The first factor is, the number of leading firms and the percentage of the market they account for: the fewer leading firms in a given market, the more likely are such firms to engage in some form of co-ordinated interaction. UK is dominated by London-listed firms Gallaher and Imperial Tobacco, which together control almost 90% of the tobacco market. That means that, lower “transactions” costs required to engage in co-ordinated interaction – both the number of meetings or direct communications that might be required and the costs of observing and adjusting to other firms’ behaviour grow faster than the number of firms co-operating. A higher degree of interdependence between the firms which in turn translates into more awareness of the need to co-ordinate plus a higher probability that the firms will be able to distinguish between the effects of cheating and changes in the market demand. Last but not least, a less chance that firms will have differing costs and other characteristics making it easy to agree on a mutually profitable course of action. In antitrust analysis, “fewness” and the share of the market accounted for by leading firms is usually referred to as “concentration” and is commonly measured as the share of the market accounted for by a given number of the largest firms. In our case the concentration ratio of the tobacco industry is equals to… this confirms the prediction that is provided by economic theory is that higher levels of concentration are likely to result in higher prices and losses in allocative efficiency.
Secondly, it is known it there is an evidence of collusion in the same market in the past it is likely that the market conditions are conductive to co-ordinated interaction. As we can see from the case study, two years ago separate allegations surfaced that BAT, the third large firm in UK cigarette market, in the early 1990s colluded with rival manufacturers including Philip Morris and RJ Reynolds to fix prices in overseas territories. Thus, this is a factor that from my opinion has helped the organization of the cartel.
Fears of collusive activity are, by and large, confined to industries in which the products are relatively homogeneous, with little differentiation or customization is yet another factor that can be applied for cigarette market. This is because it is easier to fix a schedule of collusive prices when products are similar than then they all have different characteristics, sell at very different prices and can be modified for specific customer needs. From my opinion Imperial Tobacco and Gallaher, have not necessary collude on prices, but agreed to divide market by cigarette type, and social classes. Leading to Gallaher the owner of Benson & Hedges brand, being dominated in upper social class area, and Imperial tobacco in middle or lower class, saying that if we compare the main to brands of the two firms the price difference would be at least $1 between the firms’ top seller brands.
Finally, cigarettes are such products that have an inelastic demand. This means that an increase in price will make no difference to the quantity demanded. Collusion is far more likely to be attempted when demand in inelastic. The implication however, is that, the price agreement must cover all substitute goods, i.e. include most of the firms in the industry. In our case the cigarette market is dominated by two big companies. Therefore if the demand is inelastic, the companies can increase their prices and the sales will be on the same level. There might be changes in the sales of the particular brand, for example people can switch from expensive packs of cigarettes like Benson & Hedges into a cheaper one like Lambert & Butler. The effect is that since companies produce expensive as well as cheap cigarettes, it will not affect the overall profit.
To sum up, despite of high duty levels on tobacco, the habit to smoke is influencing long-term survival of the industry. From the discussed factors, we can see that there is some degree of interdependence between the leading firms, which in most cases results in collusion. Why do they do it? Well, cigarettes are homogeneous products, with a relatively inelastic demand, almost 90% of the market is controlled by just 2 firms, there are substantially high entry barriers, and there is an evidence of collusion in the same market in the past. However investigations are still being carried out, and I have tried to apply my knowledge and research to show that there is and always have been tobacco cartels not only in UK market but other world-wide cigarette industries. There are many ways to reduce the incidence and severity of co-ordinated interaction, but in this case none of them would be relevant, because smoking kills, and bringing competition, thus more tobacco firms to an industry, will lead to expansion of such products. Whereas, the government should be concentrated in developing different product to encourage people to give up smoking, but this largely lies outside the scope of the current paper.