Structural Analysis of Industry, Factors That Influenced Cartel Operations - Case Study Example

Structural Analysis of Industry Contents Contents 2 Factors influencing or hindering cartel 3 References 10 Introduction The worldwide conspiracy of supplying marine hoses and other equipments for oil production facilities at a high price drew the attention of the Office of fair trading (OFT). The major corporations like Bridgestone, Yokohama, Dunlop oil and marine ltd, Trelleborg, Parker ITR and Manuli were a part of the cartel who sold marine equipments to the oil industry. These companies made millions of dollars from such uncompetitive trade practice that led to surprise investigation of the commission set up by Office of Fair Trading. The illicit practice of the cartel has led to a global increase of marine equipments price by 18% and the global order book also witnessed an annual rise of £75 million (Levenstein and Suslow, 2006). Factors influencing or hindering cartel Whereas in the view of political philosopher unlimited competition is a much desired thing, specially keeping in mind the welfare of the people, from the point of view of the industries and businesses competition is not at all a wanted thing. Businesses may advocate competition only when they are at far advantageous position as compared to their competitions, as they take pride in the success or can relax back and enjoy the huge amount of profits that these businesses make (Lipczynski and Wilson, 2001). However those businesses that fear that they will lose ground due to competition or are actually doing so will obviously want that the completion is avoided so that they can enjoy a life of piece and less loss of nervous energy due to the strains. There are actually two types of collusions. One is tacit and other is explicit. Tacit is a term that is used to describe a collusive outcome where there is no formal agreement and there is no direct communication in between the firms. Such types of collusions normally exist in industries that are characterised by Close contacts in between the social groups. There is an attitude to live and let live etc. On the other hand there is another type of collusion that is known as explicit where there is a written or verbal agreement in between the firms. Cartels refer to the association of firms in an industry that are formed in order to restrict competition in an industry. While joining a cartel the aim of the firms is to earn a reasonable amount of profit rather than targeting maximum profit for all the firms. The main purpose as to why organizations seem to enter into a cartel is to get security and freedom from competition rather than aiming to earn maximum profit for themselves. When the businesses come to the table for negotiating on the price for cartel they do not come prepared on the negotiating table that would give them maximum profit. The discussion always aims to come to a price that nobody will be able to cut and which will give all the members a sustainable profit. The joint profit maximization model states that assuming all the firms in a certain industry is part of a cartel, all of them produces identical product but the cost functions of the different firms are not same, maximization of the cartel profit becomes a problem of joint profit maximization in which the firms actually act together as if they are part of a single monopoly. As seen in the graph above, the marginal cost of the industry is the summation of individual marginal costs of the firms. The joint profit maximization occurs at the output where the Mr of the industry equals the Mc of the industry (Marshall and Marx, 2012). The output is given by QM and the price is PM. It is evident from the above figures that in order to be efficient there must be a process of bargaining for the firms to arrive at the price. The following figure shows the relationship between cartel price and individual profits of the firm. The horizontal axis shows the amount by which the cartel price exceeds the competitive price. If however the members of the cartel fail to come to an agreement regarding the high price then the intercept that each firm’s profit curve makes is the profit under competition. The above figure represents the cartel price of an industry where there are three firms i.e. A, B and D with differentiated cost structures and revenue line. Firm A would accept price PA and would not want its price to fall below XA as well as firm B which will also not accept any price beyond XB and demands PB as its price. Firm D on the other hand demands price PD and expects a price above XD. It explains how cartel pricing can be beneficial to the tradeoffs of competitive pricing, where one firm benefits at the cost of other. The green line in the figure signifies the cartel price and the inverted curve A+B+D represents the cartels revenue line. There are several factors that favour the formation of cartel i.e. identical cost, identical product, identical market share and number of firms. Cartel formation and pricing becomes easy when the above factors are present in the industry. Factors that influenced the Cartel Operations The Marine Hoses Industry Outlook The marine hoses industry deals in manufacturing equipments that are used to transport crude oil to and from vessels from extraction and productions sites. These equipments were mainly used to offload crude oil and petroleum products from production facilities like floating production, buoys to vessels and transporting it to other offshore or onshore production facilities. Though there were several players in the industry, still it was oligopolistic in nature that led to the formation of the marine hoses cartel. The major players in the cartel were Bridgestone (Japan), Yokohama (Japan), Dunlop Oil & Marine Ltd (UK & Germany), Trelleborg (France & Sweden), Parker ITR (Italy & US) and Manuli (Italy). The Marine Hoses cartel operated on a worldwide basis from 1986 to 2007. The marine hoses had a €32 million per annum market in Europe from 2004 to 2006. The members of the cartel met on a regular basis in regions like US, Europe and East Asia. The cartel infringed the antitrust treaty of the European Commission by engaging in activities like quota fixing, price fixing, tender allocation, sale condition fixing, market access and sharing sensitive market information on volume, price, customers and tenders (Levenstein and Suslow, 2006). The marine hose cartel operated just like other industry cartels. Usually an ex-employee among the members of the cartel was appointed as the co-ordinator who was responsible for allocating the tenders to the members. The cartel members used to communicate with the co-ordinator on regular basis over phone, email and fax during every tender process. The co-ordinator of the cartel prior to any tender process shared market related information that would not only benefit the member of the cartel, but the cartel as a whole would be benefited from the tender process. The co-ordinator provided the members of the cartel with tender information like bid instructions, market development and market share report. The marine hoses cartel implemented a scheme in which tenders were distributed between the cartel members. Upon receipt of any customer inquiry, the related member of the cartel would report to the co-ordinator. The co-ordinator in turn would transfer the request i.e. allocate the tender to the agreed member of the cartel. The allocated member of the cartel was called the ‘champion’. The champion was the agreed winning member of the tender. The co-ordinator of the cartel ensured that other members made their bids which were above the bid price of the champion. This uncompetitive practice of fixing the price of the tender was to the leverage of the entire cartel and not only to the champion. The collusion also had some laid down conditions which were followed the members of the cartel. It had drawn some measures to regulate the cartel conditions. Such conditions were implemented to protect the interest of the other members apart from the champion. The co-ordinator in consultation with the members of the collusion would set a compensation plan for the members who lost the tender to the agreed winning member of the cartel (Maurits, 2009). Key Factors that led to the effective functioning of the Cartel The marine hoses cartel was different to other classic collusions in respect to the investigation proceedings of the commission. The commission under article 21 of Regulation EC no 1/2003 made searches in the private houses of the members of the cartel where they found evidence of the various agreements between the members of the cartel. There were host of factors that led to the functioning of the collusion which were tender allocation, price fixing, tender fixing, fixing sale conditions, market access and sharing of sensitive information (Subiotto and Snelders, 2008). Out of the several stated factors tender allocation and fixing, price fixing and market access were the key determinants that led to the success of the cartel from 1986 to 2007. Agreements made between the member parties of the collusion favoured the cartel operations. Projects were allocated to the cartel members based on history of supply, factory and market situation and preference of the customers. Members benefited from such arrangements as projects were allotted to the members based on the market situation that favours them. It removes uncertainty of the marine hose business. The marine hoses industry is not driven by cyclical demand as fuel extraction and production facilities are run on a year round basis. Customer preference was also another factor that led to the high price fixation of the equipments sold. The members of the cartel enjoyed geographic advantage under a quid pro quo agreement, which discouraged its Japanese counterpart to win bids in the European region. Following this settlement the cartel enjoyed higher profitability as they incurred low transportation cost which comprised its major share in the total cost (Harding and Joshua, 2010). The member companies in the collusion enjoyed higher profits from this market arrangement agreement that allowed individual members to select a home market. Manuli and Parker ITR served the Italian market, UK for Dunlop Oil and Marine Ltd and Bridgestone and Yokohama had Japan as their home market. Pricing fixation was implemented by the cartel to enjoy higher gains from sale of marine hoses and ancillary equipments of the oil extraction and production facilities. The collusion adopted the Oil companies’ international marine forum standard in 1991 to set price points for equipments that would serve as reference for the member bidders (Commission of the European Communities, 2009). The reference price list was then used to circulate it amongst the members of the collusion. The co-ordinator of the cartel communicated with the member companies to set their bid prices so as to avoid identical bids. Following this they implemented a new scheme in which the bid prices would be altered based on the equipment type, the supplier and the diameter of the hose. The marine hose cartel engaged in the pre fixed bidding technique to avoid any kind of suspicions by the customers, other related authority and the government. The members of the cartel argue that the price referencing was not done to fix higher price, but it helped the other members to drive the tender in favour of the winning member i.e. the champion. The winning bidder was thus protected from any kind of competition from the members of the cartel (Wells and Ezrachi, 2011). Conclusion Cartel operations irrespective of the industry lead to uncompetitive practices that affect the value chain. In the case of marine hose cartel, it breached the EC treaty of fair practice by engaging tender allocation, geographic advantage, price fixing etc. The collusion led to the unfair practice that did not allow other small players to participate in the tendering process. The marine hose’s market was dominated by major corporations like, Bridgestone, Yokohama, Manuli, etc who created a high entry barrier that hindered other players to join the industry. More over the industry lacked competitive pricing that led to high price fixation resulting in an increase in the global prices of refined petroleum products. Intermediary cost shot up as a result of such high price of tenders that were pre fixed which invariably led the oil companies to hike prices. Effective regulatory practices need to be chartered that will serve as a guideline and control such black practices that affect emerging economies that are highly import dependent. References Commission of the European Communities, 2009. Commission Decision. [online] Available at http://ec.europa.eu/competition/antitrust/cases/dec_docs/39406/39406_1902_1.pdf. [Accessed on 28.03.2015] Harding, C., and Joshua, J., 2010. Regulating Cartels in Europe. New York: Oxford University Press. Levenstein, M., and Suslow, V., 2006. What determines cartel success?, Journal of Economic Literature, 44, 43–95. Lipczynski, J., and Wilson, J., 2001. Industrial Organisation: An Analysis of Competitive Markets. NY: Financial Times Prentice Hall. Marshall, R.C., and Marx, L. M., 2012. The Economics of Collusion: Cartels and Bidding Rings. NY: MIT Press. Maurits., P., 2009. The Marine Hoses Cartel. [online] Available at: < http://ec.europa.eu/competition/publications/cpn/2009_2_12.pdf. > [Accessed on 28.03.2015] Subiotto, R., and Snelders, R., 2008. Antitrust Developments in Europe 2007. USA: Kluwer Law International. Wells, B., C., and Ezrachi, A., 2011. Criminalising Cartels: Critical Studies of an International Regulatory Movement. 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