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Gaining by Breaking a Cartel In Procurement

Can You Break A Cartel?

A cartel is a group of suppliers which together attempts to control production, marketing, and pricing of a product, with an objective to increase their operating margins. Under antitrust laws in many regions of the world, cartels are illegal, because they eliminate fair market competition. However, several international cartels continue to exist despite these laws. Within nations, private cartels may control the market for certain commodities.

For the members of a cartel, cooperating together has a distinct advantage. By agreeing to not compete, the members of the cartel mutually benefit. Cartels are often successful in driving up the price of the commodity they control well beyond what could be considered the fair market value.

Typically, cartels are formed for commodities for which their suppliers were earlier forced to operate at a bare minimum profit and very low margins. Once these suppliers get together, the buyers are forced to pay higher.

Though purchasers are at liberty to take legal recourse to break such cartel, operating in an era where supplier relationship holds the key to competitive advantage, innovative concepts are often used to break a cartel. Creating a preferred pool of suppliers, listening to them closely and awarding them for their good work are some of the latest initiatives which help to break a cartel.

However, a reactive way to break a cartel is through online reverse auctions, which is also used where negotiation is done with a group of suppliers simultaneously instead of negotiating on a one to one basis.

In cases where buyers find it difficult to manage things and they find it difficult to manage the increasing demand of the suppliers, they resort to the legal mode. Legal procedures are difficult to prove and time consuming.

Forming strategic alliance and enhancing the market share of the vendor to take the best return, is a one time solution, but thereafter in case the strategic partner is not continuously evaluated on every front especially on the price front, the parent company may be losing on competitive advantage.

A solution to this is continuous vendor development activity and a continuous process of creating new business opportunity within the function so that the strategic partner finds it difficult to settle on firm ground. In this way, the motive to form the cartel can be rightly addressed.

Motive to form cartel

A vendor is moved to form a cartel when according to his perception, the market price obtained is not sufficient to justify his value addition. After failing to convince the purchaser on every occasion and working out a remunerative deal, he goes out to convince his competitors that the problem of lower margin is a universal problem and cannot be solved in isolation. The cartel then settles among themselves to only accept a price which would justify their perceived value addition.

Increasing the profit level obviously would call for increasing the selling price and if the buyer gets no other source to buy the item, he would have to shell out the set price.

In case importing is a solution to bypass the domestic vendors, vendors trying to form a domestic cartel would have to convince the government that importing would be injurious to the domestic industry and an import duty needs to be implemented as a measure of safeguard.

However, the item for which a cartel is being formed has to be a critical item to the buyer. Otherwise, the effects of cartelization would be nullified.

Detecting a cartel

A cartel can be detected for all items which are being bought critically by the buyer on a regular interval. Obviously, the buyer would always try to strategically avoid paying higher to the seller by all possible means. Similar strategic efforts would also be made by the seller to ensure that he gets paid for his perceived value addition. In case, the seller is not able to do it alone, he would form a cartel. The seller may also try to buy stakes in competing companies where ever possible and through this consolidation would try to ensure a justified margin.

Items not so critical for a company can be made critical if the specifications and terms of supply are so designed that only a very few vendor can match the competency level required to pass the eligibility criteria. This also increases the chance of cartel in non-critical items bought by the company.

Breaking a cartel

The main motive of the cartel can be resolved by properly collaborating effectively with the vendor. If the vendor feels he is part of a family where buyer is a family member, he would not indulge in any cartel activity.

But this may raise serious questions on the creditability of a buyer if the relationship goes beyond a professional relationship as corruption is not an unknown practice.

In a transactional atmosphere, where there is a central figure initiating a cartel activity, one to one negotiation can be done to break a cartel. Alternatively, there are electronic negotiations which are breaking the cartels effectively. In case this option also fails, increasing the scope of supply and accommodating service elements along with an item supply and training selected lot of suppliers to do the same job becomes a viable alternative to break a cartel.

In a one to one negotiation done after a cartel is detected, assurances are given to increase market share of the selected vendor if he discloses all financial details pertaining to his company. A vendor who has ploughed back his profit element into various research and development activity is normally preferred over a vendor who uses this profit margin in other ways. From the list of vendors so generated, the most balanced vendor is chosen who is given the larger pie on a commitment that he would give maximum value to the buying company and the selected vendor is continuously evaluated on every front.

In case such a negotiation fails to deliver, the next best alternative to break a cartel is to go for an online negotiation. Here the auction engine is so programmed that if a second person wishes to give the same offer, it is automatically rejected by the system. So all the vendors involved can only get their price registered in the system, if each vendor offers a lower price than the other. Normally at the end of such reverse auctions, an order is awarded on preset terms to a limited number of vendors out of which one gets the maximum share of business. This helps to break a price cartel.

Sometimes it so happens that all the vendors have lower capacity than the share of business offered by the buyer. Vendors here sometimes form a quantity cartel where everyone commits to supply an equal quantity at the same price. In such a scenario, a reverse auction can be so programmed that the quantity and price commitments of each vendor has to be different.

In extreme cases where an online negotiation does not give better results, the scope of supply of an item is increased and it involves an ‘apply’ element also. The supplier here needs to maintain his own workforce at the buyers’ plant to do the job in totality and the buyer ensures training to all the suppliers before awarding the order to a specific supplier based on his performance and quoted price. This is an evolving process which keeps even the strategic partner guessing for the next scope might be too difficult for him to comply.

In a nutshell, cartel is there to stay and evolve and a purchaser skill is proved if he is able to evolve tools to take best advantage of the situation without resorting to the legal route.

Authored by

RajKumar Mitra

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