India Plantation Economics: Solving the mystery of rising tyre prices,lower rubber prices

By Sreekumar Raghavan
KOCHI/KOTTAYAM (Commodity Online):Rubber prices have slumped by 15% in Indian markets in the past few months following weak offtake from the tyre industry and slowdown in automobile sales growth. Rubber growers and traders are crying foul– they have appealed for an increased import tariff on natural rubber to support domestic industry.

Being in Kerala, the largest producer of natural rubber in India, this writer has had the opportunity to intereact with Rubber Board officials,tyre industry, experts, futures exchange players,traders, growers and several stake holders in the industry.

In an internal discussion the other day with our editorial team and analysts, the falling prices of natural rubber came up. One point that was raised was why natural rubber prices were falling but not tyre prices. Why is that tyre companies continue to report profits while rubber growers are in crisis? Years ago, in a meeting with Sajan Peter, then Chairman of India’s Rubber Board, he also raised the same point. Tyre industry express concern when rubber prices shoot up, but have they ever reduced tyre prices when rubber prices crashed?

Perhaps, I realised it was time I should dust my old books on economics to find out clues from a theoretical perspective why this could be happening. I sat up for some time yesterday night motivated on reading the best seller Freakonomics, and damn sure that economic theory can provide tools to analyse any day to day happening in our lives!

Here is a humble attempt to find out how tyre industry is able to monopolise the rubber trade (for ease of understanding, some concepts and examples may be oversimplified and also this is not an academic excercise).

Indian tyre industry’s market power

In the case of indian tyre industry, there are around 39 companies but bulk of the market is concentrated in the hands of eight players whereas rubber growers and traders are fragmented producing around 875,000 tons and importing over one lakh tons a year. A market with a single supplier is called a monopoly while a market with a single buyer is called a monopsony. Tyre industry consumes more than 65% of the natural rubber produced in the country and a single entity they are close to being called a monopsony.

Normal supply curves are upward sloping- meaning more quantities will be sold at a higher price than lower while demand curves are downward sloping indicating more will be bought at lesser prices.

The tyre industry may be in an upward sloping curve with respect to its raw material natural rubber and hence has market power as a buyer. India’s tyre industry is huge with a turn over of Rs 43000 cr (2012 figures of Association of Tyre Manufacturers of India-ATMA) and the large size of the industry relative to the raw material industry whose value at current prices would be 1400 cr gives them a definite edge. (Also we have giants like Apollo Tyres who operate in the global market too)

Price Theory and Rubber

Donald Stevensen Watson and Malcolm Getz in their classic book, Price Theory and its uses points out that any firm irrespective of whether it is a monopsony or not but is facing an upward-sloping supply curve has buyer’s market power. Such a firm restricts purchases to keep input prices low. In the case of Indian tyre industry, they resort to imports when international prices are low, to put downward pressure on domestic rubber prices. They also have lobyying power in Delhi.

Two concepts need to be understood if Watson-Getz’s theories are to be properly understood– marginal factor cost and marginal revenue product. Marginal factor cost is the cost involved in buying one more quantity of the input whereas marginal revenue product is the extra income earned by utilising one more unit of an input. A firm in a competitive environment maximises profits by buying inputs to the point where marignal revenue product equals marginal product cost. Also elasticity (the concept of elasticity is basic in economics– it refers to unit change in quantity demanded to unit change in price) of supply of an input is also a determining factor impacting buying power of the firm. If the elasticity is high, the buyer has less of a market power when compared to lower elasticity in which case they have the power to reduce the price it pays for the input.

If the tyre industry works as a oligopsony and do not individually negotiate with traders to discriminate on price but buy only at prevailing market rates then they have collective market power to pull down prices.

Impact of automobile slowdown

Tyre industry is not operating in a vacuum and are impacted by general trends in the economy nad automobile, mining and other industries that use tyres. Most of the tyre companies have reported drop in margins due to lower Original Equipment Sales (OEM) while replacement market is up this year. India’s automobile sector is facing a slowdown as is evident from the latest data released by Society of Indian Automobile Manufacturers (SIAM). According to tyre industry, natural rubber accounts for only 32% of input costs while several other factors including energy costs, capacity utilisation, steel prices, synthetic rubber prices, wages impact profitability. In a depressed market, their margins could be hurt and hence can’t possible lower prices of tyres.

But as Sajan Peter, former Rubber Board Chief has pointed out time and again, Rubber has been a fortunate commercial crop despite the ups and downs it has faced over the years, as average annual farm gate prices have always been above production costs which is not the case with several agri-commodities around the world. Rubber is also a victim of the ‘Cobweb theorem’ in economics- as prices move up more people are attracted to planting rubber and by the time it is ripe for tapping, since more people have joined the race, price slumps. And they need to wait for the next cylce of boom to make profits!

SOurce: commodityonline.com