Interview: Corporate collusion in the spotlight
Corporate corruption has been in the headlines lately and Finance Minister Pravin Gordhan noted the ongoing bank collusion scandal in his Budget speech. The Daily Maverick Show spoke to Thando Vilakazi, senior economist at the Centre for Competition, Regulation and Economic Development. He broke down what collusion is, how it limits the country’s development, and how it must be stopped. By GREG NICOLSON.
Listen to the full interview with Thando Vilakazi here.
DM: What is collusion? What is a cartel?
Thando Vilakazi: In basic terms, collusion as defined in the South African Competition Act is where firms in a horizontal competitive relationship, i.e. they sell the same product or operate in the same product space, agree to either fix prices or even agree on certain quantities that they’ll sell. In some cases, they have market allocation where they say, look, you keep the Gauteng province and I won’t compete with you there and I’ll keep the Western Cape and we’ll stay out of each other’s way. There’s various ways in which it plays out but that’s in essence what it’s about.
DM: If I’m selling Chappies, and he’s selling Chappies, there aren’t supposed to be conversations? They’re not allowed?
TV: It’s not supposed to be happening. There are instances in the bounds of the Competition Act where you can justify certain interaction between firms on the grounds of efficiency. For example, if you’re an industry association of doctors or hospitals, then there is some merit of having them agree to certain standards and ways of operating so consumers will ultimately benefit. Those kind of things can be justified, but for the most part it is usually best to stay clear of chatting to your competitors.
DM: You’ve talked about market allocation and there seems to be a big stance from the regulatory authority that you shouldn’t set prices in line with each other. It might be a silly question, but why? If we are both selling books, maybe it would be easier for us to each just sell them at R50?
TV: In a competitive market where firms are making independent strategy decisions in terms of their price, their strategy, what they sell, then you’ll have the competitors competing to win the market. I’ll set my price at R45 to win the market. Why we might collude is exactly as you say. We might say let’s not disrupt each other’s businesses and agree to a R50 price. But you’re effectively breaking the definition of a competitive market.
There are different variations of this. In the construction cartel it was a case of trading off different jobs and large projects between the manufacturers and the construction firms. But again it’s similar because there you’d expect them to compete by basically submitting the best bid possible to win, say, the building of a stadium. Instead of outbidding each other or ending up with a low bidding price, they essentially took turns to construct different projects so that they all win. There’s different dimensions of this but the outcome is you and I as firms achieve higher profits than what might result in a competitive market. Those higher profits are unfortunately taken off the back of consumers who are paying for those goods unknowingly at higher prices.
DM: What’s the extent of the problem in SA?
TV: The competition agencies in terms of their track record have been quite successful in uncovering cartel conduct, but what the international studies tell you, and the experience in Europe and the US tells you, is we’ve most likely only uncovered the tip of the iceberg in terms of the extent of collusive conduct that exists in an economy.
If you consider that we’ve had very large cases – the bread cartel, the construction cartel, and now this bank cartel – even then the expectation is that there is more illicit conduct that’s going on. I think this speaks to some of the limitations the competition authorities, as competent as they are, face in terms of uncovering this conduct. The economics of it – firms will assess the likelihood of getting caught and the fines they might pay if they are caught. They might add that up and it would be rational to say, well, look, I expect a particular fine from this kind of conduct. We know that in South Africa it’s capped at 10% of total annual turnover in the republic and so it might actually pay, at least in terms of the economics, to collude, to pay the fine some years down the line.
There are those problems and what the studies tell you is that the extra profit that the colluding firms are often earning is somewhere in the region of 15-25% above what would be a competitive price in the market. Consider that in terms of the fines that are levied, and it tells you there’s a serious challenge for the competition authorities in deterring and uncovering and stopping all of this conduct.
DM: You’ve worked at the Competition Commission and mentioned an investigation you were part of regarding collusion in the glass industry. Tell us about some of the details on that case.
TV: That’s an interesting case and much of this information is now available on the Competition Commission’s website, so I’m not breaking privilege in any way. You’ll find cartels work far more easily in industries with similar products – cement, glass, etc – whereas in consumer goods one tomato sauce isn’t necessarily the same as another so it’s not as easy to collude around that.
In this particular case, glass products, the firms had particular arrangements around windscreens, flat sheet glass, which effectively involved keeping a tight-knit arrangement by geographic territory in South Africa. You might have two or three of the eight manufacturers colluding to set prices and market conditions in the Bloemfontein area, for instance. Then you had a different set of firms operating in Eastern Cape, which was the case, but nationally there’d be an agreement to kind of allocate market shares and keep the market as it was.
Importantly, and I think this is a part about cartels that often isn’t spoken about, is by their nature, if the three of us are sitting in a nice, cosy market arrangement earning extra profits, the last thing you want is some maverick to come in and disrupt the profitable life we’re enjoying. Cartels deal very strongly with entrants. In an economy like South Africa, where you have particularly concentrated markets, there’s concern around that, be it via imports or new producers trying to set up and compete.
DM: There’s a lot of talk about creating black industrialists and transforming industries. Cartels effectively block any progress on those ambitions?
TV: That’s true and often we don’t know it until it’s too late. You might not have uncovered a cartel in that industry but for some reason your entrants are struggling, and this can happen in many ways. Firms can create a reputation for undermining anyone trying to enter. They might flood the market for a period of time until it becomes unviable for the entrant, who exits, and we return to our cosy arrangement.
They’re very complex and interesting arrangements to study, which is why I think, at least from my experience, the Competition Commission places a lot of emphasis on having capable teams of investigators working on cases. You’ll have teams of economists and lawyers working on investigating arrangements. You’ll have capable teams working on conducting dawn raids.
DM: How do these investigations begin? How do you find a cartel?
TV: The options are varied. Often you’ll have a firm that decides on its own to break out of the arrangement, because of a change of management, because of a change of culture – which can happen, believe it – and might decide to come forward if they sense that “this thing is about to break and I’d rather get in there first”. This is where the commission’s leniency policy comes in. You are able as a firm to come forward to the commission and if you are the first through the door and there’s evidence to show there’s an existing cartel and these are the firms, then you’re able to effectively confess in exchange for zero penalty.
DM: If you snitch you get off lightly.
TV: If you snitch first – that’s an important qualifier. In other countries there are prizes for coming in second but in South Africa it’s only the first. It’s been a very important thing because a lot of the cartels that have been uncovered since the corporate leniency policy came into effect have come through that – firms coming forward and admitting and busting their friends, basically.
Sometimes investigations come up in other cases as well, when the commission is investigating a merger, for instance. Sometimes it’s consumers who complain.
DM: With limited punishments and large incentives for establishing a cartel, how can we reduce this type of behaviour? The dynamic seems to encourage rather than discourage cartels.
TV: Even in Europe, where they have greater investigative capabilities, you have that issue with the kind of tip of the iceberg of cartels uncovered. Some might say fines are a slap on the wrist, but it also varies with the type of firm that you’re dealing with. Ten percent of turnover on a firm that only sells that product is effectively 10% out of their whole business, so it will consider the risk of collusion far greater than another firm, such as the big banks in this case that will have their foreign currency trading desks, but also far larger businesses that they run.
In that context it might be a slap on the wrist, especially when you consider how long this has been going on for. Historically, the fine used to be calculated on one year’s turnover, but if you think the cartel’s been running for several years [that’s low compared to the profit earned].
What’s happened in this regard is the Competition Tribunal and the case law has evolved to incorporate a multiplier for duration into the fine that’s being charged. It’s quite a complex process, but now the Competition Tribunal and the Competition Commission have followed factoring in the duration of the cartel into calculating the penalty. Then they’ll consider other mitigating and aggravating factors.
DM: Can you speak more about criminal penalties. Some other African countries have had criminal penalties in place for a while.
TV: A lot of countries have had criminal sanctions for directors or managers directly involved in the conduct, but the trick for that is always the prosecution because once you enter into the criminal law realm, it’s a bit more difficult. It typically involves the prosecution authority of that country, so it gets a bit more complicated. In South Africa, currently, the legislation that came in is that there’s a potential penalty of R500,000 to the individual, or I think it’s 10 years jail time. It’s a new development and it’s a very important one.
DM: Would that see, for example, rogue traders in the banking case or CEOs charged? How does it work?
TV: The rule of thumb – it hasn’t been tested in our cases so we don’t know where we’ll end up on this – internationally it’s the individual or the manager directly involved in the decision-making around the cartel conduct. Some firms come in where the board member says they had no clue. In that case you might consider the actual agent involved in making the conduct happen was probably a lower level manager or MD.
DM: In the context of transformation in South Africa, when you think about issues of collusion and corruption, it must frustrate you. Is this why you do the work you do?
TV: I think these issues are poorly understood in developing countries, the extent of corporate conduct of this nature actually undermines the development trajectory of countries. As in the fertiliser case in Zambia, those colluding firms were the two main producers and in a largely agrarian economy it basically means that farmers in terms of growing food for sustaining those economies were paying way more for various inputs than what they were supposed to. That alone, I think, is enough to justify the kind of research that’s now emerging to say how do you take what we’ve learnt from these cases in a legal framework, through competition authorities, to translating it better to understanding how economies actually work, how this conduct, this kind of behaviour, be it abusive conduct by a large monopolist or collusion actually undermines the ability of new firms to enter and compete in markets?
In a country where we’re struggling to create 100 black industrialists, and I think that’s a commendable project but has its constraints, it’s important to think about these issues. Is it just about funding – when we talk about developing businesses, which is essentially at the core of this programme, or there are other measures and issues we need to think about when we talk about opening markets to participation – meaningful participation where you and I can come together and start a competitive business and if we’re good enough, win, without anyone bullying us out of the markets?
DM: With the banks case, and others, in the headlines, do you think there’s a growing concern and understanding of these issues? Or do they make the headlines and then disappear in a few days?
TV: We might be the only guys losing sleep over this, but I think there is a growing public awareness of this and the commission works very hard to get media coverage around their cases. The question reveals a strange balance of things in our country. To use an example, Nkandla was R250-million and we had a hoo-ha about that for a number of years, and rightly so, and I don’t take anything away from those debates. But if you consider the scale at which colluding firms are profiting off the back of consumers directly even just in the bread cartel, and you only need to look at the size of the fines which are a fraction of what they benefited as firms over a number of years, we should be talking about these issues more, and we aren’t. That’s a concern.
DM: Are conversations like that around white minority capital helpful? Do you take the allies you can get or are some discussions harmful to having a thorough conversation on these complicated issues?
TM: Now, this is my personal view, change often happens in these very uncomfortable places, in these very uncomfortable spaces in society where people are debating very vociferously, contesting ideas and pointing fingers and calling people “white minority capital”, #FeesMustFall, etc.
I’m not saying that’s necessarily the way to go. I’m saying there’s something that we are now talking about. The banks and what’s happened in this collusion case, that’s very important for the economy. The next steps will be the ones taken by the regulators and the National Treasury and whoever is looking at the follow-on. But to get it on the agenda it’s sometimes important to make a noise about it.
This concept of white minority capital – I kind of simply say that however you frame it, we have a country that’s got a legacy of highly-concentrated, state-supported industries, either concentrated in terms of cartel conduct or as monopolies that simply haven’t transformed in terms of opening up for competitors in those sectors. That is a problem for a country that needs to create jobs and sustainable growth going forward. DM