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Predicting Business Cartels-Lessons for India

Comdt. M M Sharma* Cartels create an adverse effect on the market and hits inconsiderately at the root perception of fair competition. It has been regarded as the most insidious form of violation wherein the competitors by collusive agreements fix prices, restrict outflow/supply of products, engage in bid rigging, sharing of markets etc. In India the recent rise in prices and scarcity of certain select products such as steel, cement, tyre etc., suspect the existence of hard-core cartels in these sectors and has grown as a serious concern for the Competition Commission especially in the absence of full operationalisation and enforcement of Competition Act, 2002. In this article, the Author Comdt. M. M. Sharma while trying to create awareness on this new economic offence also tries to highlights some factors, which the new CCI may like to consider while investigating allegations of cartels.

Last few months evidenced a spurt of articles in the print media, mainly the financial newspapers and journals, on the suspected cartelisation in some select sectors of industry such as steel, cement, tyre etc. and concerns have been expressed over the lack of action due to the present status of the Competition Commission of India, which continues to await its full operationalisation and notification of the enforcement provisions of the Competition Act, 2002 (amended in 2007). The Commission, on its part, under the leadership of its sole Member, Vinod Dhall (who recently relinquished his office) and a skeletal team of officers, including the author, has completed the drafting of the implementing regulations. Noticeably, this has been preceded by a long consultative process, perhaps, unique in legislative drafting

of such subordinate legislation, involving almost all stakeholders, including Apex Chambers of Industry Associations like the FICCI, CII, ASSOCHAM etc. and professional regulatory bodies like the ICAI, ICSI, ICWAI etc. besides a few international experts. These draft regulations are available on the website of the Commission for adoption by the full Commission as and when constituted. In short, the Commission is now gearing up to fulfil its mandate of, inter alia, curbing anti competitive business practices including cartels. In the absence of specific legal provisions defining and expressedly prohibiting cartels amongst sellers, producers or buyers under the MRTP Act, except as one of the restrictive trade practice, there is little awareness about such business cartels in India. This article, inter-alia, attempts to
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create better awareness on this relatively new economic offence and draws attention to the seriousness with which it is treated in rest of the World and also highlights some factors which the new CCI may like to consider while investigating allegations of cartels.

Business Cartels Across the Globe A Curtain Raiser

Of the 106 systems of competition laws in the world today ranging from the over century old Sherman Act, 1890 of USA to the latest Chinese Anti Monopoly Law, 2007 (scheduled to be enforced from 1 st August, 2008), prevalent in the six continents and in all kinds of economies, a singular feature which is common in all is that of condemning hard core cartels though treatment of such cartels may differ. The Indian modern Competition Act, 2002 (amended in 2007), soon to replace the archaic MRTP Act, 1969, defines a cartel for the first time and prescribes heavy penalties. Cartels being agreements formed in secrecy, which may or may not be in writing, between firms in direct competition with one another in the relevant market are the most pernicious form of anti competitive business practices which silently result in super normal profits due unreasonable increase of prices by the cartel at the cost of exploitation of the customers of the wholesalers as well as and consumers of the retailers. Business cartels have been known to exist in industrialised countries for over 100 years now and a huge economic literature and jurisprudence exists on cartels. In the

Cartels being agreements formed in secrecy, which may or may not be in writing, between firms in direct competition with one another in the relevant market are the most pernicious form of anti competitive business practices which silently result in super normal profits due unreasonable increase of prices by the cartel at the cost of exploitation of the customers of the wholesalers as well as and consumers of the retailers.
European Union, Mario Monti, the former Commissioner for Competition, once described cartels as cancers on open market economy 1 and the US Supreme Court has referred to cartels as the supreme evil of antitrust1. Of late, the concept of a cartel and in particular that of hard core cartel has been used with greater precision in developed economies. The fight against cartels was given increased priority around the end of 1998 after the OECD council came out with a specific Recommendation entitled Effective Action Against Hard Core Cartels in March, 1998. The Recommendation provided an explicit recognition of the objectionable character of such cartels as being the (quote) most egregious violations of competition law that injures

1.

Quoted by Richard Whish in his article Control of Cartels and other Anti Competitive Agreements in the book Competition Law today by Vinod Dhall (2007), Oxford University Press (Pp. 41).

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consumers in many countries by raising prices and restricting supply, thus making goods and services completely unavailable to some purchasers and unnecessarily expensive for others.2 Subsequently, the OECD published a Report on Leniency Programme to Fight Hard Core Cartels in 2001 followed by the Report on the Nature and Impact of Hard Core Cartels and Sanctions against Cartels under National Competition Laws in 2002. In this subsequent report of 2002, the OECD noted that the world wide economic harm from cartels is very substantial, though hard to quantify: it was estimated that 16 large cartel cases investigated in the US may have caused harm in excess of US $ 55 billion.3 The European Commission has also made great strides in fighting cartels. Between 2000 and 2005 the Commission adopted 38 infringement decisions i.e. an average six decisions per year, targeting both European and worldwide cartels, and imposed total fines of Euro 4.4 billion. The Commission under its new Commissioner Ms. Neelie Kroes has declared a crack down on cartels by setting up a dedicated cartel busting directorate within the DG Competition, besides revising its Leniency Programme, as a tool to detect and destabilize hard core cartels, which resulted into the ECN Model Leniency Programme published in September, 2006,(which was useful in drafting the draft leniency regulations adopted by the Competition Commission of India). More recently, in April 2007, the

European Commission imposed a fine of Euro 273 million for operating a cartel on the beer market in Netherlands. The brewers of the Netherlands co-ordinated prices and price of beer increased considerably during at least 1996 and 1999. The Belgian based In Bev group also participated in the cartel but received immunity from payment of fines by providing decisive information about the cartel under the Commissions Leniency Programme. Continuing the tirade, The EC, in November, 2007, busted an international cartel that fixed prices of flat glass used in the manufacture of glass products such as double glazing and safety glass. The cartel involved famous manufacturers of glass i.e. Asahi of Japan, Guardian of the US, Pilkington of the UK and Saint Gobain of France. The Commission established that in 2004 and 2005 the representatives of these companies met covertly in hotels and restaurants around Europe and conspired to increase prices for flat glass, discussing both the amount and the timing of price increase. These companies drew huge profits from selling flat glass at artificially inflated prices at the cost of not only down the- line companies, which used flat glass as the input for making products such as double glazing and safety glass but also ordinary European consumers, who had to pay the high prices for the glass used in buildings, private homes and apartments. The EC imposed fine of Euro148 million on Guardian, 140 million on Pilkington, and 133 million 900 thousand Euros on Saint-Gobain. Again Asahi of

2. 3.

OECD, Paris, 27-28 April, 1998 (C (98) 35/Final). Quoted by Richard Whish in his article Control of Cartels and other Anti Competitive Agreements in the book Competition Law today by Vinod Dhall (2007), Oxford University Press (Pp. 42-43). Apr. 08 - Jun. 08

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Japan was fined with a reduced penalty of 65 million Euros for providing substantial co-operation to the EC during investigation under its Leniency Programme. Cartels are equally or rather more harmful in developing economies where the rate of detection and quick judicial punishments may not match with those in the developed world. Mexico and Colombia are classical examples where the ill famed drug cartel mafia are known to be constantly engaged in a state of drug war forcing the newly elected government of Mexican President Felipe Calderon to treat it as military as well as criminal challenge. The gangland type executions by Mexican gangs have reportedly increased dramatically since 2001 and in 2007 an estimated 2,500 executions took place.4 In Argentina, in July, 2005, 5 Cement companies were prosecuted for a cartel that lasted for 18 years from 1981 to 1999. The companies agreed on a market division that was closely monitored by their trade association. The cartel members were fined US $ 107 million, the largest antitrust fine in the nations history.5 In Brazil, in 2005, CADE, the competition authority of Brazil, found cartels in relation to Pharmaceuticals, Steel and Crushed Stone. Heavy fines are likely to be imposed.5 In South Korea, in May, 2005, the Fair Trade Commission of South Korea fined KT Corporation with a record fine of Korean Won 115.9 billion (about US $ 115 million) for price collusion in broadband internet and landline telephone services two small rivals, Hanarotelecom and Dacom Corp. This
4. 5.

Cartels are equally or rather more harmful in developing economies where the rate of detection and quick judicial punishments may not match with those in the developed world.
is the largest fine imposed in South Korea against a single company.5 In South Africa, the Competition Tribunal, inquired into an alleged cartel of four airline companies that had conspired to announce a fuel surcharge simultaneously in May, 2004. On the basis of cooperation extended by one of these companies to provide useful evidence to the Tribunal against the cartel under the leniency programme, the Tribunal established the charge and the remaining three companies were recommended to be fined up to 10 per cent of the total turnover of each of them. In the developed economies, some of the other famous cases of international cartels are the (i) Lysine cartel case in US, in which two Japanese, two South Korean and one US Company agreed not to compete on price. As a result, price of lysine, an amino acid that stimulates growth, rose on account of collusion from 68 cents per pound to 98 cents in 1990 and continued at that level until detection in 1995. In this case evidence was collected by Department of Justice with the assistance of FBI which included documents/ transcripts of secretly recorded conversations; (ii) The International Vitamins Cartel case, in which all

Article Mexicos Cartel War: Calderon in the Cauldron by Austin Bay. Available at http://www.realclearpolitics.com/aerticles. Quoted by Richard Whish in his article Control of Cartels and other Anti Competitive Agreements in the book Competition Law today by Vinod Dhall (2007), Oxford University Press (Pp. 47-49).

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leading manufacturers of vitamins located in Belgium, Canada, France, Germany, Japan, the Netherlands, Switzerland and the United States, including the famous Hoffmann-la Roche AG and BASF of Germany, Rhone-Poulenc of France which deserves a special mention. Takeda Chemical of Japan formed a cartel dividing the world market and fixing prices of different types of vitamins during the 1990s. The cartel operated for over 10 years from 1989 to 1999 and was later prosecuted with the help of Rhone-Poulenc of France after merger with Aventis in 1999, which sought leniency and co-operated with US authorities. This cartel involved 13 Pharmaceutical companies, six European and seven Japanese and covered all major vitamins consumed the world over forming the so called cartel of alphabet soup Vitamin A to H. The overcharge on vitamins imports by 90 economies during the years 1990 to 1999 was estimated to be US $ 2709. 87 million, which is an underestimate of the total overcharges made in all vitamins transactions during the duration of the cartel. Meetings of the cartel members took place mostly in Switzerland and were shown as budget meetings ostensibly for the purpose of freezing the market shares at 1988 level. During the investigation, Rhone provided lot of documents and got 100 per cent lesser fine (of Euro 1 million); BASF and Roche pleaded guilty and were fined US $ 225 million and 500 million respectively. Total fine collected exceeded US $ 1 billion in the US alone. Two senior most executives of Hoffmann-la Roche pleaded guilty and served four of five months prison sentences. Similarly, Takeda, Eisai and Daiichi also pleaded guilty and paid fines totaling $137m whereas Rhone-Poulenc was granted conditional immunity for co-operating

with the Department of Justice (DOJ) of US. (iii) The Lombard Club case in which the European Commission imposed fines totaling Euro 124.26 million on eight Austrian banks (the Lombard Club) for their participation in a wide ranging price cartel which extended to all banking products and services and the member banks fixed interest rates for loans and savings for private and for commercial customers with the object to avoid competition in interest rates. The minutes of meetings, memoranda, records of telephonic conversations, correspondences unearthed a network of cartel committees (e.g. Lending Rates Committees, the Deposits Rates Committees, etc.) (iv) The Auction Houses Cartel involving the famous auction houses, Christies and Sothebys of UK, which were found to be involved in a collusive agreement fixing trading terms. The purpose of the cartel was to reduce the fierce competition between them that had developed during the 1980s and early 1990s. The European Commission fined Sothebys with Euro 20.4 million which was six of its world wide turnover. This fine included 40 reduction for its co-operation in the investigation. Christies, on the other hand, escaped a fine being the first to provide crucial evidence to the Commission under its Leniency Programme.

Cartels Cases Investigated in India In the absence of sound legal provisions under the MRTP Act under the MRTP Commission (MRTPC), there are only three reported cases of cartel in India, so far. (i) The Soda Ash Cartel, in which the American Natural Soda Ash Corporation (ANSAC) comprising six American producers of soda ash attempted to shift the consignment of soda ash at cartelized price to India.
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Though the MRTPC, based on the ANSAC membership agreement, held it to be a prima facie cartel and granted interim injunction in exercise of its powers under Section 14 of the MRTP Act, but this order was set aside by the Supreme Court, inter alia, on the ground that section 14 of the MRTP Act did not give any extra territorial jurisdiction to the MR TPC. This lacuna in law has now been removed as Section 32 of the Competition Act, 2002 confers extra territorial jurisdiction to the CCI in respect of such anti competitive agreements, which though executed outside India may have an effect on competition in the relevant market in India. (ii) Trucking Cartel case, of 1984, involved members of the Bharatpur Truck Operators Union and the Goods Truck Operators Union, Faridabad, which colluded to fix freight rates individually. (iii) The Cement cartel case, involving 40 manufacturers of cement, initiated in 1990 and fixing of prices of cement through the Cement Manufacturers Association (CMA) was proved recently in December, 2007 before the MRTPC. In both these cases MRTPC could only pass a cease and desist order. However, unlike the MRTPC, the CCI may not be helpless in imposing heavy fines as the Competition Act, 2002 prescribes very heavy penalties under Section 27(b).

Factors Facilitating or Hindering Cartelization or Agreements Between Business Rivals to Collude

Ironically, the existence of a free market economy by itself does not restrain the existence of cartels or such other anti competitive business practices. The example of large international cartels, detected by the competition authorities in the European Union and the US, the
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citadels of free market economy, substantiates this argument. The available competition literature on cartels suggests that there are three broad features of a market, which makes it easier for the firms to reach an agreement to collude to fix prices or otherwise avoid competition between them. The foremost being the elasticity of demand. In markets such as oil and gas, cement, steel, power and other essential products linked to the automobile or construction sectors, where the demand is inelastic, meaning that there are no substitute products available and increase in price will have no effect on the demand, there being greater scope for huge profits by price rise, there is always a chance of such collusive behaviors among the firms. The second important factor is the level of competition in the market. The fiercer is the competition and lower is the prices, in absence of cartel, the greater are the likely benefits from setting up of a cartel. The airline sector with a large number of private players competing with one another for each priority route or on favored timings in a busy route such as between metropolitan cities could be an example. The third factor is the barriers to entry in a given market, which is again linked to the level of competition. If there are low barriers to entry or expansion in a given market and the market is open for such entry by a new player or expansion of capacity by existing players, it will be difficult to sustain a cartel as any new maverick player with better efficiencies or low marginal costs can undermine the cartelized price. Retail consumer sectors such as those of readymade garments, handicrafts etc. could be examples of such situation. It may be important to note that while it may be easier to form a cartel, it may

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still be difficult to sustain a cartel for long for reasons which are interesting to note. The first being, an inherent tendency amongst each member of a cartel to derive maximum benefits by cheating on the other cartel members i.e. by undercutting the cartel price. If such cartel member is more efficient than other members i.e. have lower marginal costs, greater would be the benefit of such cheating. Such cheating will also be easier in case the cartel is between firms making many products or brands and operating simultaneously in a large number of geographic markets. A large number of firms in a given market also facilitate such cheating as the detection becomes difficult. The second reason is the likelihood of the cheating being detected by other cartel members. On such detection, the cartel either fails by itself or clue about the same is invariably given by a victim of such cheating to competition authorities leading to the detection and successful prosecution of such cartel by the authorities. The leniency programme of competition authorities comes as a handy tool for such defectors to mitigate their likely punishments. Detection of cheating is also facilitated by price transparency, small number of firms, homogenous products and predictability of demand. The third reason is the extent of punishment that other members of the cartel can impose on the cheater firm. Punishment by the cartel usually leads to the restoration of the competitive pricing by other cartel members thereby reducing the benefit of the cheater firm. This again depends upon three factors viz. availability of spare capacity with the other members, the speed with which the punishment is resorted to and the number of markets in which it can be enforced upon the cheater firm. The

It can be said that whether an industry can become cartelized or not depends on how great the incentives are for the firms in the industry to form a cartel and how sustainable the cartel is. The incentives to create a cartel depend on the difference between the profitability of the firms in the presence of a cartel and in the absence of a cartel.
punishment also may provide for the other firms to compete in the exclusive territory of the cheater firm. The longer this punishment can be sustained against such cheater firms; stronger will be the deterrence against such cheating. Apart from the above broad reasons on which the sustainability of cartels largely depend, factors such as frequent interaction among firms whether through trade associations or otherwise, institutional links between firms such as cross ownership or cross licensing, multimarket interactions between firms, markets with low fixed cost, small, regular and predictable demand by buyers, symmetries in costs and capacities of firms, production of same quality goods, homogeneity of products and absence of buyer power and practices that help companies to observe their competitors prices such as resale price maintenance, meeting the competition clause etc also facilitate the formation of cartels. On the other hand cartels are difficult to be sustained in innovative or networking markets. In conclusion, it can be said that whether an industry can become
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cartelized or not depends on how great the incentives are for the firms in the industry to form a cartel and how sustainable the cartel is. The incentives to create a cartel depend on the difference between the profitability of the firms in the presence of a cartel and in the absence of a cartel. A sustainability of a cartel, in turn, depends whether the incentives of the firms to cheat on the cartel agreement outweigh the likelihood of the cheating being detected and punished. At the same time, the supply side responses by non cartel members can undermine the cartel especially where the entry in a market is easy or it is easy for non cartel members of the industry to expand their output in response to the cartel members raising their prices, making the cartel no longer sustainable. In this way the supply side responses by non cartel members can neutralize a cartel which can also be described as the response of the market forces.6

by increasing the fines or making cartel a criminal offence and lastly (v) establishing a creditable competition authority, like those in EU, USA, Australia to signal that cartels will be detected and punished. Examples of ex post anti-cartel policies could be adoption of sophisticated investigating techniques to search for hard evidence of collusive agreements, giving strong legal powers for search and seizure to competition authorities and introducing a modern leniency programme to encourage members of cartels to come forward by whistle blowing and having a corresponding immunity programme.

A Word of Caution
There appears to be some misconception that firms making high profits must be involved in cartelization. This may not be always true as the high profits may be due to better efficiencies or other market factors such as sudden increase in demand etc. However, there are no guidelines available even in international competition literature to determine when can profits be considered as too high, except, perhaps, the UK OFT guidance on Assessment of Market Power which suggests that the following conditions that need to exist before a firm can be held to be making excessive profits in anti competitive sense: (a) profit should be substantially above the cost of capital; (b) on a persistent basis; and (c) without any evidence that entry is likely to undermine these profits in the medium-term.7 Similarly, excessive pricing is by itself no proof of cartelization and is not listed as an

Anti-cartel policies
The adoption of policies both ex ante as well as ex post , can affect the probability of formation of a cartel in the sectors where such possibilities exist due to the market structure itself and to the detection thereof by making its sustainability difficult for the cartel members. Examples of ex ante anti cartel policies are (i) issuing fewer regular orders and moving to a few irregular large orders, (ii) prohibition of pricing rules such as resale price maintenance, (iii) reducing cross ownership between companies, (iv) raising the level of punishment, either

6. 7.

The Economics of EC Competition Law by Simon Bishop & Mike Walker (2002), Sweet & Maxwell, (Para 5.31) UK OFT guidance on Assessment of Market Power (OFT 415, December 2004)

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anti competitive violation under the Competition Act, 2002, though it may be considered as an abuse of dominant position as an unfair price under the Act.8 In the United States a high price charged by a monopolist is not considered anti-competitive per se and is left for the Courts to decide. The European Union has, on the other hand, taken an interventionist approach and condemns excessive

pricing as an exploitative abuse.. This is similar to the provision of the Indian Competition Act. But nowhere excessive pricing is linked to cartelization which is primarily an anti competitive agreement between direct competitors to collude to fix prices artificially which may appear to be excessive to a common man but are not really so in the competition literature.

8. *

Section 4(2) of the Competition Act, 2002 The author is the Additional Registrar in CCI. Views are personal. Comments may be sent on cci-mms@nic.in. Apr. 08 - Jun. 08