Price Notification Schemes

Author(s): G. B. Richardson
Source: Oxford Economic Papers, New Series, Vol. 19, No. 3 (Nov., 1967), pp. 359-369
Published by: Oxford University Press
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 PRICE NOTIFICATION SCHEMES
By G. B. RICHARDSON
The legal position
OUGHT firmsto be allowed to make arrangementsto exchange information
about the prices they are charging? 'Price notificationschemes' or 'open
price agreements',as they have been called in the United States, have
attracted attention since the passing, in 1956, of the Restrictive Trade
Practices Act. The Registrar,in his Report published in January of this
year, expresses the opinion that these arrangementsare 'spread rather
widely over industryin substitutionof price agreementsthat have been
condemnedor abandoned'. He remarks,moreover,that it is 'unnecessary
furtherto argue the proposition that registrationand examination by
the RestrictivePractices Court of informationagreementsare desirable,
since I think that it has been accepted by all parties in Parliament'".
My purpose in this article is to examine the circumstancesand the ways
in which these particular agreements can influencecompetitionand to
inquire whetherthis influenceis economicallydesirable.
Let us begin, however, by taking note of the legal position. Some
notificationschemes, even under the present state of the law, are con-
sidered restrictiveand are thereforeregistrable; this much was made
clear by a Judgementof the Restrictive Practices Court given in June
1966. The matterbeforethe Court was an agreementbetween tyremanu-
facturersregardingthe supply of tyres for buses. The practice had been
for manufacturersto contract with a transport operator to provide,
maintain, and renew tyres for his fleet of buses. In 1961, the manu-
facturersenteredinto an agreementcalled the 'Rate NotificationScheme'.
It had two parts, the one binding upon the parties, the other optional or
permissive.The compulsorypart obliged membersto informeach otherof
the rates theyhad quoted to operators; the permissivepart leftthemfree
to informthe others,if they so chose, as to the rates they provisionally
intended to quote. The understandingwas, under this second scheme,
that memberswere freeto change theirintendedquotations afterlearning
of the rates others had in mind; they could then informothers of these
changes with the resultthat a freshset of revisionsmightbe set in train.
The Registrarof RestrictiveTrading Agreementsdid not contend that
the firstor compulsorypart of this scheme, referringto rates actually
quoted, was restrictiveand the Court did not pronounce on the matter.

1 RestrictiveTrading Agreements,Report of the Registrar, 1 July 1963 to 30 June 1966,

Cmnd. 3188, 1967.

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360 PRICE NOTIFICATION SCHEMES
He maintained,however,that the permissivepart of the scheme was a
restrictivearrangementand that, being to the like effectas the previous
agreementthat the firmshad undertaken to abandon, there had been
contemptof court. In the Judgement,delivered by Mr. Justice Megaw,
this point of view was sustained. The Court was not moved by the argu-
ment that the manufacturershad not agreed to operate the permissive
part of the scheme; the fact that they did operate it, over a period of
some 3- years,was evidence that an arrangementwas in fact in existence.
A quotation fromthe Judgementputs the point forcibly:
The law is not so subtle or unrealistic as to involve the conclusion that, while
an arrangement can come into being as a result of information as to one another's
intentions supplied in word or writing or by a nod or a wink, it cannot come into
being as a result of information as to one another's intentions derived from their
actual and continuing conduct towards one another.

There would appear to be two general principles,of considerable scope

and importance, established in this case. First, the mere practice of
exchanginginformationabout prices, even although there is no agree-
ment to do so, would seem to constitutean arrangementin the meaning
of the Act. And, secondly,such an arrangementis restrictive-and there-
foreregistrable-where the prices in question are those that the parties
provisionallyintend to quote.

Short-runprice competition
So much forthe presentlegal status of informationagreements; what
must now concernus is their economic effects.What is theirinfluenceon
the pricingpoliciesoffirmsand, indirectly,on the public interest? We may
beginwith the distinctionbetween agreementsaccording to whetherthey
provide forthe notificationof prices beforeor aftercontractshave been
placed. First,let us assume that firmsinformeach other,as in the optional
part of the tyrescheme, of the prices they intend to quote. On the face of
it, it mightseem that this would promote competition,in that each firm
would supply to the othersthe informationthey need to make an effective
rejoinder.But no one now needs to be told, in this world of deterrentsand
a balance of terror, that improved opportunities for retaliation may
reduce ratherthan augment the chances of conflict.It has been suggested
that if the Russians were given an early-warningradar station on the
Rhine, and the Western Powers a similar establishmenton the Oder, the
likelihood of war would be diminished. In similar fashion, in cowboy
films,two potential contestants used to put their guns on the table in
orderthat neitherof them mighthave so great an advantage frombeing
quick on the draw. Schemes forpriornotificationof prices seem to me to

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 G. B. RICHARDSON 361
fulfilthe same kind of function;each of the parties gives up the opportu-
nity to make a surpriseattack on the understandingthat the others do
so likewise.
Post-notificationschemes(as contrastedwithpriornotificationschemes)
provide for the exchange of informationabout bids after the contracts
have been allottedor at any rate afterthe closingdate fortenders.They do
not oblige firmsin effectto invite competitorsto match the prices they
are quoting on outstanding tenders and, for this reason, will be less
effectivein preventingthem fromtryingto steal a march on theirrivals.
Nevertheless,evidence that one sellerhas been quoting low prices on past
deals is likely to persuade his competitorsthat he will do so again and
induce themto retaliate at the next round; and the threatof such retalia-
tion may sometimes be sufficientto cause those considering prices
reductionsto hold theirhand. The restraintexercised will be weaker than
under systemsof prior notification,but not altogetherwithout force.
We can describe this effectof informationagreements, rather con-
veniently, in terms of a distinction between differentforms of price
competition. In some circumstances,a seller may be induced to cut his
price by the prospect of the gains to be made beforehis rivals become
aware of his move and seek to match it, or he may cut his price in orderto
forestallothers fromsecuringsuch gains. If sellers act in either of these
ways, I shall say that we have short-runprice competition.A firmmay,
however, reduce its price even although its rivals are free to retaliate
instantaneously; in this case it seeks the more durable gains which it
believes its efficiencyand productive capacity can enable it to obtain.
When firmsmake price reductions for this reason, or in order to match
such reductions made by others, I shall say we have long-runprice
competition.I do not claim that, in practice,every example of price com-
petition will fitneatly into eitherof these two categories; the distinction
is crude but importantand I hope serviceable. Its relationto price notifi-
cation arrangementsis obvious; such agreementsinhibitshort-runprice
competition but leave the parties to them free to engage in long-run
price competitionif they are in factminded so to do. Let us now consider
these effectsmore closely.
The opportunitiesthat a market will provide forshort-runprice com-
petition will depend on two principal circumstances,the firstbeing the
duration of the interval that elapses before a price reduction becomes
known and is matched by other firms,the second being the volume of
businessthat can be transacted duringthis interval.In these two respects,
marketsdifferwidely. No time need elapse beforethe manufacturerof the
typical consumergood findsout what his rivals are charging,as prices-
forgood reason-are made public knowledge. (Even here,however,there

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362 PRICE NOTIFICATION SCHEMES
may be some scope for clandestine discounts to large retailersthat take
time to be detected.) In the case of contract work, on the other hand,
rivals may remain ignorantof the bids being submittedby others unless
they have made an arrangementdesigned to keep themselves informed.
There are likewise differencesbetween markets in the value of the sales
that can be made during the interval before retaliation takes place. A
single order for large turbo-alternatorsmay be worth some ?20-million
and representmore than the average annual output in that product of a
large firm;the incentiveto steal a march on a rival is therefore,in these
circumstances,very strong,as it can make a substantial differenceto the
load on a firm's workers. In few industries can the natural unit of
sales be so large-although one can think of others-but even in the
absence of such large natural indivisibilities,there may be the possibility
ofobtaining,throughan unmatchedpricecut,the disposal ofa largevolume
of stocks or large ordersfordeliveryover a substantial futureperiod.
It is worthnoting,in this context,that the distinctionbetween prior
and post notification,now apparently crucial in law, may be of very
variable significancein termsof economic effect.Where a firm'ssales are
made up of sufficientlysmall individual transactions to amount to a
continuousflow,as for example with most consumer goods, convenience
usually dictates that prices are changed at relativelyinfrequentintervals;
in this case knowledge of a firm'spresent or immediately past prices
usually give a good indication of the price it will charge in the immediate
future.It is generallywhere sales take the formof large and relatively
infrequenttransactionsthat past prices are no reliable guide to currentor
future ones. Prior notificationschemes are often adopted in precisely
these circumstancesbecause of the likelihood that short-runprice com-
petitionwould take place withoutthem.
For manufacturingbusiness as a whole, short-runprice competition,at
least in the home market,is probably the exception ratherthan the rule.
Most national markets are dominated by a few firmswhich are aware of
each others' prices without the need for special arrangementsdesigned
for the purpose. In these circumstances,a firmwill normally reduce its
home price level, not in the hope of taking its rivals by surprise, but
because it believes that it stands to gain even after they have reduced
theirprices in retaliation. Notificationschemes, by convertingotherwise
'closed price' marketsinto 'open price' markets,cause the pricingpolicies
that they influenceto conformto the general pattern. As the successful
operationof these schemes usually demands that competitorsare reason-
ably few and reasonably trusting,their effectivescope rarely extends
beyond home markets into the wider and less restrained field of inter-
national trade.

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 G. B. RICHARDSON 363
The natural differences betweenindustriesis thereforesuch that short-
run price competitioncan be promoted in some of them merely by pro-
hibitingnotificationarrangements,whereas,in others,it could be made to
prevail,ifat all, onlythroughradical changesin structuresuch as mightbe
brought about by the measures of dissolution,divestiture,and divorce-
ment recommended by the more enthusiastic American supporters of
anti-trust.But in these matters,it may be pointed out, consistencyis not
everything.We mightdecide to seize the opportunityto encourage short-
run price competitionwhen this could be done simply throughthe pro-
hibition of agreements,but preferto tolerate its abeyance rather than
incur the risks and costs of a policy of enforceddeconcentration.In this
case, short-runprice competitionwould take place in some industriesand
not in others,its incidence being in no way associated with its appro-
priateness.
These matters of policy, however,are not my immediate concernand
they cannot in any case be resolved until the underlyingeconomic issues
are settled. Is short-runcompetitionessentialto the fullyefficient
working
of the private enterprisesystem? What are its likelyeffectson the incen-
tive to invest and upon the adaption of supply to demand in particular
markets? How does it compare, in termsof social utility,with long-run
price competition? These are the questions that we shall now have to
consider.

Stable v. fluctuatingprices
Let us begin by observingthat short-runprice competitionwill make
prices responsiveto the balance between demand and productivecapacity
in the industry affected.When firmsare working at less than normal
capacity output,so that theirphysical equipment and skilled labour force
are underemployed,the additional or 'marginal'cost of executinga further
order is no more than the so-called variable expenditure on materials,
labour, etc. necessary for the work. Considered in isolation, therefore,a
furtherorderwill appear remunerativeprovided the price obtained forit
exceeds marginal cost. Nevertheless, where only long-run price com-
petitionis practised,firmswill usually be unwillingto quote prices below
the level sufficientto make a full contributionto fixed overheads. They
will appreciate that a general reduction in the industry'sprices will nor-
mally fail to produce an increase in the volume of sales sufficientto
compensate for the fall in their average value. It is where conditions
favour short-runprice competition,that successive reductions are likely
to drive prices down towards the level of marginal costs. The firmscon-
cerned,needless to say, will not want this to happen and would generally
be prepared to maintain theirprices provided that they knew that others

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364 PRICE NOTIFICATION SCHEMES
would do likewise.In fact, however,they will have to quote in ignorance
of rival bids; by making even a small price cut, they may gain a large
increase in their share of the business, by failingto do so they may be
leftwithoutwork.
Excess capacity is not the only condition to cause prices, under the
influenceof short-runprice competition,to be drivendown to the level of
marginalcosts. The extra businessthat a firmhopes to gain by means of a
pricereductionmay serve,not to fillunused capacity, but to replace some
otherless profitableworkto which capacity is, in part, currentlydevoted.
Many, if not most, British industriesappear to be selling more cheaply
abroad than at home and in some cases export prices are well below full
normal average costs. The fact that this gap exists indicates that short-
runpricecompetitionis not practised,for,if it were,each firmwould seek,
by means of a slightreductionin the prices it quotes on the home market,
to replace exportbusiness by home business so long as the latterremained
the more remunerative.And the ultimate result of these endeavours, in
the great majority of industries,would be to bring home prices down
towardsthe level of export prices on the internationalmarket.
Short-runprice competition,I have argued, will give us fluctuating
prices,whichmay fallto the level of marginalcosts when capacity exceeds
demand. If only long-runprice competition is practised, on the other
hand,priceswillremainrelativelystable in responseto temporarychanges
in demand. Let us now considerwhich of these alternativeformsof price
behaviouris to be preferred.
Price changes,ideally,performthe usefulfunctionof inducingconsumers
to smoothout the variations in theirown demand in such a way that less
fixed equipment is required to meet it. If excess capacity develops, the
argumentruns,prices should be loweredin orderto stimulatethe demand
needed to make fulleruse of it. Conversely,in times of capacity shortage,
to persuade buyersto postpone
thereis a case forraisingprices sufficiently
theirpurchases. The logic of price variation,in these simpleterms,is both
straightforward and appealing; but there are a variety of circumstances,
ofimportancein many markets,whichdepriveit ofmuch force.
It is worth noting,in the firstplace, that consumers'ability to adapt
to price changes will largely depend upon whetherthese can be foreseen.
If it is known,forexample, that trainfaresare lowermidweek,then people
can plan to travel then. But the ebb and flowin the demand for many
commoditiesmay be all but unpredictableand the resultantprice changes,
beingunforeseen,may produce onlylimitedadaptation. A firm'spurchases
of materials and components,for example, may be tied closely to pro-
duction programmeswhich are difficultto modifyonce embarked upon.
Plans forthe constructionof power stations, forexample, are unlikelyto

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 G. B. RICHARDSON 365
be modifiedin response to a fall in the price of switchgear,whereas they
would seriouslybe disrupted if inadequate productive capacity were to
create a bottleneck in the supply of such equipment. This may be the
extreme case, but it seems likely that purchasers in general, whether
industrialor domestic,would normallybe prepared to pay at least some
premiumforthe reasonable assurance of being able to satisfytheirrequire-
ments, as and when they mightarise, at roughlypredictable prices.
Now the provision of a reliable supply, at roughlypredictable prices,
will normallyput producersto the cost of carryingstocks or a margin of
excess capacity, or both. Much will depend, of course, on the techniques
of manufacturecharacteristicof each product, which will often permit
output to be increased,at least temporarily,above the level forwhich the
fixed equipment was designed. In other industries,it will not be practi-
cable to cater for a fluctuatingdemand without fairlygenerous capacity
provision,the functionof which,fromsociety's point of view, is to provide
the same flexibilityor room formanceuvrethat financialliquidity gives to
individuals.
I have argued that short-runprice competition will cause prices to
fluctuateand to falltowardsmarginalcost when capacity exceeds demand.
Yet a margin of normally unused capacity, it now appears, is a pre-
condition, in some cases, for a reliably available supply. Here then we
are faced with a fundamental dilemma. Short-run price competition,
reliabilityof supply, and positive profitsare three things which it may
sometimesbe impossibleto combine. If, forexample, we seek to combine
short-runprice competition,giving flexible prices, and reliable supply,
provided by a margin of normally unused capacity, then prices will
normally be below full costs, thus producing a negative return on the
capital invested. If, on the other hand, we are to have both short-run
price competition and positive profitability,then it may be necessary
eitherto avoid excess capacity, which causes prices to fall below costs, or
to have periodic scarcity severe enough to permitvery high prices to be
charged. In these circumstanceswe will have eithermountingimportsor
else bottlenecks,lengtheningorderbooks and the dislocationof purchasers'
plans. Finally, if we wish to combine both positive profitsand reliability
of supply, then it may be necessary, by avoiding short-runprice com-
petition,to prevent prices fallingbelow full costs when capacity exceeds
demand.

The penalty for over-investment

Firms may frequentlybe obliged to carry a margin of excess capacity,
I have suggested,as a condition for avoiding recurrentand disruptive
scarcities. But there are two other reasons for believing that the

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366 PRICE NOTIFICATION SCHEMES
maintenanceof a continuousbalance betweencapacity and demand will be
virtuallyimpossible.Excess capacity, in the firstplace, may arise through
accident; given that demands are difficultto predict and that the in-
vestmentplans of competingfirmsare imperfectlyco-ordinated,only a
miracle could ensure that the total productive capacity installed in an
industrywas always exactly appropriate to requirements.Even if prices
remain stable in the face of short-termdemand fluctuations,firmsthat
over-investwill pay a correspondingpenalty in termsof highercosts and
lowerprofits.But whereshort-runprice competitioncauses excess capacity
to result in a fall in prices the penalty will be increased out of all pro-
portionto the loss which the over-investmentrepresentsto society as a
whole; the fall in price representsa windfalltransferto purchasers and
may preventthe suppliersfromrecouping-in the limit-any part of their
fixedexpenses. The private sector of the economy is commonlyexhorted
to maintaina highand steady level ofinvestmentin the face of temporary
set-backs; short-runprice competition,by greatlymagnifyingthe penalty
forover-investment, makes this much more difficultto do.
Excess capacity may arise also fromthe factthat the minimumefficient
scale foran addition to capacity may, as in parts of the steel industry,be
verylarge. When short-runprice competitionis practised,the installation
of a large unit of additional capacity, beforedemand has risen sufficiently
to ensure its full utilization, will cause prices to fall below full costs.
In these circumstances,the alternativesmay be to postpone investment,
thus causing a temporaryscarcity,or to install a smallerunit of capacity,
thus forgoingeconomies of scale. It does not follow that the public
interestwill be best served, on all occasions, by investmentin the large-
scale plant, but, if such investmentcan be made to pay in the absence of
short-runprice competition,then one can normallypresumethat it ought
to be undertaken.

The choice to be made

Let me now endeavour to pull together the various threads of the
argument. Normal profitability,excess capacity, and short-runprice
competition,I suggested,cannot always be reconciled. Of these the first
cannot be sacrificed,forno one would suggestthat private enterprisecan
runindefinitely at a loss. Periodic excess capacity may, in some industries,
be the price we have to pay fora reliable supply; it may also be the result
ofscarcelyavoidable errorsofforesightor of the large size ofthe minimum
efficientaddition to capacity. Finally, short-runprice competitionmay be
preventableonlyiffirmsare allowed to exchange informationabout prices.
It is apparent,therefore,that we have to make a choice. I do not propose
that we should at all costs seek to stop short-runprice competition. In

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 G. B. RICHARDSON 367
some industries,peak demands can be met withoutthe need fora margin
of normallyunused capacity, merelyby making more intensiveuse, over
short periods, of equipment designed for a smaller load; the minimum
efficientscale of an addition to plant is by no means always large and it
may sometimesbe possible, by limitedprice changes,to induce buyers to
postpone or to bring forwardtheir purchases. In these circumstances,
firmswill not need and may not wish to avoid short-runprice competition.
The situation is quite different,however, where inflexibleproduction
processes, employing much specialized fixed equipment and trained
personnel,are foundin conjunctionwitha demand that is both fluctuating
and unresponsiveto changes in price.
These considerations,by themselves,would lead us to conclude that
there are certain market conditions, by no means rare in practice, in
which inter-firm informationagreementswould be in the public interest.
Such agreements,I suggestedearlier,would not prevent companies from
engaging in long-runprice competitionif they were minded to do so.
There is in factplentyof evidence of such competitionin industrieswhere
prices are 'open' eithernaturally or by virtue of a system of information
exchange; the automobile industry is a good case in point. But when
entryinto an industryis difficult, it is possible for established producers,
wishingto live and let live, to abjure all price competitionwith the result
that efficiencymay sufferand returns be kept abnormally high. This
situationmay develop,of course,in industriesin whichprices are naturally
open, but theremay be othersin whichinformationagreementswill make
it much easier forfirmsto give effectto theirdesire not to compete at all
in terms of price. Some people may argue that these agreementsshould
then be swept away, on the grounds that it is better to put up with the
damage done by short-runprice competitionrather than have no price
competitionat all. What we do here is a matterforjudgementin the light
of the circumstancesof each case. My own view is that it would fre-
quently be desirable to allow firmsto operate a price informationagree-
ment subject to periodic officialscrutinydesigned to detect and prevent
any abuse.

Swings and roundabouts

The public supervision of prices and profitsis a rather difficultand
costly proceduremaking heavy demands on the services of accountants,
civil servants,lawyers,and the like. One mightthink, therefore,that it
would be applied sparinglyto those industrieswhere the suspension of
competition gave firmsa degree of market power that invited abuse.
What is remarkable, therefore,is that governments,while seeking to
outlaw restrictiveagreements,are at the same time moving,in pursuit of
4520.3 C C

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368 PRICE NOTIFICATION SCHEMES
an incomes policy, in the directionof a completelygeneral price control.
The likelyeffectofthese measures,when operated concurrently,are worth
examination. In the absence of control,and for reasons other than the
exercise of monopoly power, profit rates will exhibit great variation.
They will vary between firmsmaking the same product, according to
differencesin efficiencyand in luck; and they will vary between products
themselvesand over the life cycle of each product,as a result of technical
change, shiftsin consumer demand, and many unco-ordinatedbusiness
decisionstaken in this countryand abroad. Public control,however,will
be guided inevitablyby some notion of a 'normal' returnon capital em-
ployed, this being a rate neitherhighernor lower than that required to
attract capital and enterpriseinto the trade. By consideringthe level of
interestrates and the profitrates earned in other countriesto and from
which capital could move, I do not doubt that some estimate of 'normal'
profitsmightbe made and put to good use. The danger, of course,is that
this rate will in practice be equated to the average rate of profitbeing
earned in manufacturingbusiness as a whole and then come to be re-
garded as the maximum that can justifiablybe earned on any product,
by any firmat any time. The proscriptionof inter-firmagreements or
arrangements, such as we have been consideringin this paper, will see to
it that firmsare unable to limit the extent to which their profits,in the
face of a temporarydecline in demand, fall below this average figure.
Price control,on the otherhand, will see to it that profitsdo not rise above
the average veryoftenor by verymuch. Little knowledgeof arithmeticis
requiredto perceivethatifwe make it moredifficult forprofitratesto exceed
the average, and easier for them to fall below it, the average itself will
continuouslyfall. In fact,firmsrely on being able to make on the swings
what they lose on the roundabouts; it is by setting the profitsof good
times against the losses of bad, and the successful products against the
failuresthat they are able to ride out the ups and downs of business life.
To deny firmsthe rightof such offsetting, when they operate in a world
of change and uncertainty,can scarcely be the deliberate objective of
governmentpolicies, but it could be their unintended effect. However
conscientiousand respectable our commissions,tribunals,and courts,the
collective effectof their individual decisions, as these impinge over an
increasinglywider fieldof industry,may be unfavourable to investment
generallyand highly unfavourableto investmentof a speculative kind.
Competitionis a powerfulengine of economic progress,but it is mis-
chievous to pretend that there are no other requirementsfor economic
efficiencywithwhichit can ever conflict.Informationagreementsseem to
me liable to limitcompetition,but in a way that will frequentlypromote,
ratherthan impair the general interest.If we seek throughlegislationto

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 G. B. RICHARDSON 369
purge the economy of every conceivable restrictivearrangement,then I
fear that eitherthe authorityof the laws or the efficiencyof the system
will suffer.It is a curiousparadox that the effectiveworkingof the private
enterprisesector of the economy comes, not only fromits avowed oppon-
ents, but also fromthose who seek to force it to conformto their own
mistaken conceptionof the ideal.

St. John's College,Oxford.

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