Prof. Amine Ouazad
LLM in International Business Law, March 28 2014
Microeconomics/Industry Analysis
Session #2: Collusion
Outline for Session #2
1. Price & Quantity Wars:
Strategic thinking
2. Sustaining Collusion
3. Deterring Collusion
Price wars
Interactions between markets
Epson & HP 1989
Epson producing cheap inkjet printer
HP producing high-priced laser printers
Epson introduces cheap laser printer…
Inkjet printer anyone?
Put yourself in your competitor’s shoes: Chile’s shampoo war
1993: Unilever largest seller of shampoo (Sedal brand)
1993: Procter and Gamble introduces Pantene brand
and capture market share equal to Sedal’s.
P&G cuts prices to capture Sedal’s market shares. Outcome??
Strategic thinking in daily life
The prisoners’ dilemma:
Solutions?
•Price wars
•Quantity wars
• OPEC
•Lance Armstrong?
• Anti-doping regulations
•Nuclear Arms Race
• START Treaty
•Bank runs
• Bank deposit insurance
➭Outcome?
➭Common issue?
Why are Price Wars Dangerous?
Example 1:
Electronic phonebooks
• 1986: Nynex charged $10,000 per disk for NY directory
• ProCD and Digital Directory Assistance
• Chinese workers at $3.50 daily wage
• Bertrand or Price Competition → Free
Example 2:
Encyclopedia Britannica vs. Encarta
1991: EB sold @ $1,600
1992: Microsoft introduced Encarta, sold @ $49.95
1995: EB’s sales have halved
1995: EB offers online subscription for $120 p.a. or CD for $200
1996: EB lowers cost of subscription to $85
1999: EB offers FREE on-line service (www.britannica.com)
Today: <$20 for DVD; $100 for online subscription
Outline for Session #2
1. Price & Quantity Wars:
Strategic thinking
2. Sustaining Collusion
3. Deterring Collusion
A few players
• Archer Daniels Midland
United States
• Ajinomoto
Japan
• Sewon
South Korea
• Kyowa Hakko Kogyo
Japan
☞ January 1992: Face lowest prices in the history of lysine.
Price Wars: Putting Numbers
Dominant
Strategy
Ajinomoto
High price
Low price
ADM
781.25
703.125
High price
586
Dominant
Strategy
703.125
625
586
Low price
781.25
625
High prices lead to higher profits, but each firm has an incentive to deviate.
The Cartel’s Implicit Contract
• Agree on a higher price than the competitive price.
• Agree on a lower production than the competitive productive.
• Split the revenues among the cartel members.
• Why did they start the collusion in the Spring??
Setting up a cartel
• Participants in the cartel cannot enforce the terms of their
implicit contract in a court of law.
• Hence, they set up a punishment mechanism for cartel
members who deviate.
• Observe deviations from:
• Trade statistics.
• Customers’ reports.
• Creation of a lysine trade association.
Trigger Strategies to Enforce Collusive Outcome
 Begin by cooperating.
I assume equal split of the production in the collusive agreement.
 Cooperate as long as the rivals do.
 Upon observing a defection: immediately revert to a period of punishment of
specified length in which everyone plays non-cooperatively
• Example
• Grim Trigger Strategy (GTS)
• Start off setting production at the low production level
and continue to do so until the other firm cheats by producing more.
• If the other firm cheats, set high output per year forever.
Payoff Stream from Grim Trigger Strategy
PV (collude) =
1
1
703.125
703.125+
703.125+...
=
703.125+
1+ r
(1+ r)2
r
1
1
625
781.25+
625+
625+...
=
781.25+
1+ r
(1+ r)2
r
703.125+
PV (cheat) =
Profit
$781.25M
$703.125M
collude
cheat
$625M
t
t+1
t+2
t+3
Time
“Monthly scorecards were
prepared and discussed at
quarterly meetings, based on
reported sales volumes of each
firm. To verify reported sales
volumes, international trade
statistics were available.”
Collusion: Weighing Costs and Benefits
• For punishment mechanism to work:
• Gains from cooperation must exceed net gain from cheating and being
punished
• That is:
• You would collude if PV of colluding > PV of cheating
703.125+703.125/r > 781.25+625/r → r < 1 (100%)
• This condition always holds.
• Key take-away point: If detection is certain and punishment is quick…
• “Grim Trigger Strategy” can effectively deter cheating and ensure
collusion
• AND: Conditions on the Lysine market (e.g. only a few major players,
frequent meetings, international trade statistics) were very conducive to
trigger strategies working!
Cheating or not Cheating?
How many punishment periods?
• The Grim Trigger Strategy is unforgiving.
• Tit-for-Tat Strategy
• Start off by cooperating (its nice!)
• Cooperate if your rival cooperated in the previous period
• Cheat for X periods if your rival cheated in the previous period
• Back to collusion after X periods.
• Tit for tat cooperates with cooperative opponents;
punishes uncooperative opponents.
• It is forgiving & easy to understand.
Ajinomoto CEO:
“cheating was frequent
but the range of cheating
was not too big ... they
kept their promise about
90 percent. Something
like that.”
How long do you need to punish your partner to make him or her cooperate all the time??
Very impatient partner ??
Outline for Session #2
1. Price & Quantity Wars:
Strategic thinking
2. Sustaining Collusion
3. Deterring Collusion
How Did This All End?
1992
• Collusion between ADM and Ajinomoto.
• Mark Whitacre (Matt Damon) is the Informant.
1995
• FBI raid at ADM’s offices.
Price declines to the competitive price.
U.S. Attorney General
Janet Reno:
"This $100 million
criminal fine should
send a message to the
entire world.”
Really??
1996
• December :
ADM & Ajinomoto executives indicted.
Lost consumer surplus?
Incentives to collude?
• ADM Fined $100M. Additional legal costs of $640M.
Extra Profit of collusion ?? 78.125+78.125/0.05 > $1b if done forever !!
“The indictment and information further charge that the defendants and coconspirators:
•Agreed to charge lysine prices at agreed-upon levels and to increase those
prices accordingly.
•Agreed to allocate among the corporate conspirators the volume of lysine to
be sold by each.
•Issued price announcements and price quotations in accordance with the
agreements.
•Participated in meetings and conversations for the purpose of monitoring and
enforcing adherence to the agreed upon prices and sales volumes.”
Fines
[…] “The defendants are charged with violating
Section 1 of the Sherman Act, which carries a
maximum fine of $10 million for corporations and a
maximum penalty of three years imprisonment and a
$350,000 fine for individuals.
The fines for both corporations and individuals may
be increased to twice the gain derived from the crime
by the defendant or twice the loss suffered by the
victims of the crime, if either of those amounts is
greater than the statutory maximum fine of $10
million for corporations and $350,000 for individuals.”
Collusion Profits & Cost for Consumers
Lost consumer surplus?
Cartel profits?
P ($/lb)
Total Cartel Profits
Profit with competition
Pm=$1.25
Supply
P*=$1
Market Demand
Qm
=1875
Q*
=2500
Q (lbs)
Recent Cartels
• ADM was involved in two other cartels: the citric acid cartel &
the high-fructose corn syrup cartel.
• Vitamin conspiracy.
• Current investigations:
• SIM card providers in Europe.
• Elevators & Escalators in Europe: Schindler Holding.
• Construction companies in South Africa.
US/EU Leniency policy?