Modeling oligopsony market for end-of-life vehicle recycling

Abstract

End-of-life vehicle (ELV) recycling markets in emerging economies are characterized by the existence of plenty of informal dismantlers and a few formal dismantlers. The nature of these markets can be characterized as oligopsony markets, where few buyers (dismantlers) compete to purchase ELVs from a large number of sellers (ELV owners). High initial investment creates a barrier to entry and exit for formal dismantlers, whereas the perfectly competitive nature of the informal dismantling market enables free entry and exit of informal dismantlers. In this paper, we consider a market with one formal dismantler and few homogeneous informal dismantlers, and the dismantlers compete by offering a higher price for ELVs. We develop a system dynamics model to capture the feedback effects of competition in the ELV recycling market where the increase in the price of ELV reduces the profitability of dismantlers, which affects the future price increase of ELV and leads to the exit of informal dismantlers. This, in turn, creates fluctuations in dismantling quantities and scrap supplies leading to fluctuations in scrap prices. Using Indian data, the simulation results show that the competition leads to the higher market price for ELV, but a lower profit for dismantlers and reduced aggregate dismantling capacity due to the exit of informal dismantlers. The market price of ELV will rise by more than 200% in 10 years, whereas the existing informal dismantling capacity reduces to less than 50% during the same period. The higher capacities of the formal dismantler lead to the rapid exit of informal dismantlers thereby diminishing the effects of competition resulting in the lower market price for ELV. From our analysis, we recommend that establishing formal dismantling units with high capacities and vertical integration of vehicle manufacturers and end-of-life management systems aligned with suitable policy instruments will ensure more environmentally sound recycling.

Introduction

The global vehicle population is ever-increasing and has reached about 1.4 billion in the year 2018 (Chesterton, 2018). The increasing sale of vehicles also leads to an increase in the replacement of obsolete vehicles called end-of-life vehicles (ELVs). It is estimated that about 21.8 million ELVs will be generated in the year 2020 (Li et al., 2020). As vehicles are composed of many materials such as metals, non-metals, plastic, and glass. ELVs are a good secondary source of materials when they are recovered efficiently. The end-of-life management systems aim to increase the economic and environmental benefits of the recovery. The efficient recovery from material abundant ELVs provides an alternate source of materials during global supply chain disruptions and may enable the development of a circular economy.

Globally, ELV management systems can be classified as formal or regulated systems and informal or unregulated systems (In this paper, we use the term ‘regulated ELV management systems’ for those markets where the ELV management systems are governed by either legislations specific for ELV management or any other environmental legislations concerning ELV management and ‘unregulated systems’ for those with the absence of the above legislations.). In regulated systems, legislations are laid based on extended producer responsibility (EPR) where the manufacturer of the vehicle has to bear the cost of recycling and recovery (if any) at the end-of-life. Mohan and Amit (2020) provide a detailed description of the material and financial flows in an ELV management system. The flow of the ELV management system starts with the last owner of the ELV. The ELVs are collected by dismantlers who dismantle an ELV into the different components. The components may be sent for the appropriate product recovery activities, or sold in the secondary market, or scrapped, or disposed of. The remaining of the ELV called hulk is sent to a shredder, where the hulk is crushed and ground, and the various scrap is separated through physical and chemical means. The scrap is sold in the scrap market. The remaining of the ELV called as the automotive shredder residue (ASR) comprises of non-recyclable materials that are either sent for landfill or energy recovery. The scrap is used for recycling materials that are used for making vehicle components thereby closing the chain of material flow. In some regulated systems, a recycling fee is present that may be borne by the vehicle manufacturer or the first owner and is managed by a fund management system.

While the regulated ELV systems are present in developed economies such as EU and Japan, unregulated ELV systems are present in emerging economies such as India and China. Contrary to the EU and Japan, where the cost of dismantling and recycling of an ELV exceeds the benefits, ELV is traded as a valuable resource in emerging economies (Hu and Wen, 2015). The absence of regulations in the ELV management system in emerging economies leads to the growth of informal dismantlers. The informal dismantlers try to maximize their revenue from an ELV and shredders are absent in many unregulated ELV management systems. The informal dismantlers follow poor technological and occupational practices in the ELV dismantling process and dispose of the waste from ELV dismantling in an uncontrolled way. This creates environmental and occupational challenges leading to a reduction in the overall efficiency of ELV dismantling such as the case of the Indian ELV dismantling system (Sharma and Pandey, 2020). The informal dismantling used to generate their major revenue through the sale of vehicle parts, but the decreasing scope of used parts sale and fluctuating scrap prices have reduced their profitability (Akolkar et al., 2015). The scrap is traded as a commodity and the fluctuating scrap prices affect the profitability of the informal dismantlers. This makes the informal ELV dismantling system close to a perfectly competitive market. The informal dismantlers may conduct dismantling only when they are profitable and refrain from dismantling when not profitable and may engage in other business (Akolkar et al., 2015). Mohan and Amit (2020) termed this entry and exit of dismantlers from the market as dismantlers’ dilemma. They find that the dismantlers’ dilemma constraints the dismantling capacity and thereby the scrap supply in informal ELV recycling markets. Thus, the growth in informal recycling markets is restricted.

The ELV recycling system is a closed-loop supply chain involving various processes of multiple agents. ELV recycling literature considers various operational and supply chain issues such as: production planning in ELV recycling factories (Qu, Williams, 2008, Simic, Dimitrijevic, 2012, Williams, Wongweragiat, Qu, McGlinch, Bonawi-tan, Choi, Schiff, 2006), developing reverse logistic network for ELV recycling (Cruz-Rivera, Ertel, 2009, Vidovic, Dimitrijevic, Ratkovic, Simic, 2011), and ELV allocation to recycling factories (Simic, 2016a, Simic, 2016b) and strategic planning problems for ELV recycling (Simic, 2015, Simic, Dimitrijevic, 2013). This literature focuses on optimizing the payoffs of individual agents in the ELV supply chain neglecting the interaction between agents. In the absence of coordination, the agents try to maximize their surplus leading to sub-optimal performance of the system. The agents are interdependent as the individual agent’s decision on increasing their profitability will influence other members’ decisions that in turn affect the entire system. The inter-dependency among agents leads to the generation of feedback loops that play a pivotal role in deciding the governing behavior of the system. While for formal ELV management systems, the environmental and market regulations increase the system complexity, in unregulated systems the commodity nature of the scrap market and market imperfections increase the system complexity. This necessitates the importance of complex system analysis of ELV management systems and system dynamics (SD) modeling is a suitable approach. SD models have been developed to analyze the dynamics of ELV systems (Karagoz et al., 2019). The literature of SD analysis of ELV systems deals with the complex nature of formal and informal systems.

The SD literature on formal systems covers various aspects that give implications for policymaking. Zamudio-Ramirez (1996) and Bandivadekar et al. (2004) consider the impact of change in vehicle material composition on the profitability of ELV dismantling and recycling industry in North America. Zamudio-Ramirez (1996) identifies that material substitution reduces the profitability of ELV management systems and may lead to reduced benefits to the existing market-based systems. Bandivadekar et al. (2004) identify the need for dismantlers to increase the dismantling rate for better profitability. Amaral et al. (2006) analyze the Portuguese recycling industry and proposes to implement improved design for recycling and greater dismantling and component recovery over implementing ASR technology to attain the recycling targets. Inghels et al. (2016) analyze the ELV recycling system of passenger cars in Belgium. Considering various scenarios of macroeconomic and technological factors they conclude that Belgium can reach EU ELV regulation targets and they also suggest possible strategies to maintain the targets. Kumar and Yamaoka (2007) use system dynamics modeling in the context of the Japanese car recycling sector. They propose policy measures such as imposing a tax to prevent the export of used cars from Japan to facilitate a closed-loop ecosystem of car recycling and manufacturing in Japan. El Halabi and Doolan (2013) develop causal loops to understand the various factors affecting the dynamics of ELV sourcing, workforce, and land development in the context of ELV recycling in Australia. They propose various scenarios for the model-building to generate policy insights in the Australian context.

SD Models analyze the economics of various business models related to ELV recycling. Hedayati (2016) with the help of an SD model conducts a sustainability assessment to assess the best business model for energy recovery from ASR in the Australian ELV recycling context. Rosa and Terzi (2018) extend the model of Zamudio-Ramirez (1996) to include the additional recovery of automotive electronic components other than scrap recovery and find that to be economically beneficial to the dismantlers and shredders. Farel et al. (2013) develop an SD model that recommends a nationwide network for effective ELV glazing recycling in France.

SD models also analyze the ELV recycling systems of emerging economies. Azmi and Tokai (2017) estimate the ELV generation in Malaysia until the year 2040 using SD modeling. They identify an increase in ELV generation in various scenarios such as lower vehicle tax, the possible change in vehicle emission standards, and penetration of more electric vehicles and hybrid vehicles into the vehicle stock for ELV estimation. Chen et al. (2015) evaluate the impact of various government policies such as government subsidies, value-added tax, deposit-refund systems, and a combination of deposit systems & subsidies on ELV recycling in China and recommend initial subsidies and thereafter a shift to deposit systems by 2030 for better ELV recycling. Wang et al. (2014) consider the impact of various subsidy policies such as initial subsidy, recycling subsidy, R & D subsidy, and production subsidy on remanufacturing and recycling industry in China. On analyzing the impact of the implementation of subsides individually or as a combination, they identify that the combination of subsidies prove to be effective even if they are costlier. Mohamad-Ali et al. (2018) develop causal loop diagrams to understand the factors that improve the effectiveness of ELV recycling and the aftermarket industry in Malaysia. They characterize the causal relationships in the existing system and identify the influence of the Malaysian government’s aftermarket policy on them.

Mohan and Amit (2020) is the first to model the dynamics of informal ELV recycling systems using system dynamics. They analyze the informal ELV recycling system in India and identify that the dismantlers’ dilemma deters the growth of ELV dismantling in India. They recommend vertical integration of dismantlers and raw material suppliers and government support for the sustainability of ELV recycling in India. The rapid increase in the sale of new vehicles, decrease in life-cycle of vehicles, and regulatory measures such as replacement of vehicles to new emission norms have paved the way for an increase in the generation of ELVs in emerging economies. The increasing commodity prices and opportunities for product recovery have led to the entry of formal dismantlers in ELV recycling markets of emerging economies. For example, a formal dismantler “Cero Recycling” has commenced its dismantling operations in India in 2018 (cerorecycling.com, 2020).

The presence of formal and informal ELV dismantlers in a market will lead to competition between them. The dismantlers compete over each other by offering higher prices to ELV as in the Chinese ELV market (Hu and Wen, 2015). The price competition may eventually lead the weaker players out of the market. The informal dismantlers are facing problems from the formalization of the recycling markets. For example, Steuer et al. (2018) report that the informal waste electric and electronic equipment (WEEE) recyclers in China are facing challenges with decreasing profits due to fluctuating commodity prices, competition with formal and informal counterparts, and increasing regulatory pressure from the government.

Even though SD models focus on various aspects of ELV recycling, they model at an aggregate level. The strategies proposed by Zamudio-Ramirez (1996) and Bandivadekar et al. (2004) for dismantlers to mitigate the reduction in profitability due to changing vehicle material composition or Amaral et al. (2006) and Inghels et al. (2016) to meet the regulatory targets ignore any inter-firm interactions. Similarly, Chen et al. (2015), Wang et al. (2014), and Mohamad-Ali et al. (2018) analyze the impact of various government policies on the ELV recycling system on a national level, but ignore any reactive strategies from the existing informal recyclers. The previous studies consider the strategies for ELV dismantlers or recyclers as a whole but ignored any interaction such as competition or cooperation that develops between various agents in the ELV management system.

When firms compete they make decisions that not only affect their state in a system but also affect the state of the entire system, i.e., market (Rahmandad and Spiteri, 2015). The decisions of one firm affect not only the payoffs of that firm but also the payoffs of the competitors that in turn affect the whole system. The effects of firms’ decisions may also involve time delays, which make the competition a complex problem for analysis. Complex systems require a holistic analysis that is enabled by SD modeling. Though SD models generally focus on an aggregate market level, a few consider the inter-firm interactions in competition. Sice et al. (2000) use SD modeling to analyze the competition in a duopoly where the firms compete on quality to achieve a higher market share and they analyze the emerging behavior of the system and find that the system has a chaotic behavior. Brady (2009) develops a dynamic model of a Cournot duopoly, where the firms’ competition is driven by advertising and analyzes the firms’ behavior at high and low levels of advertising effectiveness. Rahmandad and Sibdari (2012) consider competition between two identical firms in a software market to analyze the effect of openness and pricing decisions on new software products on the profitability of the firms and provide recommendations for various scenarios. Thus the SD models of inter-firm competition recommend ideal strategies for competing firms.

The SD models of inter-firm competition deal with an oligopoly/duopoly setting where the sellers compete with each other, whereas our model focus on an oligopsony market focusing on the competition between buyers. We develop a system dynamics model to analyze the dynamic nature of oligopsonistic competition in ELV recycling markets and understand the effect of competition in the sustainability of the dismantling industry. In this paper, we consider the situation similar to the Indian ELV recycling market where currently there is one formal dismantler — ‘Cero Recycling’ just beginning the operations and a large number of informal dismantlers. We aim to model the dynamic competition between one formal dismantler and other informal dismantlers in an ELV recycling market. We aim to predict the effect of this competition on the market price of ELV, the profitability of the dismantlers, and the aggregate dismantling capacity. The simulation considers the price competition between the dismantlers in the market of end-of-life passenger cars taking into account the dynamics of steel scrap prices. In the competition, the dismantler with the higher price receives the major share of ELV (constrained by capacity), where we adapt the rationing rule of the Kreps-Scheinkman competition model (Kreps and Scheinkman, 1983) to allocate the ELVs to the dismantlers in the decreasing order of prices. The simulation results show that the competition leads to the higher market price for ELV, but a lower profit for dismantlers and reduced aggregate dismantling capacity with the exit of informal dismantlers. But, the competition is seen to be dampening occasionally due to dismantlers’ dilemma. Furthermore, the higher the capacity of the formal dismantler, the faster the exit of informal dismantlers thereby diminishing the effects of competition resulting in the lower market price for ELV and reduced aggregate dismantling. The model results propose vertical integration of ELV management systems and vehicle manufacturers to ensure a competitive price to the ELV as well as a closed-loop supply of scrap. This is in concurrence with the latest developments of the Indian ELV industry as ‘Maruti Suzuki Toyotsu India Private Limited’, a joint venture of Maruti Suzuki Limited and Toyota Tsusho (Economic Times Auto, 2019) and Tata Steel a sister company of Tata Motors (tatasteel.com, 2019) are also venturing into the market. There is a dearth of literature analyzing competition in oligopsony markets and to the best of our knowledge, this the first model to capture the dynamic competition between formal and informal dismantlers in an ELV recycling market.

This paper is organized as follows: Section 2 explains the theory, method, and system dynamics model. Section 3 provides the results of the system dynamics simulation model. Section 4 discusses the managerial and policy implications of the model and Section 5 concludes the paper.