Collusion

When businesses or individuals influence pricing in particular market segments to their advantage

What is Collusion?

Collusion is primarily an illegal secretive agreement or cooperation between two parties intending to disrupt market stability. Generally, individuals or companies who normally compete against each other decide to work together and influence the market to achieve competitive market advantage.

An example is when colluding businesses conspire to control the supply of a good and set a specific price that will enable them to maximize their returns at the cost of other competitors.

 

Collusion

 

Collusion occurs in different forms across various markets. For example, price-fixing is a type of collusion that happens when two oligopolistic companies offer the same product in a particular marketplace but agree to set specific pricing for their commodities.

The pricing may be inflated to maximize profits where there is no other competition (price gouging) or discounted heavily to discourage smaller-scale competitors. Generally, price-fixing eliminates competitors and creates prohibitive barriers for new market entrants.

 

Summary

  • Collusion is when two parties enter into a secretive agreement to cooperate illegally to limit open market competition.
  • Practices of collusion involve price-fixing, compromised advertisement, and giving out confidential information.
  • Collusion is frequent among duopolies and may be prevented by antitrust laws and revealed by whistleblowers.

 

Understanding Collusion

In the financial markets, colluding partners may agree to share insider information and gain a trading advantage. Financial market collusion may allow the colluding entities to enter and exit the market before the secret information is available publicly.

Business partners may also collude to synchronize their advertisements. Such a practice prevents the consumer from receiving detailed product knowledge or terms of service for their advantage.

Collusion is illegal in many countries worldwide. Antitrust laws aim to prevent companies from engaging in collusion by making it harder for companies to navigate and implement a colluding agreement. Industries with strict regulations may make it difficult for other companies to collude with other entities.

Similarly, one of the beneficiaries of the collusion agreement may defect and cut off the profits of the remaining parties; the defecting partner may also act as a whistleblower and disclose the collusion to the authorities.

 

Forms of Collusion

 

Tacit Collusion

Tacit collusion occurs when market players allow price changes to be set by a dominant company. The leading company exerts an influence that determines the pricing of commodities and services in the industry.

After adopting tacit collusion, the controlling company sets relatively high prices that enable the smaller cost-inefficient companies in the market to earn profits. For example, leading sellers in mortgage and petroleum industries may establish the pricing system for other suppliers in the market.

Generally, consumers may take a long time to notice any price gouging and won’t shift their demand since most companies are applying similar prices. Mostly, the practice is found where the market is controlled by a few large-scale companies, and it is done with the aim of lowering industry uncertainty.

However, it is very difficult to prove that companies are engaging in tacit collusion deliberately, since most of them are in oligopolistic markets and never overtly disclose such agreements, such as the airline industry.

 

Formal Collusion

Formal collusion involves groups of rival companies that agree to collude in setting prices rather than compete – usually a cartel. A cartel arrangement allows the companies to set an industry price that enables them to all achieve a level of profitability.

The cartel members may agree to establish output quotas for each member to maintain the agreed price. For example, in the oil market, OPEC is an organization of oil-producing countries that is responsible for setting oil prices.

 

Price Leadership

The price leadership form of collusion occurs when one seller sets a price for a product, and other sellers in the market adopt the said price as the market price. The arrangement allows rival companies to charge high prices and earn higher profits without colluding directly with competitors. The following are the main forms of price leadership collusion:

 

1. Barometric price leadership

Barometric collision occurs when a specific company is more flexible than others in identifying and responding efficiently to market forces. These companies quickly identify any changes in production cost and quickly initiate a change in pricing strategy.

Regardless of the market share, a company with quality products and updated market data may take the role of a barometric price leader. Other market participants will largely follow the price leader on the assumption that the latter is in possession of some information that they are not aware of. However, since the barometric leader typically exerts limited influence on other industries in the market, its price leadership is often temporary.

 

2. Collusive price leadership

The collusive model of price leadership is common in oligopolistic markets. Collusive price leadership happens when several dominant companies agree to maintain their prices in a parallel alignment. Smaller competing businesses are compelled to follow the price change set by the dominant players. The collusive price leadership model is common in markets with high entry costs and known production costs.

However, if the agreement is aimed at deceiving, misleading, or defrauding the public, the process is considered illegal. Price leadership may be considered unlawful if the changes in pricing are established through collusion.

 

3. Dominant company price leadership

The dominant model of price leadership arises when one dominant company controls the largest market share in the industry. Smaller companies providing the same products within the same industry lack the power to influence the prices.

Dominant price leadership is also referred to as partisan monopoly, where the price leader may practice predatory pricing of regulating prices to discourage small-scale companies from participating in the market. However, businesses practicing predatory pricing are considered illegal in many countries since they are aimed at incapacitating smaller companies.

 

Learn More

CFI offers the Commercial Banking & Credit Analyst (CBCA)® certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

  • Aggregate Supply and Demand
  • Barriers to Entry
  • Monopoly
  • Price Leader

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