The leader of an international lysine (feed additive product) cartel, active for three years from 1992, used these words to call upon its competitors to form an alliance against consumers. The sentence briefly summarises why cartels pose the greatest threat to consumers and why their detection is one of the most important tasks of all competition authorities. By distributing markets or agreeing on prices and other terms and condition of sales, undertakings entering into restrictive agreements eliminate or seriously restrict competition in order to operate by monopolistic means and to trigger higher prices.
The most severe cases of restrictive agreements are the secretly executed, so-called “hard core cartels”. Such agreements concern the direct or indirect fixing of purchase or sales prices between competitors, the distribution of the market by competitors (including also concerted actions in tenders), or the setting of production and sales quotas. Additionally, they include the agreements and concerted actions of undertakings in the course of public procurement proceedings or concession procedures. Consequently, these agreements are not subject to any exceptions and cannot be exempted.
What is hard-core cartel (restrictive agreements)?
A cartel is a secret agreement between competing undertakings not to compete with each other. Cartels restrict competition by distributing markets, limiting production and dictating prices. Contrary to some other forms of cooperation which do not clearly restrict competition (e.g., exemptions), cartels do not and cannot have any beneficial effect on consumers or on the economy, i.e. restrictive agreements are prohibited and are deemed to be the most severe violation of competition law.
Types of restrictive agreements
- It is deemed a restrictive agreement, if competitors agree to allocate the market on the basis of certain criteria,, i.e. by geographical area, time, product or a specific customer base.
- It is deemed a restrictive agreement, if undertakings reach an agreement on produced/sold quantities or capacities, or on the restriction thereof.
- It is deemed a restrictive agreement, if competitors fix their prices or certain components thereof, if they define minimum prices or standard pricing formulae, if they decide on the price differences applicable to various products or if they standardise or eliminate price discounts. An agreement which prohibits advertising is also classified as a restrictive agreement.
Public procurement cartels
Collusive tendering is a subcategory of restrictive agreements. In such cases, bidders agree among themselves which undertaking will win the tender at a high price. It is also agreed that the other undertakings will refrain from bidding, or that they will either submit non-competitive bids or withdraw their bids. These agreements always take place in advance. The methods listed below fall under this category.
- For the purposes of competition law, restrictive agreements concerning the sharing of information between undertakings are the least harmful type of concerted practice. In such cases, following the issue of a tender notice the undertakings mutually inform each other of their intentions to participate in the tender and try to ascertain how interested their competitors are in winning the tender and how likely they are to be awarded with the contract. By behaving in this manner, the undertakings are able to identify their position in the price competition. The exchange of information during the preparatory phase is prohibited as it prevents bids from being prepared in an independent way, and therefore distorts competition.
- A more serious version of the information cartel is cover or courtesy bidding. This occurs when an undertaking which is not really interested in winning a tender formally submits a bid which it knows has no real chance of being selected. Such bids might contain prices that are uncompetitive, or might contain terms that the conspiring undertaking knows will be unacceptable to the agency calling for bids.
- The opposite of cover or courtesy bidding, the so-called “bid suppression” may also take place. In this situation the undertakings agree that some of them will not enter bids, or will withdraw previously submitted bids. This is the simplest form that a restrictive agreement aimed at market allocation can take.
- An agreement made between bidders concerning the price of their bids qualifies as a typical restrictive agreement. In such cases the undertakings agree on the prices to be offered in their bids, thereby deciding between themselves in advance who will be awarded the contract.
- An agreement which involves both price agreement and market allocation is a bid rigging system. This occurs when on a relatively small (geographic) market the role of the winner rotates, i.e. competitors agree that they will take turns being the winners of repeated or geographically separate tenders.
The Criminal Code prohibits the following behaviours: (1) the conclusion of restrictive agreements in public procurement and concession procedures (related to the use of public funds) – aimed at influencing the results of the tender by fixing the prices (charges) and other contractual conditions or allocating the market; (2) concerted practices; and (3) participation in the restrictive decision making of an association of undertakings. The committing of such an offence shall be qualified as a crime and may result in a 5 year prison sentence for the managers of the participating undertakings.
How to recognise a restrictive agreement?
Restrictive agreements result in higher prices for consumers which will cause considerable damage to consumers. The consumers can be end consumers, or as is often the case, they can also be undertakings or institutions which are responsible for spending public money. The GVH is dedicated to detecting cartels and imposing deterrent sanctions on those engaged in them. Before a restrictive agreement can be eliminated, its existence must be proven. It would therefore greatly assist the work of the GVH if customers were able to provide information about the existence of a cartel.. Consequently, it is extremely important that customers and purchasing experts are aware of the signs of a cartel. This will enable them to not only provide the GVH with information on cartels, but will also allow them to protect themselves against sellers that are involved in cartels. The following list of hints may help to identify the existence of a cartel in the course of a tender. In general any bidding or market conduct that is contrary to what is generally expected from competitive undertakings is considered suspicious. While the conditions listed below may indicate the existence of a restrictive agreement, they do not necessarily mean that one actually exists.
The following factors are suggestive of the existence of a restrictive agreement:
- The price falls significantly when a new or rarely bidding undertaking (although similar to the other operators) also appears.
- The same company makes different bids in different cases, even though it more or less has identical expenses.
- Identical prices, including especially: prices prevailing for a long time without any change, or price stability following volatile prices.
- Significant price increase, otherwise not justified by changes in expenditure.
- The volume of manufactured products is falling, although there is demand.
- Sudden elimination of discounts.
- Market operators standardised their terms and conditions of sales, adjusting them to their competitors.
- Information indicating that certain competing undertakings had meetings and consultations.
- Both local and distant undertakings charge the same transportation costs, or calculate their transportation costs identically.
In addition to the above-mentioned signs, the following signs may also be present in a tender procedure:
- Significant decrease in the number of bidders in a tender.
- One or several undertakings withdraw their bids (or the request for the review of the decision), and the winner then invites them to join the project as subcontractors.
- Similar format, layout, and errors (letters, contextual errors) in the bids.
- Some bidders specifying absolutely identical prices with identical details.
- The same accessories, annexes and certificates are missing from the bids.
- There is an obvious difference between the lowest price and the other quoted prices.
- One bidder reveals certain knowledge of the bid(s) of (an)other bidder(s) prior to the opening of the bids.
- Bid rigging: several of the same undertakings take part in a number of tenders, with a different undertaking always winning among them each time.
- The winner of the tender invites all or some undertakings submitting non-eligible bids to be subcontractors.
- The winner of the tender suddenly withdraws from the contract and forces the contracting authority to enter into a contract with the second best bidder.
- Subsequent tenders are won by the same undertaking, while almost the same competitors submit bids which are not eligible for evaluation.
What and how much can a country and its citizens lose from restrictive agreements?
- Restrictive agreements both directly and indirectly harm consumers in many ways. It is extremely difficult, and perhaps impossible, to quantify the harmful effects of restrictive agreements both in general and in specific cases. However, based on international experience, the total damage caused in the past and at present by restrictive agreements in Hungary can be estimated based on the behaviour of the hundreds of parties involved in restrictive agreements. The surcharges which consumers face as a result of both foreign and Hungarian restrictive agreements are illustrative of the additional costs that restrictive agreements place on consumers.. The detrimental effects that restrictive agreements have on society are even greater. As a result of the higher prices that restrictive agreements entail, fewer products are sold on the market than that are sold in a competitive environment, and a lack of competitive pressure on the market makes undertakings disinterested in expanding their product ranges or in improving the quality of their products. However, as it is extremely difficult to quantify these latter-mentioned factors, this paper will only deal with the price boosting effect of restrictive agreements.
- To determine the amount of a price increase that results from the restriction of competition by a cartel, namely the price increase effect, a comparison must be made between the cartel price (the price as a result of the cartel) and the competition price (which would have prevailed if there had been competition).
- The restrictive agreements that are detected by the GVH are probably only the tip of the iceberg. According to the estimates of the British Competition Authority, only approximately 15 percent of restrictive agreements are detected each year. Based on this detection rate, and taking into consideration the period of operation of the largest Hungarian restrictive agreements included in the calculations, the actual total social damage caused by active restrictive agreements could be several times higher than the 64-142 billion HUF worth of damage that was caused by the investigated restrictive agreements and could be even as high as between 160 - 356 billion HUF. The corresponds to 0.5-1.26 percent of the Hungarian GDP (based on the 2011 GDP figures) but, by taking the medium value of that damage, it may also match the revenues expected in 2013 from the transaction levy.
Restrictive agreement concerning motorways - 28 percent price increase
One of the most illustrative examples of a cartel is the motorway cartel which resulted in the biggest fine in the history of the GVH. In February 2003 the GVH launched a procedure against the undertakings bidding in the open, pre-qualification public procurement tender issued by Nemzeti Autópálya Rt. in August 2002 for the construction of the M7 Motorway section at Balatonszárszó, the M3 Motorway section in Görbeháza and the M7-M70 motorway section between Becsehely and Letenye. The Competition Authority suspected that the bidders had coordinated their bids and had then divided between themselves the construction of the approximately 60 km long section. During the unannounced inspections which were held on the premises of the undertakings, the GVH seized several documents based on which a violation of competition law could be established. A memo confiscated from one of the managers of Strabag Rt. referred to “cost-based prices”, which could be used as a guideline for the competitive price. According to the memo, the “cost-based” price would have been 90 billion HUF which, in perfect competition, would in theory be a market price. By adding profit to the costs based on the average profit margin (5.2 percent) of the construction companies in 2002 and if that price is taken as the competitive price, it is clear that if competition had existed, the motorway sections could have been constructed for 94-95 billion HUF. Even with a generous, twice as high profit margin, the project could have been completed from 100 billion HUF. The parties to the restrictive agreement quoted a price which was 28 percent higher, placing a bid of 128 billion HUF net for the contract. Consequently, this unlawful collusive tendering between the road construction companies resulted in direct damage to consumers amounting to approximately 28 billion HUF. To place this amount in context, this is how much the government spends on the financing of vocational training and adult training each year.
Payroll accounting system for Paks Nuclear Power Plant - 46 percent wage increase
- The restrictive agreement of two IT undertakings, SAP and Synergon, also referred to the competitive price. Paksi Atomerőmű Rt. (Paks Nuclear Power Plant) issued a tender for an IT development relating to its payroll accounting system in April 2004. It was established in the investigation of the GVH that throughout the tendering process the two undertakings had held consultations with each other, had jointly agreed on the roles that they would respectively adopt in the tender, and had also coordinated their bids. Under the above-mentioned circumstances, the winner of the tender, SAP, was awarded the contract for 365 million HUF. The Competition Authority obtained a message of one employee of one of the relevant undertakings, which contained the following information:
- “The project could also be implemented for 200-250 million HUF at regular prices. The contracted price is around 360 million HUF, which involves a rather attractive extra profit […].”
- Although in this case the “normal price” is not necessarily identical to the competitive price in economic terms, the message highlights very well the price increase resulting from the restrictive agreement. Even if the upper threshold of the normal price, i.e. the 250 million HUF is considered to be a competitive price, the price quoted by the parties to the restrictive agreement was 46 percent higher, i.e. 115 million HUF higher. To put into perspective the amount of the damage caused by the restrictive agreement to consumers, the extra 115 million HUF could have been used to install WiFi networks providing full internet access in fifteen to twenty villages, or to purchase seven hundred to eight hundred new computers for schools.
Motorways 40 percent cheaper?
- The public procurement tender issued for the construction of the Balatonkeresztúr - Nagykanizsa section of the M7 motorway illustrates the importance of competition very well. The changes implemented to the former motorway construction tendering system resulted in unprecedented competition and a lower price.
- At the beginning of the new millennium the same state-owned consortium in a monopoly position was always awarded contracts for motorway construction, and there was practically no competition on the motorway construction market. Although after 2002 competition started to emerge among undertakings capable of motorway construction, the undertakings taking part in the tenders often eliminated competition with restrictive agreements and instead of offering more favourable conditions, they opted for the distribution of tasks and price increases. The GVH launched several procedures. In 2004 the Competition Council only made decisions in relation to five restrictive agreements concerning public procurements in the construction industry.
- In the tender issued for the construction of the last section of the M7 motorway, Nemzeti Autópálya Zrt., (the contracting authority) made significant changes to the terms of the tender. As the conditions restricting participation were eliminated and changed, more bidders joined the procedure. The increasing competition pressed the price, quoted in tenders since 2000 downwards: the winning bidder quoted a price of 43.8 billion HUF for the construction of the motorway section, which was below all expectations and the former price. In relation to the tender, the Minister of Economy reported a 40 percent price decrease in motorway construction prices in the interviews that were given to the media. Without being aware of the impact of stronger competition, and more lenient technical conditions, the Hungarian State managed to save approximately 30 billion HUF as a result of these two factors on the construction of the last section of the M7 motorway. This amount more or less equals the revenue collected by the budget from motorway toll in a year.
- The examples and calculations given above are used to illustrate the huge financial damage that society faces as a result of restrictive agreements. Even according to the most prudent estimates, the largest restrictive agreements detected by the GVH between 2002 and 2007 caused more than 64 billion HUF worth of damage to consumers. This amount is in fact the lower threshold of the total damage as it was calculated using only a 10 percent price increase, when in fact according to the pricing practice applied in hundreds of restrictive agreements the average price increase is much greater than this. Our estimation is only based on the damage suffered by consumers as a result of the price increase and ignores the numerous other harmful effects of such agreements. It must also be mentioned that some restrictive agreements are still under investigation and so are not taken into account in the above estimation. Regardless of the particular products or services to which they apply, for example eggs, driving school hourly fees, graphic services, bank transaction levies (Visa vs. Mastercard), motorway construction, simple purchases in shops or public procurement, restrictive agreements cause vast damage to society. A concerted practice of competitors is the most severe violation of competition law. It is in the public interest that such practices are effectively detected and sufficiently punished.
What and how much can an undertaking or manager lose by being party to a restrictive agreement?
- Participation in a restrictive agreement offers significant benefits to undertakings at the expense of consumers. For this reason competition authorities apply more stringent instruments to detect and eliminate restrictive agreements. If a restrictive agreement is detected, the participating undertakings and their managers will face serious consequences.
- One of the gravest consequences of a restrictive agreement is negative publicity as the name of the undertaking is referred to in a negative context in relation to the agreement. This may completely ruin the PR efforts that an undertaking has made over several years or may hinder an undertaking from building up its business (see Tamás Vahl case). One thing is for certain, it will definitely be reflected in the image of the undertaking for many years to come.
- As restrictive agreements are the most severe violation of competition law, the GVH punishes any undertaking that is a party to such an agreement by imposing a huge fine. Between 2002 and 2006, the GVH imposed fines amounting to 20.2 billion HUF, with one undertaking having to pay a fine of 5.3 billion HUF.
- Consumers damaged by restrictive agreements may launch civil lawsuits for compensation against the undertakings involved in restrictive agreements. The compensation granted in such lawsuits may be significantly higher than the fines imposed by the Competition Authority. The Department of Justice, proceeding as one of the competition authorities of the USA imposed a fine of 900 million USD on the vitamin cartel, which controlled the international vitamin market until the end of the 1990s, and in the compensation lawsuits the courts ruled that a further one billion USD should be paid as compensation to the injured parties.
- The court may also apply other sanctions against undertakings involved in restrictive agreements in public procurement and concession procedures. They include a ban from public procurement, or a ban from participating in tenders issued by local governments, the central government or the European Union.
- Not only undertakings taking part in restrictive agreements as legal entities, but also their managers, representing the companies and entering into the agreements, may be punished: since September 2005 the court may sentence managers to imprisonment for up to five years for taking part in restrictive agreements, which will hardly be the most attractive achievement on a manager’s CV.
- Being the member of a restrictive agreement not only implies the possibility of a significant damage, but it also depend on the skills of the undertaking whether it can avoid being detected and called to account. They cannot trust their partners in the agreement either: they are also encouraged to be first to supply information to the Competition Authority about the restrictive agreement to avoid being fined (leniency policy), which then will be imposed on the others. Thus, undertakings filing the first report can obtain a competitive advantage and will leave their partners to the restrictive agreement in the lurch. In numerous cases restrictive agreements were reported by aggrieved employees who had already left the undertakings (informant reward).
- As illustrated above, participation in a restrictive agreement can prove to be very expensive at a later date for an undertaking and its executive officers and anyone engaged in it takes a huge risk. Once an undertaking has made a mistake and joined a restrictive agreement, it should consider supplying information to the GVH (and the European Commission) on the restrictive agreement in order to mitigate a large number of the negative economic consequences that ensue from detection. By providing a statement, responsible executive officers can avoid criminal law sanctions.
- The following Schedule presents some typical conducts which qualify as a cartel, and presents opposite conducts which are not prohibited under the Competition Act.