A cartel is an organization created from a formal agreement between a group of producers of a good or service to control supply or to regulate or manipulate prices.
A collection of independent businesses or countries that act together like a single producer, cartel members may agree on prices, total industry output, market shares, allocation of customers, allocation of territories, bid-rigging, and the division of profits.
- A cartel is a collection of independent businesses or organizations that collude to manipulate the price of a product or service.
- Cartels are competitors in the same industry and seek to reduce that competition by controlling pricing in agreement with one another.
- Tactics used by cartels include reduction of supply, price-fixing, collusive bidding, and market carving.
- In the majority of regions, cartels are considered illegal and promoters of anti-competitive practices.
- The actions of cartels hurt consumers through increased prices and lack of transparency.
Understanding a Cartel
A cartel has less command over an industry than a monopoly, where a single group or company owns all or nearly all of a given product or service's market share. Some cartels are formed to influence the price of legally traded goods and services, while others exist in illegal industries, such as the drug trade. In the United States cartels are unlawful under American antitrust laws.
Cartels hurt consumers because their existence results in higher prices and restricted supply. The Organization for Economic Cooperation and Development (OECD) identifies and prosecutes cartels when there is evidence of price-fixing, output restrictions, market allocation, bid-rigging, or the submission of collusive tenders.
Collusive tendering occurs when companies coordinate their bids on procurement or project contracts for the acquisition of goods or services.
Types of Cartel Agreements
A cartel agreement can hinder, restrict, or create false competition. Types of agreements among members of a cartel may include:
Price cartels maintain or fix a minimum pricing strategy where members cannot sell products or services below the floor price. Members may also be required to raise prices in unison and avoid discount pricing.
Customers or regions may be divided among the members of a cartel to ensure an even flow of revenue. Members may not be able to sell outside of a region or share customers with other members. Cartel members may also be restricted in their product offerings depending on the region or customers they serve.
Terms of Delivery
Cartel members may agree to formal terms of delivery, like mode, locations, delivery time, and billing and interest payments.
Output and Production
Cartels may require members to adhere to production levels, forcing higher price trends for goods or services.
Advantages and Disadvantages of Cartels
Cartels form to fix the prices, define trading terms, allocate trade zones or achieve economies of scale. A cartel's power often depends on the leadership of the nation in which it operates and cartels may not be challenged on their pricing or production. While the members of a cartel profit from the agreement, both competition and the consumer suffer.
Provides a monopoly-like power to its members
Savings for members is achieved through economies of scale
Products or services are sold at higher margins to maximize profit
Discourage new entrants into the market and act as a barrier to entry
Lack of competition leads to price fixing and a lack of innovation
Impact consumers as prices for products or services are over market price
Cartels and Market Inefficiencies
Cartels harm consumers and affect economic efficiency. The success of a cartel depends upon its ability to raise prices above the competitive level while reducing output. Consumers may choose to pay the higher than the market price or forego the good or service as market forces are not in play.
When the cartel guards its members against full exposure to competitive market forces, it reduces pressure on them to control costs or innovate. This adversely affects efficiency in a market economy.
The World's Biggest Cartel
The Organization of Petroleum Exporting Countries (OPEC) is a group of 13 oil-producing countries whose mission is to coordinate and unify the petroleum policies of its member countries and ensure the stabilization of oil markets.
Its activities are legal because U.S. foreign trade laws protect it.Controversy in the mid-2000s blocked the U.S. Congress' attempt to penalize OPEC as an illegal cartel. Even though OPEC is considered by most to be a cartel, members of OPEC have maintained it is not a cartel at all but rather an international organization with a legal, permanent, and necessary mission.
A Note on Drug Cartels
Drug trafficking organizations, especially in South America, are often referred to as "drug cartels." These organizations do meet the technical definition of being cartels. They are loosely affiliated groups who set rules among themselves to control the price and supply of a good, namely illegal drugs.
The best-known example of this is the Medellin Cartel, which was headed by Pablo Escobar in the 1980s until he died in 1993. The cartel famously trafficked large amounts of cocaine into the United States and was known for its violent methods.
In What Type of Industry Do Cartels Thrive?
Cartels often operate best in an oligopoly, a market characterized by a small number of firms that are interdependent in their pricing and output policies. The small number of members allows each some market power. The theory of "cooperative" oligopoly provides the basis for analyzing the formation and the economic effects of cartels.
How Is Collusion Evident in Cartels?
The formation of a cartel involves open or explicit forms of collusion. Cartels are formed for the mutual benefit of member firms who agree on pricing, terms, and output.
What Laws Regulate Cartels In the United States?
Anti-trust legislation such as the Sherman Act and the Clayton Act regulate cartels within the United States since cartel activity robs consumers and other market participants of the benefits of competition.
The Bottom Line
A cartel is a formal agreement between a group of producers of a good or service to control supply or to regulate or manipulate prices. Cartels often fix prices, define trading terms, and allocate trade or market share rules to achieve economies of scale. Cartels are illegal in the United States and regulated by anti-trust laws.