Industrial Organization 03: Collusion
Industrial Organization 03: Collusion
Industrial Organization 03: Collusion
Collusion
Marc Bourreau
Telecom ParisTech
1 Definition
2 Why cartels are forming?
3 Why do we not observe only cartels?
Sanctions against cartels in Europe and in the US
Instability of cartels due to the strategic interactions
4 A model of collusion
5 Factors favoring collusion: examples.
Introduction
Definition
Definition of collusion
We talk about collusion (or cartels) when firms on a market agree to realize
profits superior to the "normal" profits they should get in a situation of compe-
tition.
Firms in a market are tempted to collude to raise their market power (their
profits)...
We suppose that in the case of competition, firms "maximize their profit". Why
then forming a cartel makes it possible for firms to raise their profits?
Price fixing
Quantity fixing (rare)
Geographic markets repartition
etc. (other ideas?)
But...
We can have parallel behaviors without collusion
Some concerted practices are authorized under some conditions (ex: Re-
search Joint Ventures)
Yet, in the 19th century, cartels were common and legal in the US (steal, sugar,
petroleum...).
In France, since 1810, the article 419 of the Code Pénal forbids price-fixing
agreements "prices above and below of what would have been set by the free and
natural competition"...
... but in practice, the Courts punish few cases ("good" cartels).
At the end of the 19th century, beginning of the 20th, the American Congress
voted two laws to fight against the high prices set by the "trusts":
The Sherman Antitrust Act in 1890
The Federal Trade Commission Act in 1914
These laws forbid explicit agreements which aim at reducing competition in-
tensity.
Now Article 101 of the Treaty on the Functioning of the European Union.
Case Sanction
Worldwide cartel of graphite 300 millions $ and sentences in
electrodes the US ; 218 millions euros in Eu-
rope
Anti-competitive agreement re- 378 millions French francs
lated to the TGV
Worldwide cartel of vitamins 1 billion $ and sentences in the
US ; 855 millions euros in Europe
Worldwide cartel of lysine et cit- 200 millions $ and sentences in
ric acid the US
Legislations implementation:
The interdiction is applied more or less strictly according to the countries
(US more strictly) and according to the time (stricter nowadays)
The interpretation of what constitutes an anti-competitive agreement may
also vary from one country to another (ambiguities).
R&D agreements
Professional association, information exchanges...
Leniency programs:
A company which participated in a cartel which would inform on the cartel,
may benefit from a partial or complete sanction reduction.
Introduced in the US in 1993, in Europe in 2002, in France in 2001.
An Example of Cartel
The diamants cartel:
DeBeers Group, founded in 1870, dominates the worldwide diamant mar-
ket.
Mostly controls trade rather than production: Central Selling Organization
(CSO).
More than 80% of the worldwide production transit through the CSO.
A deviation:
Zaire (Mobutu) tried to deviate (in 1981).
Two months later, a huge quantity of unidentified diamants flooded the
market: price fall by almost 40%.
A Model of Collusion
δ is the discount factor (value today of one euro, which will be obtained only
in the next period). In general, δ < 1.
For example, an investor could invest 1 euro today to get 1+r euro at the next
period (r: return rate per peiod). We would get:
1
δ= .
1+r
When we apply the discount factor to future profits, we talk about discounted
value of future profits.
Collusion period:
A firm sets the price p = pm (monopoly price) if the other firm has set pm in the
previous periods.
Punishment period:
A firm sets p = c after a deviation (i.e. if the other firm has set a price p < pm in
the previous period) and for all following periods.
Every period, both firms set the monopoly price. Therefore, every period, both
firms share the monopoly profit.
1 m 1 1
Π= π + δ πm + δ2 πm + ...
2 2 2
1 m
Π= π 1 + δ + δ2 + ... ,
2
1 m 1
Π= π .
2 1−δ
We look for the incentive to deviate from the anti-competitive agreement (i.e.
the net profit in case of deviation).
Best deviation
At any period, the best deviation consists in setting a price equal to pm − .
Π
e = πm + δ × 0 + δ2 × 0 + ... = πm
Collusion Sustainability
It is "not" in the interest of any firm to deviate if its profit in case of deviation is
lower than its profit in case of collusion, that is, if:
Π
e < Π,
or
1 m 1
πm < π ,
2 1−δ
therefore
1
δ> ≡ δ.
2
Collusion Sustainability
The collusion is sustainable if the firms value future profits high enough.
The parameter δ (limit discount factor) indicates to what extent the collusion is
feasible:
If a factor tend to decrease δ, we say that it facilitates collusion.
If a factor tend to increase δ, we say that it makes collusion more difficult.
Remark: there are other equilibria to this repeated game (e.g., the Bertrand
equilibrium of the one-period game is an equilibrium).
Why?
Backward induction reasoning.
The last period (Tth) corresponds to the one-period Bertrand game, so the
unique equilibrium of this period is such that pT = c
At period T−1, firms expect that at the last period the Bertrand equilibrium
will prevail
They are in the same situation as in the last period and set pT−1 = c
etc.
1 M 1
Π= π ,
n 1−δ
1
δ≡ 1− ,
n
For example, two firms with a discount factor of 0.6 could hold a situation of
tacit collusion, but not three firms.
In the cartel cases dealt with by the Department of Justice (DOJ) in the US
between 1990 and 2003:
77% were related to anti-competitive agreements between 6 firms or less
13% only related to anti-competitive agreements between 50 firms or more
Out of the 111 cartels detected and sanctioned by the European Commis-
sion between 1969 and 2009 (Combe and Monnier, 2012):
On average 7.7 participants and median of 5
50% of cartels comprised less than 5 participants and 75% less than 10.
Definition
When firms compete in several different markets.
1 M 1 M πM πM
π + π ≤ δ + δ2 + ... + δ2 + δ4 + ... ,
2 2 2 2
or
4δ2 + δ − 2 ≥ 0,
with δ ≥ 0, 593.
In this context, perfect collusion (monopoly price even after a demand shock)
is not possible.
Remark: although there are periods of price wars at the equilibrium, no firm
cheats at the equilibrium.
Some clauses could also facilitate collusion: for example, clauses such as "if
you find cheaper elsewhere, we reimburse the difference..." → allows to detect
deviations.
→ This type of clauses highly reduce incitations to deviate and make cartels
more stable.
Other Factors
Other factors:
Cost asymmetries make collusion more difficult for two reasons:
Difficult to agree on a common pricing strategy.
It is more difficult to "discipline" the most efficient firms.
Growing markets: collusion is easier to sustain, as the profit of deviation
is weaker compare to the cost (as the market will keep growing).
Take-Aways (1)
Take-Aways (2)