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Collusion

1. What is Collusion?

Collusion is a practice in which companies competing in the same market agree to raise or fix prices, reduce output, divide up the market, or block the entry of new competitors, with the aim of increasing the profits of the participating companies (OECD, 1993).

Most jurisdictions consider that collusion between companies to raise or fix prices or reduce output is the most serious violation of competition law, as it nullifies the benefits of rivalry and competition between companies —the mechanism that allows consumers to enjoy lower prices, greater variety, and better quality of goods and services. Collusion is also one of the oldest observed practices in markets and one of the most actively prosecuted since the emergence of antitrust laws in the late 19th century (González, 2011).

2. Cartels and Collusion

2.1. Cartels or Explicit Collusion

Among the most well-known collusive practices are the so-called explicit agreements or cartels, which consist of formal agreements between companies aimed at fixing prices, limiting production, or dividing the market either geographically or by customer type. In this broad sense, cartels are synonymous with straightforward forms of collusion.

2.2. Concerted Practice

In some legal systems, such as European law, the term “concerted practices” is used when there is no explicit agreement between the parties but rather a mutual understanding to cooperate (that is, to stop competing). It has been stated that:

“Three elements are necessary to establish the existence of a concerted practice. First, some type of contact between companies is required, which may be indirect or weak. Second, there must be some kind of consensus among the parties to cooperate rather than compete. Lastly, there must be subsequent market conduct and a causal relationship between this conduct and the coordination between the parties” (Grunberg, 2017).

2.3. Conscious Parallelism (or "Tacit Collusion")

Sometimes a collusive outcome does not necessarily depend on any agreement or communication between companies (European Commission, 2002).

In oligopolistic industries, companies tend to be interdependent in their pricing and production decisions, so the actions of one company impact and provoke a counter-response from others. In such circumstances, oligopolistic firms may take into account their rivals’ actions and strategically coordinate their behavior as if they were a cartel, without any explicit or manifest agreement. This coordinated behavior is often referred to as “tacit collusion” or conscious parallelism.

Conscious parallelism, unlike the other two types of collusion—where there is at least some evidence of a shared and reciprocal understanding—is not considered illegal under competition law. In Europe, this doctrine has been established at least since the Dyestuffs (1972) and Wood Pulp II (1993) cases, and in the United States, with the Supreme Court decision in Brooke Group v. Brown & Williamson (1993).

3. Economics of Collusion

What mechanism leads companies to stop competing and choose to coordinate? Cooperative oligopoly theory provides the foundation to analyze the formation and economic effects of collusion. To understand the rationale behind collusion, Chart 1 presents a simple example developed by economist Aldo González (2011) showing the options faced by two companies competing in the same market.

Table 1: Competition Between Two Companies

		Company 2
		Compete	Collaborate
Company 1	Compete	20, 20	50, 10
	Collaborate	10, 50	40, 40

Source: González (2011)

Each company has two possible options: compete or collaborate. As shown in the table, the profits that each company earns depend on its strategy and on that of its competitor. Assuming the companies face this game or interaction only once, each will choose to compete, regardless of what the other does, resulting in a competitive equilibrium.

However, both companies are aware that they would be better off if they chose to collaborate. Market competition is not a zero-sum game. When competing for customers, companies must lower prices, which—although beneficial to consumers—results in rent dissipation that reduces company profits. In general terms, the option to collaborate allows them to behave like a monopoly, restricting industry output, raising or fixing prices, and ultimately dividing up the monopoly profits among themselves.

The risk a company faces when choosing to collaborate is that the other may decide to compete and gain a higher benefit. This possibility of deviating from collaboration to increase individual profits is what creates instability in collusion. Given the illegality of collusive agreements, companies cannot rely on contracts to enforce collaboration. An alternative mechanism to sustain this strategy is repeated interaction over time. If companies encounter each other repeatedly, they can adopt strategies that lead them to choose collaboration. When one company deviates, the other will “punish” it in the future by choosing to compete in all subsequent periods. Thus, when considering deviation, a company must weigh the short-term gain of acting individually against the long-term cost of ceasing collaboration. As theory predicts, if companies are sufficiently patient, cooperation will be the strategy they choose (Church & Ware, 2000). It is the expectation of long-term benefits from cooperation that drives companies to collude.

4. Harm of Collusion

Una de las características principales de una economía de libre mercado es la presencia de mercados competitivos. Como resultado de la libre competencia, los recursos escasos de una sociedad son asignados en forma eficiente, generando efectos positivos en el crecimiento económico y en la productividad de un país (Acemoglu, Johnson y Robinson, 2004).

One of the main characteristics of a free market economy is the existence of competitive markets. As a result of free competition, a society’s scarce resources are allocated efficiently, generating positive effects on economic growth and national productivity (Acemoglu, Johnson, and Robinson, 2004).

Cartels are harmful to consumers and society as a whole because participating firms charge higher prices (and earn greater profits) than in a competitive market. On one hand, there is allocative inefficiency due to suboptimal production levels. On the other, there are also negative redistributive effects. The higher prices paid by consumers are transferred as abnormal profits to the industry, as occurs with monopolies. Empirical evidence, both anecdotal and from systematic studies, tends to confirm that cartels lead to higher prices for consumers (Whinston, 2008; Connor & Bolotova, 2005). Hence, it is often said that collusion is “the supreme evil” of competition law (Trinko case, 2004).

5. Factors that Facilitate Collusion

Several factors can facilitate the formation of price-fixing agreements (Ivaldi et al., 2003; Motta, 2004). These include:

Market Concentration: Collusion is more likely in industries with a small number of firms. On one hand, this facilitates coordination and monitoring of members’ behavior, increasing the likelihood that a firm breaching the agreement will be punished and thus raising the cost of potential deviation. On the other hand, with fewer firms, each one can enjoy a larger market share and, therefore, greater benefits from colluding.
Entry Barriers: The easier it is to enter the industry, the harder it is to sustain collusive prices. If profits are high, new firms will be attracted to enter. Increased competition makes a collusive agreement increasingly unsustainable.
Frequency of Interaction: The frequency of interaction between firms affects how quickly a cartel can detect and punish breaches. When interaction is frequent, the likelihood of detection increases and punishment occurs more swiftly. This reduces the benefits of cheating or defecting.
Symmetric Costs: When costs are asymmetric, firms may find it harder to agree on a common price. Firms with lower marginal costs will want to set a lower collusive price. A firm with lower costs may seize the opportunity to capture the entire market by deviating and offering lower prices, increasing the expected gains from defection.
Homogeneous Goods: It is not easy to reach uniform price agreements if products differ in attributes like quality and durability. If products are perceived as different, companies will fear less the consequences of punishment for deviations, as the severity of the punishment may be limited by consumer loyalty.
Business Practices: In general, these may include practices that facilitate information exchange and coordination among firms. The existence of industry or trade associations, for example, tends to provide a basis for coordination and information exchange. They may also reduce the organizational and monitoring costs of the cartel.

In any case, it is worth noting that collusion does not necessarily arise in the presence of all or some of the above factors in a given market.

6. Known Forms of Collusion

6.1. Price-Fixing Agreement

One of the most well-known forms of collusion is that in which prices are fixed in order to restrict competition between firms and obtain higher profits. Price fixing is an agreement (written, verbal, or inferred from conduct) among competitors to increase, reduce, or stabilize prices or competitive terms. In general, antitrust laws require that each company set prices and other terms on its own, without reaching an agreement with a competitor. Consequently, price fixing is one of the primary concerns of antitrust enforcement.

6.2. Bid Rigging

Another specific form of coordination is known as bid rigging, a practice in which companies coordinate their actions in private or public tenders.

There are two common forms of bid rigging. In the first, companies agree to submit joint or aligned bids, thereby eliminating price competition. In the second, companies agree on which company will submit the lowest bid and rotate in such a way that each company wins a pre-agreed number or value of contracts. Since most (but not all) open bidding contracts involve governments, governments are most often the target of bid rigging. Bid rigging is one of the most actively prosecuted forms of collusion.

7. Illegality

The economic harm associated with collusion justifies public policy action against this type of agreement, which is usually considered illegal. Most countries with antitrust legislation condemn collusion as the most serious conduct.

In the United States, the first competition law—the Sherman Act (1890)—declared illegal any contracts or agreements that restrict trade. In Europe, Article 101 of the Treaty on the Functioning of the European Union (TFEU) includes collusion among the actions that affect trade between Member States.

Explicit collusion or cartels are considered per se anticompetitive in most countries. This is the case in the United States and Australia. However, in other countries, such as Canada and Brazil, collusion is judged under the rule of reason. To sanction a cartel under the per se rule, it is not necessary to demonstrate that the fixed price is abusive or that harm has been caused to third parties. In general, the per se offense definition has been adopted because it is considered highly unlikely that a price agreement between competitors would produce beneficial effects for society.

8. Evidence of Collusion

Collusion is the most reprehensible and harmful conduct to free competition, and at the same time, the most difficult to detect. Unlike other anticompetitive actions, collusion is not directly observable, nor are its effects always easy to distinguish from competitive behavior—either by its victims or by the agencies in charge of monitoring competition.

Broadly speaking, there are two ways to prove the existence of collusion: hard evidence and circumstantial evidence. Hard evidence refers to material proof, such as documents, minutes, recordings, emails, that clearly show there has been direct communication between companies to agree on prices or divide up the market. Circumstantial evidence, on the other hand, draws on the strategic behavior of firms in the market, which is presumed to be explainable only by an explicit agreement among companies.

Qualitatively, both types of evidence are not equivalent. Courts tend to give greater probative value to material evidence than to circumstantial or behavioral evidence, as the former dispels doubt beyond reasonable doubt regarding the existence of the cartel, while the latter always leaves room for the allegedly unlawful conduct to be explained by competitive behavior.

9. Detection Policies

Among the most commonly used methods by competition agencies around the world to obtain hard evidence are (i) direct inspections and (ii) leniency programs.

In direct inspections—or “dawn raids” in English—antitrust agencies, together with the police, conduct searches of the headquarters of companies allegedly involved in a cartel, with the aim of finding crucial evidence that can be used to prove in court that the companies were part of a collusive agreement.

In leniency programs, it is the companies involved in the cartel themselves that provide the authority with the material evidence to prove collusion. The companies provide the evidence in exchange for having the penalties erased or reduced.

Both tools are used together to uncover a cartel. The report from one company provides the competition agency with the initial information needed to search the headquarters of the other companies that colluded. In this sense, both instruments are usually considered complementary.

10. Bibliography

Acemoglu, D., Johnson, S., & Robinson, J. (2006). Understanding prosperity and poverty: Geography, institutions and the reversal of fortune. Understanding poverty, 19-36.

Church, J. R., & Ware, R. (2000). Industrial organization: a strategic approach (pp. 367-69). Homewood, IL.: Irwin McGraw Hill.

Connor, J. M., & Bolotova, Y. (2006). Cartel overcharges: Survey and meta-analysis. International Journal of Industrial Organization, 24(6), 1109-1137.

European Comission. Glossary of terms used in EU competition policy–antitrust and control of concentrations. Luxemburg: Office for Official Publications of the European Communities, 2002.

González, A. (2011). Prácticas colusivas. La libre competencia en el Chile del Bicentenario, 143-160.

Grunberg, J. & Montt, S. (2017). “La prueba de la colusión”. Reflexiones sobre el Derecho de la Libre Competencia. Fiscalía Nacional Económica, 305-383.

Ivaldi, M., Jullien, B., Rey, P., Seabright, P., & Tirole, J. (2003). The economics of tacit collusion.

Khemani, R. S. (1993). Glossary of industrial organisation economics and competition law. Organisation for Economic Co-operation and Development; Washington, DC: OECD Publications and Information Centre.

Motta, M. (2004). “Colluson and Horizontal Agreements”, en Competition policy: theory and practice. Cambridge University Press.

Whinston, M. D. (2003). Lectures on Antitrust Economics, Chapter 2: Price Fixing (No. 0040). CSIO Working Paper.