BSc Economics and related programmes

BSc Economics and related programmes

Economics of Competition and Regulation EC 3015

Week 6: Cartels

Adam Smith

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in conspiracy against the public, or in some contrivance to raise prices.”

Cartels and price fixing 2

Overview

• Examples• Legal framework & sanctions• Economic theory• Detection

3Cartels and price fixing

Examples Legal framework & sanctions Economic theory Detection

Examples

• Fuel surcharges: BA and Virgin“on at least six occasions the two companies discussed and/or informed each other about proposed changes to the level of the surcharges, rather than setting levels independently”

• Vitaminsvitamins A, E, B1, B2, B5, B6, C, D3, Biotin (H), Folic acid (M), Beta Carotene and carotinoids.



Legal framework

“Article 81 of the EC Treaty and the Chapter I prohibition contained in the Competition Act 1998 (the Act) both prohibit, in certain circumstances, agreements which prevent, restrict or distort competition.”

(OFT guidelines.)



Legal framework (2)

“Section 188 of the Enterprise Act created for the first time a specific criminal offence, which arises when an individual dishonestly agrees with one or more persons that two or more businesses will engage in certain prohibited cartel arrangements, such as price-fixing or bid- rigging.



SanctionsEU: up to 10% of annual sales

Eight companies were fined 855.2m euros (£529.5m) for what the EU antitrust chief, Mario Monti, described as the "most damaging series of cartels the commission has ever investigated".

Hoffman-La Roche of Switzerland received the largest fine, 462m euros, for being the "prime mover and main beneficiary" of the cartel.

Mr Monti said that the Swiss firm, the world's largest vitamin producer, was the main instigator and produced all 12 vitamins concerned.

The second-largest fine - 296m euros - was levied against Germany's BASF, the world's second-biggest maker of vitamins. Source: Guardian http://www.guardian.co.uk/money/2001/nov/21/



Sanctions

UK: “The cartel offence is punishable by a maximum of five years' imprisonment and/or an unlimited fine. The Enterprise Act also created a series of independent offences for failing to cooperate with, or obstructing, an investigation, carrying a range of penalties that include unlimited fines and imprisonment for up to five years...



“The danger of extradition to the US, where the sanctions are much harsher, is a scary prospect for those BA executives who may have proceedings launched against them.

Last year Ian Norris, the former chief executive of industrial giant Morgan Crucible, became the first foreign national to receive a court extradition ...


Sanctions (2)Examples Legal framework & sanctions Economic theory Detection

Sanctions (3)

“Norris, who is being advised by White & Case London litigation head Alistair Graham, appealed against his extradition on price-fixing offences last month (October). During his appeal Norris argued that, for extradition to kick in, price-fixing had to be a criminal activity in both the UK and US. The decision is expected to be handed down by the end of the month.”Source: http://www.rjw.co.uk/Russell Jones walker solicitors



http://www.rjw.co.uk/

Sanctions (4)

British Airways has admitted collusion over the price of 'long-haul passenger fuel surcharges' (surcharges) and will pay a penalty of £121.5m to be imposed by the OFT, thus enabling the OFT to close its civil investigation and resolve this case. The penalty will be the highest ever imposed by the OFT for infringements of competition law, and demonstrates the determination of the OFT to deal vigorously with anti-competitive behaviour.”Source: OFT web site



What is a cartel?

• price-fixing• bid rigging• market sharing• output quotas=> • higher prices for customers/consumers• lower quality, lack of choice



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Economic theoryFirms seek to maximise profits =>Joint monopolyMRindustry = MCindustry

But

MRfirm > MCfirm

Therefore each firm seeks finds it in its interest to increase output or cut price unilaterally

If every firms does this cartels collapses.

Cartels and price fixing


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Market demand

Example: Differentiated products

Share of market (DD’)

Output

Price

MC

MR(DD’)

Qcollusive

Pcollusive

Unilateral (dd’)

mr (dd’)

Qunilateral

Punilateral



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Market demand

Example: Differentiated products (2)

Share of market (DD’)

Output

Price

MC

MR(DD’)

Qcollusive

Pcollusive

Unilateral (dd’)

mr (dd’)

Qunilateral

Punilateral

If each company argues in the same manner…

Qprice war Cartels and price fixing


RED

BLUE

H

L

LH

(3, 3)

(5, 0)

(0, 5)

(2, 2)

The familiar prisoners’ dilemma



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Economic theory

• Are cartels unstable in practice?

• Sometimes: See Stigler paper“A theory of oligopoly” JPE Feb 1964(On cubbin.org.uk)



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Determinants of cartel stability

• Number of sellers• Visibility of terms offered• Visibility of market shares• Number of buyers• Lumpiness and infrequency of orders• Proportion of repeated sales expected• New sales as proportion (customer churn)• Etc..



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Devices to maintain stability

• Meetings• Tit for Tat behaviour• Depends on gaining knowledge of

competitors’ behaviour =>– Publication of prices– Publication of sales/market shares behaviour



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Cartel detection

In practice, how are cartels detected? • Stainless steel - Buyers complained to the European Commission about the rapid increase in prices.• Lysine - An employee of Archer Daniels Midland divulged the existence of a cartel and became an FBI informant. • Sodium gluconate - Defendants in the lysine and citric acid investigations informed the authorities.• Monochloroacetic acid - Clariant alerted European and American authorities to price fixing involving the Hoechst chemicals business that it had recently acquired.

Source: Joseph Harrington presentation



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Cartel detection

3. Observation of behaviour

1. Complaints

2. Whistle blowers

Hence leniency laws

(may also directly affect cartel stability)



Example

“A TIP-OFF from British Airways’s arch rival Virgin Atlantic prompted competition authorities on both sides of the Atlantic to investigate price fixing and collusion at the UK’s biggest passenger airline. “The revelation that Virgin supplied the information that triggered the inquiry has revived memories of the vicious rivalry between the two airlines in the 1990s, when Richard Branson accused BA of running a dirty tricks campaign against his young airline.” Source :Times on-line



Signs to look for

• prices always very similar• raised by same amount at same time• same discounts or discount structures• refuse to supply because of location• give-away phrases:

– “industry has decided margins need to be increased”– “we have agreed not to supply”– “competitors will not offer you a lower price”

Source: OFT pamphlet



Signs to look for: bid rigging

• do certain suppliers unexpectedly decline to bid?• is there a pattern of success for winning bidders• unusually high margin between successful and

unsuccessful bids?• when a new bidder arrives do all prices suddenly

drop?• is one particular bidder successful in one area or type

of product?Source: OFT pamphlet



Check your understanding: typical exam essay question

“Discuss the contribution that leniency programmes can make to the stability and detection of cartels”

(emphasis added)


BSc Economics and related programmes

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