Retreading

When examining market failures for retreads, it is important to make a distinction between truck tyres and passenger car tyres. Although the technique of retreading tyres has been established for decades it has never broken through in the passenger car tyre market as a serious substitute for new tyres. Conversely, retreads are fully accepted for truck tyres, where about 50% of used tyres are retreaded. The limited share of retreads in the passenger car market is somewhat surprising but can be partly explained by the lack of supports from which trucks benefit. Truck tyres are generally inventoried, tracked when used commercially, properly inflated, rotated and checked on a schedule. According to the above mentioned engineering studies, retreading is clearly indicated as the most efficient method of recovering values from used tyres. Retreads are 30% to 50% cheaper than new tyres and appear to have functional attributes which are not dissimilar from "new" tyres. Therefore, the main question to be addressed in this section is why the market for retreaded tyres is not more important than it is. Several possible explanations are put forward.

4.1.1. Technological externalities

Technological externalities arise when goods are designed in an economically suboptimal manner. In the case of tyres this would arise if incentives are not in place to ensure that the optimal degree of recyclability is present. Thus, if costs associated with the landfilling (or illegal disposal) of tyre waste are not transmitted up the product lifecycle to the point of purchase, consumers will have no incentive to demand (and manufacturers to supply) tyres with the socially optimal design.

An issue affecting the potential for retreading is the introduction of energy-efficient tyres (often labelled as eco-tyres, or smart tyres). These can save up to 6% of a vehicle's fuel. The retreadability of these tyres, however, is said to be limited. It is possible that the reduction in externalities associated with increased fuel efficiency is not as great as the increased externalities associated with reduced recoverability. However, there is a "market" for fuel efficiency. Conversely, if the costs of disposal are not transmitted back to the consumer there is not a market for recoverability. As such, design will not be socially optimal.

Recent changes in trade patterns have exacerbated such problems. In the last decade, the import of new tyres from China and other Asian newly industrialised countries to

Europe has increased significantly. These tyres are much cheaper than the high-quality tyre produced in Europe and the US. Due to the lower quality of the casing, these cheaper tyres are less suitable for retreading and have a shorter life span. The concern expressed by Rosendorfova et al. (1998) regarding the negative impact of this trend on the overall performance of the retreading sector has proved to be valid. The continuing decline in the passenger car retread market has forced the closure of a number of retread companies in the UK. Despite the improved quality of retreads, sales have dropped by over 50% in the past five years. The traditional key selling point for retreads was that they were significantly cheaper. However, the growth in the market for budget tyres, where prices may be marginally higher than retreads, has significantly affected retread business (DTI, 2001).

4.1.2. Information failures and risk aversion

It is hardly surprising that retreaders claim that there is no quality difference between new tyres and retreads (UK Environment Agency, 1998). They have a vested interest in encouraging their use and as such their claims must be considered in that light. However, a number of reputed government agencies confirm the fact that retreaded tyres are perfect substitutes, at least in terms of functional attributes, for new tyres. The US EPA (2000) dispels the myth of retreads being less safe than new tyres. "Statistics compiled by the US Department of Transportation show that nearly all tyres involved in any tyre-related accidents were under-inflated or bald. Properly maintained tyres, both new and retreaded, do not cause accidents." The US EPA (2000) also repudiates the notion that retreads have a higher failure rate than new tyres. "Rubber on the road comes from both new tyres and retreaded tyres, primarily from truck tyres that are overloaded, under-inflated, or otherwise abused." Studies of tyre debris in the UK have shown that it arises from a mixture of around 46% new tyres and 54% retreads (TRL, 1992). This is representative of the use pattern of truck tyres. (These findings are further discussed in Box 4.2.)

No evidence has been found in the literature or elsewhere of reports that claim a lower structural performance of retreads compared to new tyres. This leads us to reject the hypothesis that the engineering studies are wrong about their conclusion of complete substitutability of retreaded and new tyres. However, despite the lack of scientific evidence for the existence of quality differences between new and retreads, the public image of retreaded tyres remains poor among passenger car owners. Thus, there may be an information failure within the market. This failure may, however, be less prevalent amongst road freight operators due to the strong competitive pressures to operate efficiently, and thus have full information about relative tyre quality.

There may also be other factors at work, undermining the market even if there is full information concerning their relative quality. This can partly be explained by the fact that consumers are generally risk averse. The "risk aversion" literature points out that even a slightly inferior quality (or perception of slight inferiority) can have significant repercussions on demand.

Indeed, many studies in other areas have shown that people are disproportionately averse to low-probability high-impact risks that may lead to morbidity and mortality. This is likely to be particularly true for car tyres that are crucial for the safety of a car. The incident of a blow-out at full speed on the highway is every car driver's nightmare. Moreover, although retreads are up to 50% cheaper than new tyres, the price difference is still insignificant compared to the value of the car. Therefore, it seems crucial for the retread market to eliminate the perception of car users that retreads are inferior in quality to new tyres.

In addition, there is also evidence that consumers are often reluctant to change consumption patterns in the face of perceived uncertainty concerning quality. Encouraging consumers to "switch" from a product (new tyres) whose quality attributes are thought to be known through previous experience to a substitute (retreaded tyres) which is perceived to be of potentially lower quality may require relatively greater price incentives than is implied by the standard economic assumptions.

Indeed, both of these factors can undermine the market for retreaded tyres to a greater extent than might be imagined. In effect, the standard assumptions of certainty equivalence (i. e. in which the value of the good is discounted by the probable degree of inferiority relative to a substitute) may not hold. Consumers need even stronger incentives than is usually the case.

Box 4.2. The truth behind the gators

In the United States several organisations, such as the Maintenance Council of the American Trucking Association and the American Retreader's Association and government agencies from Virginia and Arizona have researched the performance of retreaded or recapped tyres compared to new ones. This research was initiated because of public concerns about the quality of retreaded tyres. In the eye of the public many of the failed tyres routinely found lying on and alongside roadways - the so-called road gators - are believed to originate from retreaded tyres often associated with heavy-duty trucks and other large road equipment. Unlike for passenger car and light truck retreaded tyres there are no federal standards for retreaded heavy-duty truck tyres, nor are there any plans to establish them in the near future (Federal Motor Vehicle Standard Number 117 sets norms for retreaded passenger car tyres comparable to those for new tyres).

From this research it was established that poor maintenance of tyres was the foremost cause of failure (especially under-inflation). Even though retreaded tyres were over-represented in the recovered tyre parts, this was mainly due to their use on failure-sensitive vehicles like tractor pulled trailers (this was the conclusion in the Virginia study; the Arizona study did find other reasons for the over-representation of retreaded tyres).

Sources: Virginia Department of State Police, 2000; Carey, 1999; AAMVA, 2000.

4.1.3. Consumption externalities and signalling

Closely related to the issue of information failures, are the issues of "consumption externalities" and "signalling" effects, both of which may contribute to the likelihood of passenger car owners favouring new tyres over re-treaded tyres. "Consumption externalities" refer to the effect of consumers take their "cue" from other consumers (i.e. consumption patterns from one consumer provide information to other consumers). This is often the motivation behind demonstration projects and public procurement policies. Indeed, public procurement favouring the use of retreaded tyres could have the effect of reducing other consumers" degree of risk aversion.

However, quite frequently policies have the opposite effect, favouring new tyres over retreads. For instance, although the US EPA (2000) strongly promotes the market for retreads by encouraging government agencies to purchase retreads for their fleet, legislation has also been implemented in the US that is likely to strengthen the public in its mistrust towards retreads. This legislation prohibits the use of retreaded (and regrooved) tyres on the front wheels of buses. Although this legislation is relatively unknown to the general public, and therefore has only a small influence, it does show the government has mixed feelings about retreads that are not justified by its own research or that of others.

In addition, the consumer's perception of the value of their car (and not just the tyres) can be affected by the choice of retreaded over new tyres. This is known as "signalling", and occurs in situations where the perceived value of a car is negatively affected by the use of retreads. Because the use of retreads sends a negative signal to the potential buyer of a car, the cost savings of using retreaded tyres are more than nullified by the reduction in the value of the car itself. This may partially explain why car manufacturers (and even second-hand car dealers) sell cars with tyres manufactured from "new rubber".

4.1.4. Market power and market segmentation

There may also be factors on the supply side which are restricting the use of retreaded tyres. The tyre manufacturing industry can be characterised as an oligopolistic market with a limited number of large brands. In 1999, production of tyres in the global market was dominated by six companies: Michelin (France), Bridgestone (Japan), Goodyear (USA), Continental (Germany), Sumitomo (Japan) and Pirelli (Italy). Based on global market sales, the top three controlled 57% of the world market (see Table 4.2).

Table 4.2. Production data of major tyre producers in 1999

Rank

Company

Output/tonnes (in US$ million)

Market share (%)

1

Bridgestone

13 750

20

2

Michelin

13 200

19

3

Goodyear-Dunlop

12 725

18

4

Continental

4 955

7

5

Sumitomo

2 783

4

6

Pirelli

2 600

4

7

Yokohama

2 514

3

8

Cooper

1 803

2

9

Toyo

1 323

2

10

Kumho

1 235

Source: BLIC, 2002.

As opposed to the tyre manufacturing industry, the majority of tyre retreading and recycling companies in Europe are small and medium enterprises. Recycling operators at the collection and sorting level are commonly thought to be price takers in their transactions with buying traders. Moreover, they have little influence over their costs in terms of the price they pay for waste. Their low market power is further influenced by competition with other ways of waste elimination as well as the fragmented characteristics of collection and sorting stages.

The literature provides little evidence of primary tyre manufacturers exercising market power (i.e. through dumping and other means) to constrain the share of retreaded tyres. However, retreaders in the UK were said to face difficulties in reaching their customers due to the fact that the main retailers have strong ties with the primary manufacturers of tyres, and therefore only promote new tyres (Aardvark Associates,

2001). Random checks at tyre retailers in the Netherlands confirm this experience but this test cannot be considered representative for Europe as such.

Another important segment in the market structure of the tyre supply chain is the collection and processing network of used tyres. Figure 4.6 shows the actors and the level of concentration in the Dutch tyre supply chain. As mentioned earlier, the level of concentration at the stage of the producers and importers is particularly high. At retail and car service centres, the dispersion of the market is large. Approximately 13 000 car service stations, 279 tyre replacement shops and 300 spare part centres are involved in the replacement of old for new tyres. The large number of entrepreneurs makes it necessary to implement collective initiatives to improve efficiency in the post-consumption stages rather than pushing for individual initiatives.

Figure 4.6. Supply chain of passenger car tyres in the Netherlands in 2002

Figure 4.6. Supply chain of passenger car tyres in the Netherlands in 2002

Source: VROM, 2002.

In addition, however, it is possible that tyre manufacturers are able to exercise discrimination through their links with wholesalers and retailers. A number of manufacturers of tyres made from primary rubber are themselves involved in the manufacturing of retreaded tyres. Therefore, they have incentives to optimise the share of each. In the presence of market power, they may be able to maximise their profits by segmenting the market between new and retreaded tyres, and exercise price discrimination in particular markets.

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