Monday, April 7, 2008

Gas Stations: A Theory of the Gains from Banning Self-Service

Since in New Jersey, there seems to be this belief in some circles that self-service would lead to higher prices, I tried to come up with an economic model that would generate such an outcome. This is the best I could do (if anyone else has a better idea or more specific information that would inform the model, do share):

Suppose that self-service stations rely more on non-gas retail operations (mini-marts) for their revenues. [This makes some sense, once you are out of your car, you are more likely to wander to the mini-mart, or perhaps you have to go in to pay in cash.] Banning self-service gas therefore reduces the importance of these retail operations in stations’ revenues.

Now assume that building and stocking retail operations requires a large up-front expenditure (what we would call a fixed-cost investment), and that independent gas retailers are more capitally constrained than are Big Oil operated gas stations.

In this case, moving from a ban to allowing self-service could benefit Big Oil more than independent retailers. Big Oil could emphasize more the mini-marts and outspend the independents.

Mini-marts may also benefit from advertising, something that Big Oil stations could do more efficiently because of economies of scale.

If independent/unbranded retailers provide the heaviest price competition on gas itself, losing these retailers could lead to price increases.

Thus, in this model, self-service bans make independent gas stations more competitive by keeping people out of the mini-marts, thus more independent gas stations exist and price competition is heavier so lower gas prices result.

Question that need to be answered:
Are independents really more price competitive? (some evidence to suggest that they are)
Are independents really that much more capitally constrained? (most certainly)
Could not big oil compete in other ways (refinery pricing, more advertising, bigger stations, faster service, etc.) with a ban on self-service? (yes, they could)

So this is the best I can do, but I don’t think it is enough to really hold up, basically because of the third question. There are so many ways Big Oil could compete against independent retailers, I don’t think self-service or not makes much difference. But perhaps…

UPDATE: Perhaps the model is all wrong. This story suggests that being unbranded allows stations to shop for the cheapest gas - giving them a comparative advantage in gas. So I am still puzzled by the idea that self-service matters in all of this.


pril said...

there is this, too- just about all gas stations that have a big name on them are independently owned and operated. The owner leases the right to use the name and sell the company's gas. The owner could be one person owning one station, one person owning several stations or a local company owning several stations/one station. The move away from having a mechanic down at the local gas station has been pretty much economic. The equipment has become expensive, you need more of it, and most single-station owners haven't been able to absorb those costs unless they already had a very good business in it. So the bays have been turned into C-stores, with as much as a 40% markup from wholesale on snacks and things. They make much more on the crap in the store than they do off the gas, even with prices of fuel as high as they have been lately.

thebenevolentbuddy said...

Oregon has very low proportion of independent/unbranded service stations as compared to other states in the country.

However, if you look at the figures, independent gas stations offers gas at lower prices than branded states irrespective of brand. This is true in every states, and I am sure those independent gas station owners are making money, otherwise we won't be seeing them today.

Probably, they save their costs by reducing their branding costs, and they have flexibility to buy gas from any Oil company. Simply, they can buy from any company whichever is cheaper on that given day, whereas a chevron station has to buy from chevron only. So, this helps independent stations to offer lower prices to customers.

Summarizing the above, restricting self-service stations leads to reduction in independent gas stations, which in turn leads to less possibility of customers getting lower prices.

Another great example to prove, rigidity in labor markets create inefficient distortions – they raise prices and and lower employment. Oregon economics is flawed here.