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What’s it: Horizontal price-fixing is an agreement between businesses, either explicitly or implicitly, to set the selling price for a product or service. In this case, an agreement occurs between companies under the same value chain level, for example, between producers, between wholesalers, or between retailers. In other words, the agreement occurred between players who were actually in direct competition with each other.
Horizontal price-fixing is an example of collusion. It can take many forms, including setting prices, production quantities, or even discounts. It prevents the market mechanism from working. Firms conspire with each other to establish a market equilibrium instead of letting the free market determine it. Therefore, such practices are illegal and against antitrust laws. These unfair competitive practices ultimately make consumers have to pay high prices.
Types of price-fixing
Price fixing falls into two general categories:
- Horizontal price-fixing, involving companies in the same supply chain level.
- Vertical price-fixing involves companies in different levels of the supply chain, both downstream and upstream.
Horizontal price-fixing
Under horizontal price-fixing, the players who were previously competing now collude with one another. They cooperate explicitly or implicitly to set prices and market output. In particular, we call explicit collusion a cartel. For example, OPEC members agree on their members’ production levels to keep oil prices profitable.
They may also set discount limits for products on the market. That way, players do not have the opportunity to set massive discounts to attract and divert customers from competitors.
Long story short, in horizontal price-fixing, the players act as if they are monopolists. They cooperate with each other to increase mutual monopoly power and make higher profits. Such cooperation also reduces the intensity of competition in the market.
Vertical price-fixing
Vertical price-fixing involves various firms in different stages of a supply chain. They may consist of manufacturers, wholesalers, and retailers. For example, an automaker uses its influence to force its distributors to follow the manufacturer’s suggested retail price.
Another example is resale price maintenance. In this case, the producers and distributors agree on a range of selling prices. If the distributor refuses to sell in that price range, the producer can break the contract and stop working.
Examples of horizontal price-fixing
Horizontal price-fixing can take many forms.
First, some retail companies can set prices at a premium or at a specific price range. They will sanction when a company does not comply with the agreement. By doing so, they can generate higher returns.
The company may also agree to formulate a limit on price changes. When all companies adopt it, the selling price of each does not move from a particular range.
Second, in other cases, companies agree to limit supply, as in the case of OPEC. As a result, the market price will be at a level in their favor. In particular, the OPEC case is beyond the law because it involves the state’s government, not a commercial entity. So, it may be “illegal” in law, but not in theory.
Third, the company sets a maximum discount limit for the selling price. Such discount deals reduce the intensity of competition in the market. Players cannot set the discount too low to divert consumers from competitors.
Fourth, the company agrees on standard packages of goods and services or terms of sale such as credit, shipping costs, guarantees, and rebates.
Fifth, the company deliberately divides the marketing area. Thus, a company acts as a monopolist in a particular area.
Impacts of horizontal price-fixing
Horizontal price-fixing aims to coordinate prices for mutual benefits. It keeps market profits high and reduces the intensity of competition.
Such collusive practices violate antitrust laws, which prohibit collusion. Companies deliberately cooperate for their benefit by reducing competition. It hurts consumers because they have to pay higher prices than when the market is operating competitively.
Reducing consumer surplus
Horizontal price-fixing is terrible for consumers because it reduces the consumer surplus. Less competition makes prices higher than when under competition. The market operates inefficiently and transfers some of the consumer surpluses to the producers.
In a competitive market, the consumer surplus is relatively high. Intense competition forces companies to operate more efficiently to offer lower prices.
However, when firms engage in price-fixing agreements, the intensity of competition decreases. Consumers must pay a higher price than if price adjustment does not exist.
Increase the company’s market power
Horizontal price-fixing agreements increase the firm’s market power together. That way, they can keep prices high without losing customers.
A sufficiently broad agreement can allow them to act like a monopolist. When successful, they might expand the deal, not only on price but also on production and other non-price aspects.
Why is horizontal price-fixing illegal
Collusion occurs when firms in the market cooperate with each other secretly to influence market profits. Examples of collusive practices include price-fixing, prior notification of price changes, and exchange of information. Such practices are illegal because they inhibit competition and harm consumers.
Price fixing interferes with the free market mechanism. It is an example of the practice of unfair competition and giving companies, collectively, higher market power. They can increase profits at the expense of consumers.
Firms can charge a higher price than when the market is operating in competition. Also, lowering the intensity of competition reduces the incentive to innovate and increases barriers to entry.
Why horizontal price-fixing is difficult to prove
Several horizontal price-fixing collaborations are taking place in secret. Companies may use signals or information exchange instead of direct contact.
Even though each company’s prices are relatively identical, this does not necessarily indicate that companies collude to set prices. Take, for example, a commodity product. Their prices are almost identical in various markets. Supply comes from multiple companies, making it difficult for them to cooperate in setting prices.
However, regulators can use circumstantial evidence to unravel such a deal. For example, they can examine patterns of sales requirements between manufacturers. They may check for uniformity of discount changes between companies over time. If it tends to be uniform, it may lead to collusive practices.
Another indication is when all firms raise prices simultaneously. And, the price increase is not due to an increase in input costs.
The regulator also checks whether the executives have met or not. If, after the meeting, each producer adopts relatively uniform strategies and policies, it indicates collusion.
Why the horizontal price-fixing failed
Price fixing agreements are less stable and, therefore, useless. Every company tends to have a strong incentive to defect from the agreement. They can secretly offer lower prices to attract more customers.
The high prices due to the price-fixing also attract new entrants. New players bring new capacity to the market and push the market price downwards, bringing it back to competitive levels.
Consumers also choose to switch to substitute products when prices are high. They reduce the demand for the product, making it unprofitable for the company involved. Apart from substitute products, consumers can also switch to similar products from other countries (imports).
