An Analysis on Cartel

Introduction

Cartel is a form of collusive oligopoly. The dominating firms in an oligopoly market engages in the cartel agreement and take mutual decision regarding price and output. The paper discusses case study related to behavior of automotive bearing companies. Now a day, formation if cartels has become a prominent feature of many industries. Cartel provides firms opportunity for earning a higher profit and revenue by charging a higher price than it is otherwise be. As cartel behaves like a monopoly there is a social welfare loss (Jacobides, MacDuffie & Tae, 2016). Government intervene with the tool of competitive policy to enhance efficiency in the market. In case of infringement, the commission charges penalties or fines to the cartel participants.

Market Structure of Automotive bearing

Bearings refer to machine parts that have elements of rolling which are used in rotating arts of automobiles like cars, truck and other components related to automotive. Classification of market structure is based on several attributes. Number of buyers and sellers signal the specific form of market structure (Salim, Islam & Bloch, 2015). Competitive market is one where numerous buyers and sellers compete in the market place. As against this in an imperfectly competitive market structure there are imperfect knowledge among market participants with sellers enjoy some degree of market power. Monopoly, oligopoly and monopolistic competition are the three forms of imperfectly competitive market structure.

Oligopoly is a form of imperfectly competitive market characterized by dominance of few large firms. The few firms serve a large number of customers. Because of a relatively small number of firms, each firm enjoys a significant control over the market (Gomez-Martinez, Onderstal, & Sonnemans, 2016). The few firms maintain a high entry barrier for the new entrants. In case of automotive bearing, scale of each automotive part can be limited to few suppliers. Approval to few suppliers encourage market concentration erecting high barriers to entry. The characteristics of automotive bearing market thus resembles to concentrated marker of oligopoly.

Symptoms of Collusive behavior

In an oligopoly market intense competition prevailed among the dominating firms. Under this situation the dominating firms can either chose to compete with each other or decide to collude. In a collusive oligopoly the firms take joint decision which is profitable for all firms. One common symptom of collusion is the convergence of price among the different firms present in the industry (Colombo, 2016). The collusive firms engage in artificially fixing prices. This type of collusion can be in different forms. Decisions can be taken to increase or freeze the existing price. Decision can also be taken to lower prices to get tenders. Firms involve in collusive agreement decides not be compete in certain market and co-operate each other in getting tenders. The price fixing can be done in two ways. One is fixing price among the competitors over a particular product. This is known as horizontal price fixing (Gomez-Martinez, Onderstal & Sonnemans, 2016). The other is to fix price between manufacturers and dealers. This is known as vertical price fixing.

 Other symptoms of collusion can be growth of the industry and can be tested in terms of concentration ratio, presence of contestability and profitability (Sawyer, 2018).

Collusion on oligopoly

In an oligopoly market there are favorable conditions which encourage firms to collude in the market. In the automotive bearing market number of competitors in the market is limited by allowing only a few firms to operate in the market.  If in each part only a few suppliers are allowed, then they can dominate the market by hindering entry of new firms in the market. The direct victim of this are the car makers. All these create a fertile condition to engage in collusion or cartel activity (Ciliberto & Williams, 2014). The associated interdependence in the oligopoly market prepares condition for collusion. When large firms engage in collision through price fixing agreement then it helps to reduce uncertainty caused by actions taken by other firms.

Collusion however is not cheat proof. Larger the number of firms engaged in collusion greater is the possibility to breach the contract. Some firms might be cheated by firms they own partly. For example, 22% of Denso is owned by Toyota. Denso passed the information on request for quotation prepared by Toyota to its rival. The strategic interdependence among the firms can be understood from a simple game theoretic approach. In a game theory, action of a player is directed from its payoff matrix. Firms chose the action which gives is higher payoff. In the collusive oligopoly price is fixed through mutual agreement (Oechssler, Roomets & Roth, 2016). In the presence of too many firms in the carte each receives only a small share of profit earned from the fixed price. Now if breaching the price contract offers a firm a higher payoff in forms of higher profit then it the concerned firm chose to breach and cheat other members in the cartel.

Incentive of the companies in cartel formation

 In reference to the given case study, in automotive bearing market JTEKT, NKS, NFC, SKF, Schaeffler and NTN are some dominating companies which engage in a cartel. Main objective of the cartel was to coordinate a pricing strategy to car makers and thud directing price to automotive customers. Cost of steel is one of the main cost components for all the bearing manufacturers. Increase in price of steel imposes a higher cost to the manufacturers. The cartel agreement allows the bearing manufacturer to bypass the increased steel price to customers in form of a high price. This increase revenue and profitability of the companies under cartel (Chen, Ghosh & Ross, 2015). Under the cartel arrangement companies agree to provide a coordinate response to the quotation issued by customers. The companies agree to coordinate in terms of price of their quotation and time to submit the quotation. Cartels provide a mutual understanding among the members regarding not to undercut each other’s share and maintain their respective fixed share on occasion of rising steel price.

Welfare consequence of cartels

In an ideal cartel companies try to restrict quantity by raising price. By doing so, companies attempt to increase their profit of earned in the industry and to the individual firms as well (Davies, Ormosi  & Graffenberger, 2015). The figure below shows price and output decision in a cartel.

Figure 1: Price and output decision in the cartel

(Source: Friedman, 2017)

Suppose there are two firms a and b. MCa and ACa indicates marginal and average cost of firm a, Similarly MCb and ACb shows the same for firm b. Q1 is the output produced by firm a while Q2 is denotes the output of firm b. Output in the industry is the sum of output by firm a and firm b and is denoted as Q. The industry output is obtained where the marginal revenue and combined marginal cost curve intersects indicating profit maximizing price output combination.

The formed cartel charged price and output similar to that of a monopoly. As described above the cartel produces output where marginal revenue (MR) is equal to marginal cost (MC). The equilibrium point if an ideal cartel is shown by point D in figure 2. At this point quantity produced by the cartel is Qm and corresponding price is Pm. The competition price and quantity is shown as Pc and Qc respectively. The formation and operation of cartel thus leads to a deadweight loss shown by the area A (Kaplow, L. (2018).

Figure 2: Welfare consequence of cartel

(Source: Baumol & Blinder, 2015)

Cost and benefit of government control

 Under the operation of cartel interest of consumers are at stake. The monopoly power of cartel allows it to charge a high price by restricting supply. Faced with high price, consumers receive a lower surplus (Bruneckiene & Pekarskiene, 2015). The inefficient allocation of resources leads to a deadweight loss. Therefore, government intervention to enhance competition helps to achieve socially efficient outcome and secure interest of the consumers.

The direct cost of government intervention include cost incurred for administration, monitoring activity of cartel and enforcement of law (Abbott, 2015).Indirect cost might be generated from legitimacy in implementing regulation

Conclusion

 In the cartel agreement, it is not possible for the commission to completely cease infringement. In case participants are found to involve in infringement intentionally they are the commission charge a fine. The fine is to be determined after considering all the circumstances and intensity of infringement. Additionally, individual assessment is made to determine role of each participating agents in the contract. The fine amount is calculated by multiplying 30% of sales value of goods and services with duration of infringement participation. The entry free lies between 15% and 25% of sales value independent of infringement duration. The fees however can vary depending upon aggravating and mitigating condition. Imposing fines is less effective in deterring behavior if cartels as the fine or penalties charged is still low than what it should be. The structure of fines should be revised to make it an effective policy.

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