Collusion

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Collusion is a term to refer to acts of cooperation or collaboration among rival entities.

In the study of economics and market competition, "collusion" takes place within an industry when rival companies cooperate for their mutual benefit. Collusion most often takes place within the market form of oligopoly, where the decision of a few firms to collude can significantly impact the market as a whole. Cartels are a special case of explicit collusion. Collusion which is not overt, on the other hand, is known as tacit collusion.

According to game theory, the independence of suppliers forces prices to their minimum, increasing efficiency and decreasing the price determining ability of each individual firm. If one firm decreases its price, other firms will follow suit in order to maintain sales, and if one firm increases its price, its rivals are unlikely to follow, as their sales would only decrease. These rules are used as the basis of kinked-demand theory. If firms collude to increase prices as a cooperative, however, loss of sales is minimized as consumers lack alternative choices at lower prices. This benefits the colluding firms at the cost of efficiency to society.

Practices that facilitate tacit collusion include:

• Uniform prices
• A penalty for price discounts
• Advance notice of price changes
• Information exchanges
• Swaps and exchanges

Collusion is largely illegal in the United States, Canada and most of the EU due to antitrust law, but implicit collusion in the form of price leadership and tacit understandings still takes place. Several recent examples of collusion in the United States include:

• Price fixing and market division among manufacturers of heavy electrical equipment in the 1960s.
• An attempt by Major League Baseball owners to restrict players' salaries in the mid-1980s.
• Price fixing within food manufacturers providing cafeteria food to schools and the military in 1993.
• Market division and output determination of livestock feed additive by companies in the US, Japan and South Korea in 1996.

There are many ways that implicit collusion tends to develop:

• The practice of stock analyst conference calls and meetings of industry almost necessarily cause tremendous amounts of strategic and price transparency. This allows each firm to see how and why every other firm is pricing their products.
• If the practice of the industry causes more complicated pricing, which is hard for the consumer to understand (such as risk-based pricing, hidden taxes and fees in the wireless industry, negotiable pricing), this can cause competition based on price to be meaningless (because it would be too complicated to explain to the customer in a short advert). This causes industries to have essentially the same prices and compete on advertising and image, something theoretically as damaging to a consumer as normal price fixing.

There are significant barriers to collusion, however, under most circumstances. These include:

• The number of firms: as the number of firms in an industry increases, it is more difficult to successfully organize and communicate.
• Cost and demand differences between firms: if costs vary significantly between firms, it may be impossible to establish a price at which to fix output.
• Cheating: there is considerable incentive to cheat on collusion agreements; though lowering prices might trigger price wars, in the short term the defecting firm may gain considerably.
• Potential entry: new firms may enter the industry, establishing a new baseline price and eliminating collusion (though anti-dumping laws and tariffs can prevent foreign companies entering the market).
• Economic recession: an increase in average total cost or a decrease in revenue provides incentive to compete with rival firms in order to secure a larger market share and increased demand.

References

• Vives, X. (1999) Oligopoly pricing, MIT Press, Cambridge MA (readable; suitable for advanced undergraduates.)
• Tirole, J. (1988) The Theory of Industrial Organization, MIT Press, Cambridge MA (An organized introduction to industrial organization)
• Tirole, J. (1986), "Hierarchies and Bureaucracies", Journal of Law Economics and Organization, vol. 2, pp.181-214.
• Tirole, J. (1992), "Collusion and the Theory of Organizations", Advances in Economic Theory: Proceedings of the Sixth World Congress of the Econometric Society, ed by J.-J. Laffont. Cambridge: Cambridge University Press, vol.2:151-206.