The Graphite Electrode CartelM. Hviid, A. Stephan (2009), The graphite electrodes cartel: fines which deter? In: Cases in European Competition Policy: the economic analysis. Cambridge University Press, Cambridge.

Presented by: Anup KalaniKishor BalbudheKatarzyna WilkFelix Sarfo

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Agenda

• About Cartels

• Theory of Optimal Deterrence

• Case and Industry background

• Guidelines on fines – description of the fining proccess

• The C/G case

• Conclusions

• Cement Cartelization in the Indian Economy

• The Indian vis-a-vis the European cement cartelization. Institutional differences

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What is Cartel?

• Under Article 81 of Treaty of Rome, Cartel is defined as:“All agreements between undertakings, decisions by associations of undertakings and concerted parties which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within common market”

• Amended as Article 101 and 102 of Treaty on the Functioning of the European Union (TEFU) under Treaty of Lisbon

• This can be achieved by following methods:1. Fixing purchasing or selling price

2. Limiting or controlling production

3. Sharing market or sources of supply

4. Engage in collusive bidding or bid rigging

Source: European Union Law - http://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:12008E101

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About Cartels

• The term Cartels was originated in Germany for alliance of enterprises in 1880s.

• Different types of Cartels:1. Public Cartels

2. Private Cartels

3. International Cartel

4. Import Cartel

5. Export Cartel

• Interesting Facts:• Public Cartels were allowed during Great Depression (1930s) in US

• Washing powder cartel between Unilever and P&G

• OPEC Oil Cartel???

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Conditions conducive to Cartelization

1. High concentration – few competitors

2. High entry and exit barriers

3. Homogeneity of products

4. Excess capacity

5. Similar production costs

6. Inelastic demand

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Harms of Cartelization

• Cartels are harmful because of below reasons:1. Higher prices

2. Lower quality products

3. Lack of transparency

4. Restricted output

• Lysine price-fixing cartel• To raise price of animal feed additive Lysine

• Price rise of 70% during first nine months of cartel formation

Source - http://www.justice.gov/atr/public/speeches/201477.htm

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EU Statistics about Cartelization

Source : http://ec.europa.eu/competition

Cartel cases decided by EU Commission – 1990 - 2014

Fines Imposed (Mn Euros) – 1990 - 2014

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Detection of Cartels

1. Whistle Blowers

2. Investigation – Dawn raids, Inspection of premises/books etc.

3. Conducting Sector inquiries

4. Requesting information

5. Leniency Program Very popular Leniency/Amnesty program of US

https://www.youtube.com/watch?v=V945c9rvi1k

Source: http://europa.eu/legislation_summaries/competition/firms/l26092_en.htm

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Detection Problem

1. Secretive and concealing nature of cartel members

2. Need of extraordinary power vested with authorities

3. Jurisdictional reach in case of international cartels

4. Requirement of high standard of proof and procedure

To deter cartelization, the fine imposed on the undertaking should be greater than the expected benefit of collusion.

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Theory of Optimal Deterrence

• Relies on cost-benefit analysis by firms

• Balancing of expected gain against the expected punishment

• Due to presence of only monetary losses, the calculation is simple

• The theory is based on below fact:

“Firm will deter against cartelization when expected benefit is less than expected fine”

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Theory of Optimal Deterrence

The key to deterrence of price fixing is to ensure that the expected loss from being found guilty of a violation outweighs the expected benefit from collusion

• B – Expected benefit out of cartelization

• F – Expected fine if found guilty

• Pd – Probability of detection

• Pc – Probability of being convicted

• Then the undertaking will be deterred from cartelization if:

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The graphite electrodes industry

• Graphite electrodes

• Ceramic moulded columns of graphite

• Used for the production of steel in the electric arc furnaces, called “mini-mills”

• Recycling process – Scrap metal to new steel

• Purpose – Steel production using recycled scrap metal

• One-thirds of steel production in EU from the industry

• €420 million industry in European Economic Area by 1998

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The graphite electrodes industry in EU

Firm EU Market share

SGLX%

UCAR

VAWY%

Conradty

Carbide Graphite group 7%

Showa Denko K.K.

3-4%SEC

Nippon

Tokai

• 18 major firms before cartelization

• 9 active firms after crisis – Consolidation

Signs of collusion

• High concentration of power (90% share with 2 firms)

• High entry barriers• 18 firms operating before cartel formation

• Complicated and expensive production

• Crisis before the cartel• Strong fall in demand during 1980s

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Case and the appeals

• Joint investigation between European Commission, USA, Canada

• Direct participation of high-level executives

• Market prices set in ‘top-guy’ meetings

• Side payments made to deter companies from cheating the cartel

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The Case – Timeline

June 1997EC starts investigation

January 1998SGL attempts

persuasive measures for non-cooperation

July 2001EC decision announced

– 8 of the 9 firms charged penalties

April 2004CFI decision on 7 firms’

appeal against EC

June 2006ECJ gives its decision favouring EC on its appeal against CFI

decision

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The Commission’s guidelines on fines

The commission imposed fines following The 1998 Guidelines on the Method of Setting Fines Imposed Pursuant to Article 15(2) of Regulation No.17 and Article 65(5) of the ECSC Treaty (98/C9/03).

The purpose of the guideline was to ensure transparency and impartiality in the face of the violators and European Court of Justice.

However the Commission’s discretion in using the guideline to set the fines should be coherent, non-discriminatory and consist.

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Method of calculating the fines

The method of calculating the fines consist of five (5) steps:

1. Basic Amount

2. Aggravating and Attenuating Factors

3. 10% Annual Turnover Cap

4. Leniency

5. Ability to pay and other factors

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Method of calculating the fines 1. Basic Amount.

The Basic Amount consists of the following elements - the gravity of the offence; deterrence uplift which is part of ; and the duration of the offence.

The gravity of the offence (x)- The Commission deemed this infringement as serious and deliberate as decision to fix the price was taken by high profile managers of the undertakings.

Deterrence Multiplier- The Commission set the fine at a level which ensures that it has a sufficiently deterrent effect. Using the worldwide turnover(table 1, next slide) based on the last year of infringement, the Commission categorized undertakings into four categories applying relative weights.

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Method of calculating the fines 1. Basic Amount.

Firm EU US Worldwide

SGL X% 23% >10%

UCAR   36% >10%

VAW Y%   <5%

Conradty     ?

C/G 7% 18% 5-10%

SDK 3-4% 18% 5-10%

SEC     <5%

Nippon     <5%

Tokai   1% 5-10%

Source: M. Hviid, A. Stephan, The graphite electrodes cartel: fines which deter?

Table 1:Market share in graphite electrodes (1998 turnover)Source: EU case; Kobayashi (2001, Table 2)

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Method of calculating the fines 1. Basic Amount.

Summary of the initial categorization:

Category 1: SGL and UCAR. Starting point €40 million

Category 2:Tokai, SDK and C/G. Starting point €16 million

Category 3: VAW, SEC and Nippon. Starting point €8 million

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Method of calculating the fines1. Basic Amount.

Summary of the categorization:

Category 1: SGL and UCAR. Starting point €40 million

Category 2: SDK. Starting point €16 million

Category 3: Tokai and C/G. Starting point €8 million

Category 4: VAW, SEC and Nippon. Starting point €4 million

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Method of calculating the fines1. Basic Amount.

In determining the multiplier, the Commission used the means testing method , which, was found to be inconsistent with optimal deterrence argument.

Duration: the basic amount is not increased for short term infringements (less than one year); for medium-term infringements (one to five years) it is increased by up to 50%, and an additional 10% for each year thereafter.

The Commission in this case used the calculation of fine increment to the maximum as most of the undertakings have been part of the cartel for at least five(5) years.

The basic amount was increased by 55% for each of the undertaking

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Method of calculating the fines2. Aggravating and attenuating factors.

The basic amount is increased/decreased where there are circumstanes of certain kind.

The guidelines do not provide an exhaustive list of this circumstances but do provide examples.

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Method of calculating the fines2. Aggravating and attenuating factors.

Aggravating circumstances Attenuating circumstances

• The repeated infringement of same type (10%)

• Refusal to cooperate or obstruction (25%)

• Acting as a leader or instigator (50%)

• Using retaliatory measures to enforce infringement

• The need to increase penalty to exceed improper gains

• Other

• A passive or follow-my-leader role (40%)

• Non-implementation or termination of infringement when Commission intervenes

• Reasonable doubt• Infringements commited as a

result of negligence or unintentionally

• Other

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Method of calculating the fines2. Aggravating and attenuating factors. Companies’ appeals.

C/G argued the reduction was inadequate – rejected.

SEC and Nippon argued they took a passive role – rejected as they had been represented by Tokai at some meetings and present at others.

Nippon cliamed it had not reduced it’s sales – not substantiated.

SEC argued it had quadrupled its output between 1992-97 – the CFI accepted that fact although noticed it hadn’t alleviated the harm as SEC had obtained only a small market share in the EEA.

The disastrous economic situation argument – rejected.

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Method of calculating the fines 3. Ten per cent annual turnover cap.

From the 1998 guidelines – the final fine imposed by the Commission may not in any case exceed 10 per cent of the worldwide turnover of the undertkings on the year preceding the year in which the decision is taken.

SDK and SGL argued that the 10 per cent limit should apply after the leniency discount – the CFI rejected as this would remove the incentive to apply for leniency.

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Method of calculating the fines 4. Leniency notice.

What for?

1. Incentive to cooperate

2. Cartel detection

3. Avoiding costly appeals

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Method of calculating the fines 4. Leniency notice.

SDK – 70% reduction for being the first to provide substantial evidence of the cartel

UCAR – 40% reduction for contributing to establishing important aspects of the case

SGL – 30% reduction for handing over information that went beyond that specified in the formal request

C/G – only 20% reduction as initially it gave ambiguous information as to its role

VAW – 20% reduction for cooperation

Tokai, SEC, Nippon – 10% reduction each for not contesting the actual allegations

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Method of calculating the fines 4. Leniency notice – commentary.

The Commission has a substantial degree of freedom when it comes to awarding leniency => lack of clear guidelines

Should there be a discount simply for not contesting the facts? – incentives (?)

The leniency programme did not manage to avoid costly appeals - companies’ appeals focused on the size of the leniency discount awarded.

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Method of calculating the fines 5. Ability to pay and other factors.

The guidelines leave open the possibility to reduce the fine to take account of a firm’s ability to pay in certain circumstances.

The Commission turned down all out of three firms (SGL, UCAR, C/G) that argued for a reduction due to certain circumstances (market conditions, changes in company’s corporate structure).

The Commission stated that to take account of an undertaking’s bad financial situation would be equall to conferring competitive advantage to companies least well adapted to the market conditions.

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Method of calculating the fines 5. Ability to pay and other factors.

SGL argued the company’s situation was weakened by the high fines imposed by other competition authorities and civil damage payments and further sanctions by the Commission might force the company into bankruptcy.

In this case the Commission rejected the argument although it granted SGL two 33% discounts in two other cartel cases involving some of the same firms.

Unknown motivation and methods of calculating the bankruptcy discount - Are bankruptcy discounts applied transparently?

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The odd one out – C/G. The problem of over-deterrence.

The Commission’s treatment of C/G stand out as harsh.

C/G took a passive follow-my-leader approach and more than doubled it’s sales during the period.

According to the Commission, the company had access to early information about price increases and used it.

Was the investigation meticulous, the treatment fair and does it matter?

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Conclusions

Fines and leniency discounts are not calculated in a manner that is transparent

The means-tested element of setting fines is also incompatible with an economic model of deterrence based on expected benefits and gains

The harsh treatment of C/G, despite it’s passive role, is a missed opportunity to encourage firms to pursuit cartel-destabilising strategies

Basing fines on EEA market shares, rather then worldwide shares, will not be deterrence enhancing for as long as external enforcement is weak

The guidelines make it difficult for the size of a fine to be forseeable with a good degree of precision

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Cement Cartelization in Indian Economy

• In 2008, Competition Commission of India (CCI) sent notices to 42 cement companies including Cement Manufacturing Association for alleged cartelization

• With the surge in demand for cement, the price of cement also increased

• This led CCI to investigate the cartelization in the industry under Competition Act, 2002

• Evidence is provided by Whistle-blowers to confirm the cartelization in the industry

• The CCI fined all the involved companies a combined fine of €800 M

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Methodology Used

Concentration Index (C3/C5)• The C3 and C5 index for the industry remained more or less constant during three

years (2004-2006) in study

Price Surge• All the 5 regions experienced sudden price increase simultaneously during March

2006

Demand/Consumption• High demand/consumption variability affects cartelization in the long run.

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Methodology Used

Expenses to Sales Ratio• In spite of sales picking up sharply and steadily, the cost of production has not

increased at same pace which could point towards cartelization

The increase in demand is matched up by increased capacity and hence no shortage is observed. But the increased prices and declining expense to sales ratio point towards possible cartelization

Source: http://www.circ.in/pdf/Case_Study_04.pdf 37

The Indian Cement Cartel and the European Cement Cartelization. Institutional differences.

Indian Institutions European Institutions

• Weak rights of victims of the illegal anti-competitive conduct – difficulties with filing cases in courts by private parties

• Encouragement of a class action type of private antitrust enforcement

• Leniency programs are not effective or wrongly implemented

• Leniency programs are greater in number and generally encourage reporting cartel-like activities

• The institutions in charge have relatively less power

• The institutional set is more empowered

• Small involvement of economic expertise • The economic analysis plays important part in the detection of a cartel

• Lack of international perspective • There are bilateral economic arrangements within the EEA

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Question 1

• What should be minimum fine for deterrence if probability of detection is 25% and probability of conviction is 80% when the price under collusion is 10% higher ? (Note: Consider inelastic demand)

25% of Sales

30% of Sales

50% of Sales

60% of Sales

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Question 2

• A cartel is a collusive agreement among a number of firms that is designed to

Expand output and lower prices but not to a predatory level

Expand output and lower prices to a predatory level

Restrict output and raise prices

Expand output and raise prices

Restrict output and lower prices to a predatory level

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Question 3

• What over-deterrence is?

It means the authorities in charge take up too much cases which renders them

ineffective when it comes to infringement detection.

It means that a treatment of a company is too harsh considering seriousness of its’

infringement and therefore it doesn’t incentivise companies to cooperate in the first

place.

It means putting false accusations on companies that are innocent and not involved

in a cartel.

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Question 4

• Under which Act, cartelization is prohibited in EU?

Act 81 of Treaty of Rome

Act 81 of Treaty of Lisbon

Act 101 and 102 of Treaty of Rome

Act 101 and 102 of Treaty of Lisbon

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Question 5

• Cartels usually happen in:

Monopolistic Industry

Perfect Competition Industry

Oligopolistic Industry

None of the above