Price Fixing
An agreement between competitors to collectively raise, lower, or stabilize prices to control profit margins.
What is Price Fixing?
Price fixing is simply an agreement between competitors to collectively raise, lower, or stabilize prices to control profit margins. Collusion is another term used when market participants decide to settle the price levels amongst themselves.
Fixing prices prevents competition in a rational free market which, in return, restricts firms from engaging in market price competition.
This process is in clear violation of competition-related laws because price fixing has the power to control prices in the market. Competitors should be able to freely compete in any marketplace and individually fix their prices based on supply and demand.
There are specific industries where price-fixing occurs more in comparison to others. For example, firms tend to fix prices when alternatives at a lower price can not easily replace their products.
In other words, the chance of price-fixing rises when fewer vendors are in the marketplace. This ideology works the same way when a few major competitors in a marketplace have many smaller competitors.
The beauty of free competition is that it benefits consumers as the model usually lowers the price. But unfortunately, when firms decide to partake in a price-fixing scheme, they threaten consumers' livelihoods.
Hence, this type of agreement is illegal under antitrust laws, provided it may lead to higher prices or eliminate competition.
How Does Price Fixing Work?
The beauty of the free market is that the law of supply and demand determines the price of a product or service. That is because when prices are high, there will be an increase in the number of new entrants in the market.
Consequently, this will result in only a smaller population being willing to pay such a high price. Therefore, resulting in a distorted market equilibrium.
Therefore, if the price is relatively low to what is on the market, producers will not be incentivized to produce while the demand for the product will skyrocket.
In a free market, the price will settle at an acceptable number for the consumer and producer, and this is known as the fair market value or market equilibrium.
To further explain, there are various methods by which collusion occurs:
- Firms can decide to set their prices high, providing their customers with no choice but to purchase at an inflated price.
- Firms can decide not to give discounts on the sale price below the agreed minimum price.
- Two firms can engage in cooperative advertising.
- Firms can start including mandatory price surcharges.
- Individual firms can start putting limits on discounts and coupons.
Why Is Price Fixing Illegal?
Fixing prices is illegal when colluding amongst competitors to maintain artificially high or low prices. These artificial prices will directly affect the supply and demand of the market, hence disrupting the market equilibrium.
When potential consumers decide on what services or products to purchase, they make their decisions by understanding that the price has been adjusted based on supply and demand, not by competitors agreeing on a price for personal monetary gain.
The same ideology can be used when agreements are made between competing employers or purchasers about the wages or prices they will pay when manufacturers decide to restrict competition. As a result, consumers end up paying higher prices.
Governments' antitrust enforcement has price freezing at the top of their agenda. Firms and individuals that willingly collude are investigated by federal law enforcement agencies and can be criminally prosecuted. Ultimately, laws around fixing prices are severe and punishable by law if broken.
Why Is Price Fixing So Hard to Prove?
The most important element of credit squeezing is getting it done in private with several security buffers. Most governments and agencies rely on the confession of one of the parties involved.
The incentive to come forward is that the confessor is given immunity in exchange for their testimony. Price fixing is extremely difficult to spot because collaboration between two firms can often reflect something other than normal competition.
As mentioned previously, competitors will often increase or decrease prices based on demand and supply, so it is common for prices of products to move up or down together, hence why it is critical to look out for exceptionally high prices.
Governments look out for prices that cannot be exemplified by a rapid rise in demand and cannot be demonstrated by an increase in cost. Authorities spend a lot of time relying on insider information and whistleblowers to catch and prosecute price fixers.
What Are The Types Of Price Fixing?
Setting prices when conducted amongst competitors in the same market is known as horizontal price fixing.
On the contrary, it is known as vertical price fixing when the price is fixed through the supply chain.
Let's understand the concepts in detail.
Horizontal
Horizontal price fixing occurs when firms who compete in a marketplace come together to fix the price of a good or service. These specific goods can be fixed at a higher price to elevate profits for the company.
The ideology of setting prices can be conducted as a remedy to increase a firm's market share and drive out smaller competitors. These are some tactics multinational corporations employ to combat new smaller entrants.
As mentioned previously, this involves an agreement among competitors to increase or decrease the price of their products. To put this in a real-life situation, television producers may come together and agree on fixing the price at a premium or a discount.
Vertical
On the contrary, when an agreement is made along the supply chain to fix the price at a maximum or minimum, it is known as vertical price fixing.
This collusion occurs when two manufacturers or producers who are part of a supply chain decide to collude on setting a premium price.
The manufacturer agrees with their retailers to enforce a minimum resale price for its product. This form of setting prices is also known as retail price maintenance. An example would be when automobile producers simultaneously agree on setting a minimum resale price.
An Agreement To Raise Prices
This occurs when all the competitors in an industry come together to increase the price of a service or product by a certain amount.
Freeze Or Lower Prices
This occurs when governments or regimes decide to freeze prices to fix prices. Additionally, this usually occurs when there is an ineffective monetary policy, and fixing prices is a strategy used to combat inflation.
Examples of Price Fixing Collusions
Various examples of collusion are:
1. In 1992, Japanese and Korean competitors colluded with the Archer Daniels Midland company to set the price of lysine; Lysine is an additive in animal feed and wheat. Matt Damon depicted this scandal in the movie The Informant.
2. In 2012, major banks worldwide, such as UBS, Barclays Bank, and the Royal Bank of Scotland, decided to fix the LIBOR rate, a type of interest rate used as a relative standard for other interest rates around the world.
The LIBOR rate diverged in 2007 while simultaneously affecting the Fed fund rate. This disparity signaled the 2008 financial crisis, and eventually, the LIBOR administration was given to the Intercontinental Exchange.
3. Milk distributors and supermarkets decided to set prices on essential items, such as milk and other dairy products. Reports later suggested that this colluding of prices started in 2002 in Britain.
The Dairy Crest and Robert Wiseman Dairies initiated this scandal and aimed to raise the prices of all dairy products in the United Kingdom.
4. British Airways was one of the major airline fuel manufacturers in 2004. They proposed an idea to Virgin Atlantic Airways to raise aircraft fuel prices, increasing fuel prices 12-fold by 2006.
Once lawyers of Virgin Atlantic got wind of this scheme, they ratted out British Airways in exchange for immunity for their hand in this scandal. As a result, British authorities slapped massive fines, which led to a multi-million-pound court case.
How Do Governments Combat the Price Fixing Dilemma?
For starters, collusion is extremely challenging to prove because these meetings take place in secret. These agreements often occur through a burner phone line or secret meeting with an emphasis on leaving no paper trail behind.
Governments should emphasize formulating guidelines for firms to stand and abide by. Moreover, the government should incorporate specific core values that mitigate the risk of colluding at an organization.
Most multinational corporations ensure honesty or integrity as one of their core values, so as a result, it instills a certain standard that employees should abide by, thus affecting various parts of the organization irrespective of the region.
Whistleblowers or consumers usually feed details of these private meetings to governmental agencies then investigations are conducted. Firms suffer heavy fines and imprisonment if caught and prosecuted for fixing prices.
Ultimately, firms are threatened by the fact that the company's reputation and brand image can be severely affected due to collusion. In addition, governments subtly threaten major corporations through nationwide court cases that can negatively affect an organization's image.
What Are the Signs That Indicate Price Fixing Is Taking Place?
Various indicators indicate that collusion is taking place in the marketplace. The most obvious sign would be when the price of a product simultaneously increases.
If competing brands raise their prices as well, this adds to the proof of illegal fixing occurring. Governments often include a comparables analysis between competitors' financial statements in search of illegal activity.
Additionally, authorities also look out if discounts or promotional offers suddenly disappear from all firms in a specific industry competing with one another. They also ensure to look for evidence of two competitors contacting each other, which would raise suspicion.
Overall, a firm would be crossing the line if it contacted another rival firm and decided to charge the same price or provide discounts simultaneously. Therefore, manufacturers should maintain a strictly professional relationship with their retailers and avoid setting prices.
How Do Businesses Stay Away From Collusion?
There are plenty of ways multinational corporations prevent scandals and collusion. The easiest method for companies to do this would start with implementing core values and a standard.
When firms establish core values such as integrity and professionalism, it sets a standard level that employees must work towards.
Firms emphasize educating and training employees on professional work while instructing them on what to avoid when working at the office.
Firms should also train employees of the pricing department on the risk of discussing pricing strategies with employees of competing organizations.
Large corporations' executive boards and management must pay attention to red flags regarding spot-fixing and price fixings. This way, companies will easily spot and avoid potential scandals and allegations that could ruin an organization's brand image.
The Impact of Price Fixing Today
When competitors mutually decide on setting prices, there is a high possibility that it may affect the target consumers' choices and negatively affect the small and local businesses that rely on these producers/manufacturers.
Single business entities can get the best prices from the market, which could increase pricing for the general public. Moreover, there is no violation of price-fixing laws when firms decide to operate at the same price without prior agreement.
Nevertheless, there will always be a transparent disparity between a firm conforming to prices voluntarily and another forced to join a price-fixing agreement. These two scenarios are what define the legality of setting prices. Now, let us dive into how setting prices affects the economy today.
Apart from the most obvious reason that price-fixing usually leads to higher prices for consumers, price-fixing can take a huge toll on the economy. This is because the art of competition between firms is vital to how well an economy functions.
The balance between supply and demand is what composes market economies today. The economy could not sustain itself if every firm fixed prices before releasing a product into the market.
Additionally, healthy competition promotes efficiency, innovation, and the improvement of processes altogether.
Overall, firms cannot just agree on charging higher prices since they would lose the incentive to design new products, provide value to customers, and produce higher quality products. Competition is one of the many forces that establish a balance in the economy.
or Want to Sign up with your social account?