Collusion Course: Why Price-Fixing Schemes Survive or Collapse
A look at the Vitamins Inc. cartel reveals what causes businesses to choose conspiracy over competition.
In the late ’80s, pharmaceutical executives hatched a plan to defraud some of the world’s largest food companies. | iStock/shironosov
Despite the risks of exposure and prosecution, executives looking for a way around the demands of the open market may be tempted to team up with their competitors and form a cartel. In the past few years, the Department of Justice has gone after companies for allegedly fixing the prices of canned tuna, broiler chickens, and ready-mix concrete. In another recent case, liquid crystal display makers including LG, Samsung, and Sharp were fined for colluding to control LCD prices.
Some illegal cartels survive for decades, secretly raising prices and restricting output. Others collapse within just a few years. In new research, Takuo Sugaya, an economist at Stanford Graduate School of Business, identified the conditions that illegal collusion needs to survive and those that can lead to its imminent failure.
With Mitsuru Igami of the Yale Department of Economics, Sugaya applied game theory to analyze one of the most egregious cartel cases in modern history. In the late ’80s and early ’90s, the Swiss drug company Roche teamed up with 20 other vitamin makers from around the world to cartelize 16 products. For years, executives met in secrecy to set production quotas and drive up the prices of Vitamin A, C, and E, and beta carotene, among others — commodities whose quality tends to be similar across manufacturers.
Through a conspiracy the execs called Vitamins Inc., the companies defrauded some of the largest global food companies, such as Coca-Cola, Nestlé, and Kellogg’s. While the Vitamin C cartel was short-lived, the Vitamin A, E, and beta carotene price-fixing schemes continued until they were broken up in 1999. Eventually, the companies were hit with record-breaking penalties: Roche and BASF agreed to pay $725 million in U.S. fines; the EU fined the companies more than 855 million euros.
The Incentive to Collude
Sugaya and Igami tapped into data and documentation from American courts and European regulators to explore why the Vitamin C cartel collapsed while the others endured until they were caught. They found that sustained collusion requires all the companies involved to have strong, mutually beneficial incentives to cooperate. “The future benefit of keeping collusion needs to be sufficiently attractive,” Sugaya says.
The Vitamin C cartel’s 1995 collapse came as Chinese producers commercialized a cheaper manufacturing method and more fringe players entered the market. “Incorporating all of these new entrants into a collusion scheme is very difficult,” Sugaya says. At the same time, demand for the vitamin fell, further reducing the incentive to collude and fatally weakening the cartel. “When the future doesn’t look so good, it’s hard for collusion to survive,” Sugaya says.
If only one of those factors had been at play, the cartel might have survived, Sugaya and Igami conclude. They also suggest that if the 2001 merger between BASF and a Japanese pharmaceutical company had happened a few years earlier, the incentives to collude might have remained strong enough to save the cartel from collapse.
Unlike the Vitamin C cartel, the Vitamins A and E and beta carotene cartels did not face a demand downturn or outside competition, so the incentives to keep colluding were unambiguously positive until regulators stepped in.
To Merge or Not to Merge?
Sugaya says cartels are more common among companies with high fixed costs of production since they need to recoup their spending on infrastructure investments. The number of companies in a particular industry also plays a role. Notably, the beta carotene cartel was comprised of just two manufacturers.
“As the number of firms involved in collusion gets larger, it’s harder to sustain because you need to discipline more people,” Sugaya says. In short, so long as everyone’s incentives to work together are aligned, illicit cooperation may be more appealing than open competition.
These findings have implications for policymakers and regulators as they consider whether to approve mergers, Sugaya says. Permitting the number of competing companies in a given industry to get too low could make collusion more attractive. “If we reduce the number of firms, the risk of collusion will increase,” he says. He also suggests using game theory to model how easy it might be for companies to sustain collusive prices after consolidation.
Future research should look at how collusion might impact investment in innovation, the researchers say, which could be a hidden cost of collusion. For example, investing in better technology could make one company more powerful than another, creating an imbalance that might disrupt a cartel. “An executive might think, ‘If I make an investment now, it could make asymmetry in the market and hurt the cartel, so I’m not going to invest now,’” Sugaya says. “That’s another worry of allowing collusion in a market, in addition to higher prices.”
Cautious customers may have some leverage over cartels as well. Buyers who suspect suppliers might be fixing prices could try to disrupt the collusion by insisting on buying from only one company. That could interfere with the conspirators’ efforts to carefully balance their output, Sugaya says. “If you create an event that looks like somebody violated the quota, sometimes that can destabilize the collusion.”
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