank. These banks have also earned their places among the top 50 safest bank in Australia, which makes it all the more difficult for a new bank to penetrate into the banking industry and make a substantial profit (Grubel 2014). The banks behave like a group and the decision or action of one firm influences the others to make changes in their policy to retain the market share. Thus, it can be said that the oligopolistic market structure best describes the retail banking industry of Australia.

Economic and pricing policy represents the policies that are concerned around the economic objectives of the business and pricing of the products and services in a way that would bring profits for the company. According to Nagle, Hogan and Zale (2016), pricing strategy or policy takes into account the market segments, customer’s ability and willingness to pay, actions of the competitors, condition of the market, trade margins and cost of inputs etc. This policy is usually targeted at particular customer segments and against the competitors. There are several types pricing policy. Those are explained below.

• Premium pricing is the high price, which is used when a firm has very strong competitive advantage over the others in the industry.
• Penetration pricing is the strategy where the price is set very low to enter a new market and capture a market share.
• Economy pricing is the no-frills price with very low margins, overhead and marketing costs. It is targeted at the mass market and aims to capture a larger market share with a low price.
• Skimming pricing strategy is the one where the firms put a higher price to the product or service when there is very less competition in the market and attract more customers. When the high profit from the product or service attracts more competitors, the price falls leading to lower price (Nätti and Lähteenmäki 2016).

Apart from these, there is another type of pricing that is widely used in retail banking. As the retail banking is also facing high level of competition, the banks are adopting new economic and pricing strategies to retain the customers and make profit. The banks use pricing innovations as a mechanism or tool for raising the profitability and competitive differentiation. All the pricing rules are determined by the central banks and the banks design their own pricing policies based on that (Wruuck, Speyer and Hoffmann 2013).

Economic Policies in the Australian Retail Banking Industry

In the retail banking of Australia, since the market structure is oligopolistic, the banks behave like a cartel. It is a group that allows the banks to manipulate the prices of their services to create a high barrier to entry. The banks behave like a group to set the price high for profit maximization, like in a monopoly. If one bank changes its rates and prices for other services, the other banks will also follow to retain their market share (Dornbusch et al. 2013).

Figure 1: Cartel pricing

(Source: Author)

In this industry, the collusive pricing model is adopted as the banks will collude to set the prices higher for profit maximization. It helps in reducing the competition (Correa, García-Quero and Ortega-Ortega 2016).

The economic policies in the retail banking revolve around the policies on deposit, credit and money management (RBA 2017). The banks are the safest place to deposit money through savings account and earn interest on them. They also give credit to the customers when they need money, and lastly, it manages the money through checking accounts and cards. The banks in Australia follow the same structure as the economic policy and contribute in the economy through GDP, employment and money supply in the economy.

Among the big four banks, ANZ is taken for pricing policy recommendation. In this industry, these banks set the price for the services quite higher than the other banks and make higher profit. This way, they create high barriers to entry for new firms that try to enter the market. The banks exert monopoly power on the market by capturing almost 80% of the total market. At the same time, the banks exploit the consumers with higher prices by reaping off the consumer surplus.

ANZ is a major part of the retail banking of Australia. ANZ will follow the change in decision of any one of the other 3 major banks. There can be price war in this structure of the market. If one bank cuts its rates too much, the other banks would follow and the level of profit would be reduced for all. On the other hand, if one bank raises its prices for the services high, following the premium price strategy or skimming price strategy, then other banks would not raise their product and service prices in the hope of gaining more customers. Since, the products and services in the banking industry are almost similar among the competitors; the customers can switch to another substitute product or service in order to reduce the losses (Gomez-Martinez, Onderstal and Sonnemans 2016). Hence, there can be a few recommendations for ANZ, which could be helpful to maintain a stability in the market.

Pricing Strategies in the Australian Retail Banking Industry

Firstly, the bank should not be engaged in a price war with other banks, as that would lead to a fall in profits for all of the banks. It should maintain the rates of interest as per the RBA guidelines and at a competitive rate at par with the other banks. Lowering of interest rates too much would increase the liquid money supply in the market and excess supply of money would create inflation in the economy. On the other hand, raising the interest rate more than the required level would attract too much savings and expenditure in the economy would be lowered. Hence, there will be excess supply of goods and services, creating instability. Hence, ANZ should refrain from involving in any price war.

Secondly, the pricing strategy should enhance the customer experience and boost the profits. In other words, customer value proposition should be in focus for ANZ. In the times, when the prices have become more important than the loyalty towards the bank, ANZ should think about innovative strategies to attract and retain customers.

Thirdly, ANZ should focus more on the relationship banking. The quality of service as well as the relationship with bankers is equally important. Hence, the bank should go for more relationship based pricing. The relationship based services should be higher priced as that would entail some personnel to take care of individual customers. This is a new concept, and this would not only create a good relationship between the bank and the customer through personal touch, but would also bring revenues for the bank.

From the above discussion, it can be said that, the retail banking of Australia is quite an established financial sector. RBA has maintained the stability of the economy is such a well manner that the country never faced recession in the past 26 years. It has been a great achievement on part of the Australian Government. In this country, the four banks dominate the 80% of the total banking market and the other 20% is captured by another 20 or so financial institutions. The banks have been able to dominate the market for a very long time through its quality of service, economic policies, pricing policies and relationship with the customers. These have been able to build the trust among the customers, which has become a barrier for the other new banks.

The banks have formed an oligopoly market structure in the banking sector. Only four firms dominating the entire market, with products and services very close to each other is an example of oligopoly market. In this market, the banks have informally formed a collusive oligopoly, which has the features of a cartel and have created high barriers to entry for the other banks. The new banks face challenges in capturing the market due to many issues, such as, these banks lack the trust from the customers, these do not have enough funds to handle the set up costs and these cannot provide high quality service at a cheaper cost since, that would further lower their profits. Hence, the four banks have the market dominating power. At the same time, the banks set up the price for the products and services quite high to maximize their profits.

In this context, it can be said that the banks have a risk of engaging in the price war. This can lead to a fall in profits for all the banks. Hence, they should refrain from engaging in a price war. Along with that, the banks should invest more in customer value proposition, and relationship based pricing. These would help in enhancing the customer loyalty towards the bank and boost their profits. Innovative strategies, pricing and products should be the target of the banks to improve the customer experiences.

Although the retail banks of Australia have gained their positions among the top 50 safest banks in the world, still they must keep on improving their pricing and services to retain their market share in the future.

References

Bernanke, B., Olekalns, N. and Frank, R., 2014. Principles of Macroeconomics. 4th ed. McGrawHill Education Australia.

Correa, M., García-Quero, F. and Ortega-Ortega, M., 2016. A role-play to explain cartel behavior: Discussing the oligopolistic market. International Review of Economics Education, 22, pp.8-15.

Dornbusch, R., Bodman, P., Fischer, S. and Startz, R., 2013. Macroeconomics. 3rd ed. McGraw-Hill Education Australia, pp.24-26.

Global Finance Magazine, 2016. Best Banks & Financial Rankings. [online] Global Finance Magazine. Available at: https://www.gfmag.com/awards-rankings/best-banks-and-financial-rankings/ [Accessed 30 Nov. 2017].

Grubel, H.G., 2014. A theory of multinational banking. PSL Quarterly Review, 30(123).

Hubbard, G., Garnett, A., Lewis, P. and O'Brien, T., 2015. Microeconomics. Pearson Australia.

Liu, M.H., Margaritis, D. and Qiao, Z., 2016. The Global Financial Crisis and Retail Interest Rate Pass-Through in Australia. Review of Pacific Basin Financial Markets and Policies, 19(04), p.1650026.

Nagle, T.T., Hogan, J. and Zale, J., 2016. The Strategy and Tactics of Pricing: New International Edition. Routledge.

Nätti, S. and Lähteenmäki, I., 2016. The evolution of market orientation in Finnish retail banking–from regulation to value creation. Management & Organizational History, 11(1), pp.28-47.

Nellis, J. and Parker, D., 2006. Principles of Business Economics. 2nd ed. Essex, England: Pearson Education.

RBA, 2017. About Monetary Policy. [online] Reserve Bank of Australia. Available at: https://www.rba.gov.au/monetary-policy/about.html [Accessed 1 Dec. 2017].

Stonecash, R., Gans, J., King, S. and Mankwin, N., 2015. Principles of Macroeconomics. 7th ed. Cengage Learning Australia.

Wruuck, P., Speyer, B., AG, D.B. and Hoffmann, R., 2013. Pricing in retail banking. Scope for boosting customer satisfaction & profitabili.

Zheng, L.I. and Lin-na, M.A., 2015. Strategy of entering the Australian retail banking market. Technological Development of Enterprise, 7, p.013.