CARTELS AND THEIR EFFECT ON COMPETITION

Picture Courtesy: https://dcmworld.com/wp-content/uploads/2015/07/CARTEL_LAND.jpg

This article was written by Satarupa Sarkar, a student of Amity Law School, Noida.  

Competition is a situation in the market, in which sellers independently strive for buyer’s patronage to achieve business objectives. It improves quality, lowers prices and makes people aware of the attractive benefits of buying a product or service. Free and fair competition is one of the pillars of an efficient business environment. It improves quality, lowers prices and makes people aware of the attraction of buying a product or service.[1]The introduction of a greater degree of competition can play a catalytic role in unleashing the fuller growth potential in many critical areas of the economy of a nation. It is necessary to promote an environment that facilitates fair competition outcomes in the market, restrain anti-competitive behaviour and discourage market players from adopting unfair trade practices, in the interest of consumers. The antithesis of competition is a monopoly which is achieved when a few producers instead of competing with each other come together and form an association or a cartel.

Section 2( c ) of the Competition Act,2002 defines cartels as “ an association of producers, sellers, distributors, traders or service providers who, by agreement amongst themselves, limit, control or attempt to control the production, distribution, sale or price of, or trade in goods or provision of services.”

A cartel is an organisation created by a formal agreement which is anti-competitive in nature, between a group of producers of a good or service to take control over supply in an effort to regulate manipulate prices. In its simplest terms, a cartel is an agreement between businesses not to compete with each other. The agreement is usually verbal and often informal. Cartels have a negative effect for consumers because their existence results in higher prices and restricted supply. The detection and prosecution of cartels has been made a priority by the Organization for Economic Cooperation and Development (OECD). It has identified four major categories that define how cartels conduct themselves: price fixing, output restrictions, market allocation and bid rigging. As observed by the Supreme Court of India in Union of India v. Hindustan Development Corporation, a cartel is “an association of producers who by agreement among themselves attempt to control sale and pricing schemes to obtain monopoly”.

The OECD in 1998 in its recommendation proclaimed that cartels are the most serious form of infringement of competition. Cartels are the most severe violations of competition law. Cartelisation distorts prices and leads to adverse impacts on the overall competitive structure in the market. The severity of this conduct is evidenced by the fact that cartels have been subjected to the highest penalty under section 27 of the Competition Act, 2002.

The Supreme Court of India in Haridas Exports vs All India float glass manufacturers association case stated that a mere formation of a cartel itself cannot give rise to any action until something more material is proved to demonstrate its detrimental effect on the market.

The three ingredients to constitute  a ‘Cartel’ are:

1. an agreement which includes arrangement or understanding;
2. an agreement amongst producers, sellers, distributors, traders or service providers i.e parties are engaged in identical or similar trade of goods or provision of service; and
3. an agreement which aims to limit, control or attempt to control the production, distribution, sale, price, trade in goods or provision of services.[2]

WHAT ARE CARTELS?

Cartels are horizontal agreements. Horizontal Agreement is an agreement for co-operation between two or more competing businesses operating at the same level in the market. This is generally to develop a healthy relationship between competitors. The substantial clauses of the agreement may include policies regarding pricing, production and distribution. The Agreement may also discuss sharing of information regarding the products and the market. Horizontal agreements can prompt violations of antitrust laws because these agreements may include clauses which restrict competition.

Horizontal agreements may cause negative market effects with respect to prices and quality of products. On the other hand, horizontal cooperation can lead to substantial economic benefits such as sharing risk, cost savings, sharing know-how and making innovations faster.

The operation of the horizontal agreements can be varied ranging from cartels to parallelism. The operation of cartels has a tendency to be very complex and it varies according to the number of participants involved and the nature of the market in question. In the cases for cartels, there must be the presence of a credible mechanism for enforcing the agreement between the cartel members and a method of detecting the cheating on the cartel provisions. There can also be situations wherein there is no overt collusion between the cartel members but they act in a manner, which seems to be a collusive behaviour in line with the existing market forces.

NATURE OF CARTELS

Competition law seeks to promote, maintain and sustain competition in the market which is beneficial to various stakeholders in the society. But in the case of suspected cartels, competitors agree not to compete with each other on prices, products and customers and opt for collusion leading to their personal gains and a loss of the benefits of healthy competition in general. Competitors know that such an agreement is unlawful and it compels them to keep such agreements secretive. As a result, such agreements are not reduced to writing and is often found in the form of an arrangement and understanding. It is more of a meeting of minds scenario than a formal agreement. These compulsions have convinced lawmakers to prescribe that cartels are presumed to have appreciable adverse effects on competition(AAEC).

The office of Fair Trading, UK points out that agreements between members are usually verbal and often informal. Typically cartel members may agree on prices, output level, discounts, credit terms, which areas to supply, targeted customers, who should win a contract (bid rigging).

Cartels can occur in any industry and can involve goods or services at the manufacturing, distribution and retail level. However, some sectors are most susceptible to cartels than others because of the structure or the way in which they operate.

For example, where there are few competitors, the products have similar characteristics, leaving little scope for competition on quality or service, communication channels between competitors are already established, the industry is suffering from excess capacity or there is a general recession.

TYPES OF CARTELS

1. Price fixing

Price-fixing agreements are the most common form of anti-competitive agreement which directly or indirectly determines purchase or sale price. Price fixing can occur at any level in the production and distribution process. It may involve agreements as to the price of primary goods, intermediary inputs or finished products. It may also involve agreements retailing to specific forms of price computation, including the granting of discounts and rebates, drawing up to its price lists and variations therefrom, and exchange of price information.

An agreement which directly and indirectly determines the purchase or sale price is prohibited under Section 3(3)(a). Price fixing is a per se prohibition. It may be direct or indirect. It may relate to prices or pricing methods.  In Arizona vs. Maricopa County Medical Society[3], the court observed that the aim and object of price-fixing agreements are the elimination of one form of competition. Such agreements are made by way of informal understandings s to prices for preventing competition and keeping the prices up. The power to fix prices, whether reasonably exercised or not, involves the power to control the market and fix arbitrary and unreasonable prices.[4]

Air Cargo Carriers- A classic example of price fixing cartels

The European Commission imposed charged a fine of 799 million euros on the following known airlines: Air Canada, Air France-KLM, British Airways, Cathay Pacific, Cargolux, Japan Airlines, LAN Chile, Martinair, SAS, Singapore Airlines, and Qantas.

The aim of these carriers was to ensure that these surcharges were introduced by all the carriers involved and that increases (or decreases) of the surcharge levels were applied in full wihout exception. By refusing to pay a commission, the airlines ensired that surcharges did not become subject to competition through the granting of discounts to customers. Such practices violated EU competition rules.

1. Market sharing

Market sharing occurs when competitors agree to divide or allocate customers, suppliers or territories among themselves rather than allowing competitive market forces to work. The agreement can be in the nature of agreeing on specific locations of operation by one firm and non-intervention by others. It may also be with respect to transactions with specific customers.

Market sharing is a practice whereby competitors divide customers or Judicial pronouncements have also held that horizontal customer or market allocation is the practice by which the competitors divide up customers or markets and coming to an agreement of non-compete with each other for sales or in those markets. Thus, in one territory, only one product is generally available and buyers have no choice. Such agreements tend to create a monopoly like situation in the given area. For example, an agreement between manufacturer A and manufacturer B ( both manufacturers of a certain product XYZ) that A will sell a product in one geographical area, while B will sell product XYZ in another area and A will not sell XYZ in the area allocated to B and vice-versa is anti competitive as it will create a monopoly like situation. Geographic market sharing is particularly restrictive from customer’s point of view since it diminishes choice.

1. Output controls/Limiting production

Output controls can occur in the form of production or sales quota arrangements between competitors to limit the volume or type of particular goods or services available in the market.

Output or Production restrictions are agreements between competitors wherein the competitors agree to curtail output or restrict production. There is a presumption that such kinds of agreements are made to limit supply and gain the ability to raise prices and such sort of agreements are treated illegal per se.[5]

1. Bid Rigging

Bid rigging is the way that conspiring competitors effectively raise prices where purchasers — often federal, state, or local governments — acquire goods or services by soliciting competing bids.

Essentially, competitors agree in advance who will submit the winning bid on a contract being let through the competitive bidding process. As with price fixing, it is not necessary that all bidders participate in the conspiracy.

Bid rigging also takes many forms, but bid-rigging conspiracies usually fall into one or more of the following categories:

Bid Suppression: This occurs when one or more competitors who are expected to bid, or who have previously bid, agree to refrain from bidding or withdraw a previously submitted bid so that the winning competitor’s bid will be accepted.

Complementary Bidding: Complementary bidding is also referred to as courtesy bidding or cover bidding. Basically this refers to the concept of one firm submitting an artificially high bid that they know is sure not to win in exchange for some sort of participation in the profits of the winning bidder. Such bids are not intended to secure the buyer’s acceptance but are merely designed to give the appearance of genuine competitive bidding. Complementary bidding schemes are the most frequently occurring forms of bid rigging, and they defraud purchasers by creating the appearance of competition to conceal secretly inflated prices.

Bid Rotation: In bid rotation schemes, all conspirators submit bids but take turns being the low bidder. The terms of the rotation may vary; for example, competitors may take turns on contracts according to the size of the contract, allocating equal amounts to each conspirator or allocating volumes that correspond to the size of each conspirator company. A strict bid rotation pattern defies the law of chance and suggests collusion is taking place.[6]

Subcontracting: Subcontracting arrangements are often part of a bid-rigging scheme. Competitors who agree not to bid or to submit a losing bid frequently receive subcontracts or supply contracts in exchange from the successful low bidder. In some schemes, a low bidder will agree to withdraw its bid in favour of the next low bidder in exchange for a lucrative subcontract that divides the illegally obtained higher price between them.

Almost all forms of bid-rigging schemes have one thing in common: an agreement among some or all of the bidders which predetermines the winning bidder and limits or eliminates competition among the conspiring vendors.

[7]

INQUIRY INTO CARTELS

Section 7 of the Competition Act,2002 talks about the establishment of the Competition Commission of India. In exercise of powers vested in under section 19 of the act, the commission may inquire into any alleged contravention of section 3(3) of the Competition Act which prescribes cartels.

After the inquiry, the Commission may pass any or all of the following orders under section 27 of the act if it is satisfied that there exists a prima facie case of ‘cartelization’:

1. The commission directs the parties to discontinue and not re-enter such an agreement;
2. The commission directs the enterprises concerned to modify the agreement;
3. The commission directs the enterprises concerned to abide by such other orders passed and to comply with the directions including payment of costs if any.
4. The commission may pass such orders or issue such directions as it may deem fit.

PENALTY

Section 27(b) provides for the punishment for breach of Section 3 by a cartel. The commission may impose upon each producer, seller, distributor, trader or service provider included in that cartel a penalty for up to 3 times its profit for each year of the continuance of such agreement or 10% of its total turnover for each year whichever is higher.[8]

HARM CAUSED BY CARTELS

There are a worldwide recognition and consensus that Cartels harm consumers and damage economies. Japan has estimated that recent cartels raised prices on average by 16.5 %. In Sweden and Finland, competition authorities observed price declines of 20-25% following enforcement action against asphalt cartels. The ‘football replica kits case’ in the UK has resulted in long term price reduction to the extent of 30%  following the OFT’s enforcement action. Estimates in the United States suggest that some hardcore cartels can result in price increases up to 60-70%. Based on a review of a large number of cartels, it is estimated that the average overcharge is somewhere in the 20-30% range, with higher overcharges for international cartels than for domestic cartels. In India too, cartels have been alleged in various sectors, namely cement, steel, tyres etc.

India is also believed to be a victim of overseas cartels like soda ash, bulk vitamins, petrol and etc. All these tend to raise the price or reduce the choice of consumers. The business houses are affected most by cartels as the cost of procuring inputs is enhanced or choice is restricted making them uncompetitive, unviable or is satisfied with fewer profits.[9]

The 1998 OECD Recommendation proclaimed that Cartels are “the most egregious violations of competition law.” Further, developing countries are affected more either due to the absence of competition regime or inadequate capacity to detect, discover and prosecute domestic as well as overseas cartels.

THE FIGHT AGAINST CARTELS

Fighting cartels remains a top priority for competition authorities since cartels are secretive in nature and cartelists take good care in concealing their illegal activities.

Cartel enforcement can, therefore, be extremely challenging for competition authorities who most of the times can only react after receiving complaints by competitors and customers or applications by participants to a cartel for leniency or amnesty.

More rarely, competition authorities take proactive actions to identify firms which are potentially involved in a cartel conspiracy, or markets which may be affected by cartelization. These proactive cartel detection tools involve the analysis of observable economic data and firm behaviour, systematic monitoring of media, tracking of firms & individuals to detect behaviour which is inconsistent with a healthy competitive process. Discussing the balance between proactive and reactive detection and particular detection methods may benefit competition authorities evaluating their anti-cartel detection and enforcement policies. [10]

[1] http://www.mondaq.com/india/x/33971/Antitrust%20Competition/Indian%20Competition%20Act%20An%20Overview

[2] Competition law in India, T Ramappa

[3] 457 U.S. 332(1982)

[4] https://www.justice.gov/atr/price-fixing-bid-rigging-and-market-allocation-schemes

[5] http://www.yourarticlelibrary.com/oligopoly-market/collusive-oligopoly-price-and-output-determination-under-cartel/37340/

[6] http://www.competitionbureau.gc.ca

[7] https://www.justice.gov/atr/price-fixing-bid-rigging-and-market-allocation-schemes

[8] http://www.cci.gov.in/sites/default/files/advocacy_booklet_document/cartel%20book.pdf

[9] http://www.cci.gov.in

[10] http://www.investopedia.com/terms/c/cartel.asp