Market Power and Monopsony: Economic Theories for Subcontractor Advocacy
By Courtney Little
In the construction industry, government officials, construction owners, contractors and even our competitors often shrug at subcontractor concerns about poor and frequently harmful business practices and risk allocation. They say, “Why don’t you just do business with someone else if you don’t like what’s happening?”
Unfortunately, because of the economic structure of our industry, a glazing subcontractor can be pressured into accepting terms that it wouldn’t otherwise accept. Fortunately, many of us love our businesses and our industry, and we’re fighting to change the way our industry operates. This is where an understanding of the economic theories of market power and monopsony can provide a powerful support for the American Subcontractors Association’s advocacy agenda.
TERMS TO KNOW
“Market power” can be described as the power to dictate contract terms, including payment, retainage, hold harmless and insurance terms. You’ll remember from high school that a business with a monopoly has market power because a monopoly is the only seller of a product without readily available substitutes.
A “monopsony” is the mirror image of a monopoly. Instead of a single seller, a monopsony is a market with a single buyer.
A prime contractor on a construction project may be described fairly as a monopsonist, because once the prime contract is awarded, that contractor becomes the single buyer of subcontract work for that project. Since each bid is necessarily unique to the parameters of a particular project, the “relevant market” for the work proposed in any particular bid will be a single project.
In addition, a subcontractor’s relevant market for its services, in general, will have geographic and other import-ant limitations, limiting the number of potential buyers and enhancing the monopsony power of the few prime contractors available to purchase any particular subcontractor’s services.
Besides considerations of monopsony power, prime contractors have other levers of economic power to dictate terms. For example, they have the market power of bid shopping—that is, the power to share the details of one subcontractor’s bid with other subcontractors.
As a contract glazier, your cost to prepare a bid is arguably a “sunk cost.” However, the incentive to expend resources on future bids, and to include important details, depends on your confidence that your means and methods for a particular job won’t be shared with competitors. Competitive bidders may choose to “free ride” rather than invest the work to prepare their own bids properly. When the disclosure of a subcontractor’s bid details to another will be a “cost” of their refusal to accept terms dictated by a prime contractor, the pressure can force them to accept terms they wouldn’t accept otherwise.
After the contracts are signed, the parties are locked into a relationship with substantial “switching costs,” a situation that economists call a “bilateral monopoly.” The existence of switching costs gives each party power over the other. However, prime contractors often can dictate terms, before the contract is signed, that are designed to undermine the “bilateral monopoly” power of the subcontractor after the ink has dried on the contract. This could include change order procedures and fixed unit prices. The prime contractor, however, retains its own power to back-charge the subcontractor or to switch to another subcontractor altogether.
Perhaps one of the most extreme examples of a “bilateral monopoly” is an insurance wrap-up, like an owner-controlled insurance program (OCIP) or contractor-controlled insurance program (CCIP). The subcontractor is locked in, but may not even be told what the cost will be until after the project is over. The company may be forced to bar-gain away all its contemplated profits as a cheaper alternative to challenging the administration of the wrap-up.
An understanding of the economic theories of market power and monopsony can provide powerful support for ASA’s pro-subcontractor advocacy agenda. Certainly, key issues such as prompt payment, retainage, indemnity and insurance terms can all be described using economic models that favor government intervention to protect construction subcontractors.
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