In 1998 two British sugar producers 'British Sugar' and 'Tate & Lyle' were found to be operating a cartel by the European union.
CARTELS ESSAY
NICOLA ACTON 13JLB
In 1998 two British sugar producers 'British Sugar' and 'Tate & Lyle' were found to be operating a cartel by the European union.
A) Explain the circumstances under which a cartel is likely to be successful
B) Analyse the economic implications of operating a cartel for producers and consumers in the sugar industry.
C) Examine methods by which firms might compete in the absence of a cartel.
<A>
During the 19th Century and for most of the 20th century British industries were dominated by collective agreement. Firms colluded to restrict competition. By colluding, a firm could gain some monopoly power over their respective markets; as a result they become price makers rather than price takers. A cartel is a group of producers, which have agreed to restrict competition in the market. Essentially, they make agreements about the prices and quantities that will be sold. In markets, which are unregulated by the government, there is a strong tendency for firms to collude and act as if they were one firm. Possibly the most famous cartel today is OPEC.
THE SUCCESS OF A CARTEL DEPENDS ON A NUMBER OF FACTORS:
Production must be in the hand of relatively few producers, as an agreement has to be reached. This is likely to be easiest in Oligopolies, where only a few firms dominate the market. With a larger number of firms, there is a greater possibility that at least one key participant will refuse to collude.
Cheating has to be prevented. Once an agreement is made and profitability in the industry is raised, it would pay an individual firm to cheat, so long as no other firms do so. For instance, it would pay a small cartel producer with 10% of the market to 12% by slightly undercutting the cartel price. The profit it would lose by the small cut in price will be counter-reacted by the gain in profit on the sale of the extra 2%. However, if all producers did this, the market price would fall to a new lower equilibrium market level and all firms would lose the privilege.
All products should be homogenous and the product should have no close substitutes. That is people are forced to use your product, so therefore when price goes up, it is possible to increase total revenue and demand will not differ greatly.
Another important factor which is needed in order for a cartel to be successful, is that potential competition and new entrants must be restricted as abnormal profits encourage firms to expand output or for new firms to try their hand at the market. To prevent this, cartel firms could agree to drive other firms, which compete, too aggressively out of the market. Cartel firms could also agree to increase barriers to entry to the industry.
Finally, it is important that supply can be varied easily, for example, in the case of oil, more oil could be extracted ...
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Another important factor which is needed in order for a cartel to be successful, is that potential competition and new entrants must be restricted as abnormal profits encourage firms to expand output or for new firms to try their hand at the market. To prevent this, cartel firms could agree to drive other firms, which compete, too aggressively out of the market. Cartel firms could also agree to increase barriers to entry to the industry.
Finally, it is important that supply can be varied easily, for example, in the case of oil, more oil could be extracted out of the ground or it could simply be left there.
<B>
There are a number of economic implications when a cartel is in operation.
SUGAR PRODUCERS WILL SEE:
An increase in total revenue and profit. Assuming the demand for sugar is price inelastic i.e. a percentage change in price will bring about a smaller change in the percentage of quantity demanded, then an increase in price will lead to an increase in total revenue. All cartel members will be making abnormal profit.
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With the operation of a cartel in place, there is an increased likelihood that producers within the sugar making industry will compete with non-price competitive methods. In perfectly competitive markets, firms producing homogenous goods compete solely on price. In an imperfectly competitive market, price is often not the most important factor. They decide on a marketing mix, which is a mixture of elements, which form a strategy designed to sell their product to the market. In a cartel some of these are likely to be non-price competitive strategies. An example of this is advertising- the purpose of advertising is essentially to bind consumers to particular brands for reasons other than price. Brands will advertise to make an effect of increasing demand. It would increase market share but also the demand curve could pivot and so be steeper thus, creating new opportunities for raising both price and revenue.
However, it is interesting to note that if a firm believes they have market power they will not try as hard. They become complacent.
Another implication is that higher profits will allow the firms to re-invest the extra money into the firm. Investment is the purchase of capital goods, which are then used to create other goods and services. This makes firms stronger and more efficient and in turn, this will be passed onto the consumer through lower prices.
It is important to remember that cartels are extremely illegal. Their movements are monitored by the OFT (Office of Fair Trading) which used to be the Competition Commission. They investigate cases where it is believed that a cartel is in operation. Cartels can be broken down and heavily fined- under the New Competition Act the fine is 10% of turnover.
FOR THE CONSUMER:
The operation of a cartel will mean an increase in the price of sugar for consumers and also a lack of choice as to whom the consumer can buy their sugar from. This may be viewed as an increase in the price of plain sugar, but this is not the case. Products, which contain sugar, such as chocolate and many processed goods, will also have higher prices. This is because the cost to firms for making the product containing sugar will be higher and this is then passed through the price onto the consumer. On the other hand, if these producers did not increase the price it would mean lower profits for them.
The demand curve shows the price that the buyer would be prepared to pay for each unit. Except on the last unit purchased, the price that the buyer is prepared to pay is above the market price that is paid. The difference between these two values is consumer surplus. In another way, it is the amount of extra enjoyment the buyer gets. If the price of sugar rises there will be a loss in consumer surplus i.e. a disadvantage to the consumer.
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IN THE ABSENCE OF A CARTEL FIRMS MIGHT COMPETE IN DIFFERENT WAYS:
Firms may wish to use sales maximising techniques. Here, firms are seeking to sell the greatest quantity of output subject to not making a loss, and here firms maybe looking to increase their market share and gain a greater presence in the market because this can be important in showing there to be a market leader.
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Another way of competing is by aggressively cutting prices, which could lead to a price war. This is where one firm cuts its price and sells more at this price because for a short period of time, it is the cheapest seller. The others firms will follow and cut their prices by a little bit more than the first firm, and so on. A war develops. Obviously, the motive is to protect, or increase, market share at the expense of immediate profits. Often this is the result of a broken collusive agreement or cartel. In some instances a firm might use a price war deliberately to drive another out of business, this is known as predatory pricing. It itself makes a loss but it has other business interest that can be cross-subsidised. In recent years, we have seen price wars in the following industries: News papers, fast food, mobile phones and an extreme example was the price war in the cross channel market in 1996. Many of the ferry companies were under threat from the newly opened channel tunnel. Fares fell in that year by 60%.
Of course, these price wars do not go on forever and one of the reasons why firms want to use non-price competition is that they wish to avoid price competition, as it can cause a situation where both firms see a fall in revenue.
The argument is that in Oligopoly price competition there are unfavourable consequences for those involved. So we get a kinked demand curve.
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If the firm raises it price then none of the other firms will tend to follow a price increase. So the effect is that of, when price is increased and demand is elastic i.e. an increase in price leads to a fall in total revenue. Conversely, if the price is cut, then the other firms do the same, so for this the effect is that of a cut in price, for a price inelastic good, total revenue falls.
As mentioned before, firms wish to stay away from price competition; they then turn to non-price competition methods. An important part of this, is advertising. The aim of advertising is to increase awareness about a product and to move the demand curve to the right. This could be to maintain market share. Advertising is a distinguishing feature of Oligopolies and branding is equally important. Firms with established brands can easily charge a premium on their products. More recently, we have seen sugar firms taking a much more involved role. Tate & Lyle sponsors many sport events and both companies have used celebrity chefs such as Gary Rhodes to increase the awareness of their product.
THE CONCLUSION OF THE CASE
The EU believed that this cartel gave rise to cause for concern from the viewpoint of large companies operating in concentrated markets. The Commission fined British Sugar and Tate & Lyle 39.6m euros (£27.9m) and 7m euros (£4.9m) respectively, for adopting a 'collaborative strategy of higher pricing' on the British markets for industrial white granulated sugar and retail white granulated sugar. Napier Brown and James Budgett were each fined 1.8m euros (£1.3m) for participating in the cartel in the industrial white granulated sugar market. The Commission took account of the fact that Napier Brown and James Budgett, both sugar merchants, were dependent for supplies on British Sugar and Tate & Lyle. Between them, the four companies accounted for 90 per cent of the British white granulated sugar market.
The Commission decided that there was a cartel on the basis of an initial meeting between all the firms. The Commission commented that while it did 'not have sufficient evidence that prices to be charged to individual buyers of industrial or retail sugar were jointly fixed, the systematic participation of all the four parties in regular meetings concerning industrial sugar, and of British Sugar and Tate & Lyle concerning retail sugar, led to an atmosphere of mutual certainty as to the participants' intentions concerning their future pricing behaviour'.
