Saturday, June 26, 2010

If the Price Ain't Broke, Don't Fix It

Tonight I watched The Informant - starring Matt Damon, it chronicles the true story of Mark Whitacre, a corporate whistleblower who turned his company in for price fixing in the 1990s. Having gotten to hear him interviewed at The King's College last semester (you can download the interview here), I was especially excited to see it.

What struck me while watching the film was the amount of trust and effort that went into price fixing. In order to fix prices, at least two companies have to agree to buy or sell the same product for a set amount. In this case, that product was lysine, and Whitacre's company ADM was involved with multiple producers on an global level.

In order for price fixing to work, someone initially has to suggest it - in other words, you have to casually bring up the possibility of illegally joining forces to your competitors (people who don't want to see you succeed). This is dangerous and could result in a variety of bad outcomes - however, assuming your competitors lack conscience to the same degree you do, you both have to trust each other to not cheat the other one, and to stick to the agreed-upon price. Two crooks/cheats/liars have to trust each other to play by the rules when it comes to playing by the rules. Not a good risk to take.

If (miraculously) this works, you actually have to determine a price point at which to artificially set the prices. This should be close enough to the market price to not arouse suspicion, but far enough away from it to make it worth your while. This requires market research, calculations, estimates, and ultimately a guess. After all the work that goes into finding a good price alone, would that time have produced a revenue increase if you spent it trying to cut costs, improve production, or help more customers?

Price fixing is a lot like cheating on a test - for starters, both are forms of cheating. There's also a good deal of trust involved - just like the price fixer trusts his competitor to not rat him out, the copycat trusts his classmate to have better answers than he does. The effort is similar too - while the price fixer has to spend all sorts of time (that could have been spent on real work) figuring out how to not get caught, the cheater does as well - in the time it takes to concoct an elaborate cheating scheme, he could have simply studied the material.

Price fixing (beyond the obvious moral failings) simply doesn't make sense as a sound business decision - having to trust your competitors with incriminating information, having to pour in an inordinate amount of effort, and facing the constant threat of jail all make it a poor choice.

While I'm all for the free market (and I think it is too regulated right now), price fixing should not be allowed for two main reasons (as well as the common-sense ones I've listed above):
1. Agreed-upon economic rules are necessary.
2. It takes power away from the free market.

1. Agreed-upon economic rules are necessary because the rules determine the game. It's pretty hard to play Canasta if half the people are using Texas Hold 'Em rules. If people start playing by different rules, they start playing a different game. If we're playing Canasta, it doesn't matter that you think your cards are better suited to poker - just because you don't like how the game is treating you doesn't mean you get to switch games in the middle.

2. Though typically we think of the free market as minimally regulated (which I think is typically accurate), forbidding price-fixing actually helps the free market, by letting it set the prices instead of a room of board members. In a free market setting, the supply and demand curves determine the equilibrium price. In a price fixing setting, whoever is fixing prices determines how much you pay. As an advocate for the free market, I'd always rather let the "invisible hand" determine the cost of goods and services than someone in a conference room in Hawaii.

From a purely economic standpoint, without ever having to point out the obvious (that price fixing is immoral and should not be done simply because it is unethical), we've established that price fixing requires too much trust and poorly allocates time and resources, and that this view is consistent with favoring free markets.

If none of those reasons are good enough, just think - there's always the possibility that an A-list actor will gain weight in a high-publicity manner to make a movie about the man who exposed all your dirty laundry, and they'll say your company's name repeatedly to make sure everyone in America knows who tried to change the rules on them. Later, a girl in a pencil skirt will blog about it and will mention your company name again just for good measure. But if that's what you really want ...

I did all this in:
Grayish pencil skirt, purple embroidered wrap shirt, pearl bead necklace, pink faux crystal flower studs, and black leather open-toed slingback pumps.


  1. There might be some effort involved in cheating and price fixing, but everybody who chooses those alternatives has determined that it is less effort than the alternative. Also, you are gaining a higher degree of certainty toward your desired outcome. It's not entirely trust - it's really a hope that both parties engage in enlightened self-interest, where the benefits of cooperating with your competitor (and the uncertain nature of that endeavor) are likely to outweigh the benefits of competing. They may also come with less effort. Keep in mind that the way somebody cheats in a price-fixing scam is to LOWER their prices, which is a risky venture in and of itself.
    Better to simply declare yourself a cartel and go public with your price fixing. It's worked pretty well for OPEC for about 30 years.

  2. Scoop - I think that game theory would side with me and say that there is a large amount of trust in having both parties charge a higher price. Also, since the whole point of price-fixing is to get away with charging artificially high prices, as you said, cheating in that situation means reducing prices - which would likely bring them back to around the market value. So, while it's risky in the sense that you could probably get more money in the price-fixing club, if you can undercut and outsell your competitors, you stand to profit more (obviously, this is all hypothetical - real numbers may dictate different outcomes).
    Personally, I don't usually use Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela as my economic role models - and certainly not my moral ones.
    I appreciate your comment - you raised interesting points.