It is likely that one of the reasons for the high cost of living in Israel is a phenomenon called a "vertical secret cartel." A cartel is an agreement between competitors not to compete with each other and is prohibited by antitrust laws. The problem is that rivals may collude to set a cartel-like price, without any communication between them (hidden cartel). When competition is long-term, and competitors care about their future profits, each competitor may prefer to charge a high price now, with the aim being that rivals will reward them by setting a high price in the future.
In an article published by David Gilo and Yaron Yehezkel, in the RAND Journal of Economics, they demonstrated that through a seemingly innocent sales contract between a supplier and retailers, the supplier can help the retailers create a hidden cartel, and help itself to charge a high price from the retailers. A significant and dominant supplier, or an exclusive supplier (such as a supplier of cottage cheese), supplying retailers (supermarket chains), can help to create a hidden cartel between them by combining a high wholesale (per unit) price it charges the chains, with a "compensation" paid by the chains, every year, through a "slotting allowance," a payment that is not passed on to consumers. The chains are reluctant to deviate from the cartel price because then they will stop receiving the slotting allowance. The cottage cheese supplier is reluctant to stop paying the slotting allowance because the arrangement allows it to charge higher prices from the chains.
Cartel price fixing
In an article published in Marketing Science, Noam Shamir examines options for creating a hidden cartel by using a common supplier. Shamir examines a situation in which each retailer, for example, a chain of toy stores, has its own forecast regarding the level of demand for toys in each period. The challenge of the cartel is to determine what the optimal price level is, without the retailers being able to directly share their forecasts with each other.
Shamir shows that a cartel can be created as follows: each retailer shares with the supplier their own forecast, and the supplier fixes the wholesale price to charge the retailers based on the data of all the retailers. The wholesale price, which contains data provided by the retailers, is used as a tool for them to fix the cartel price. In this case, even though the supplier is not part of the cartel, it finds it appropriate to cooperate with the retailers to get the demand forecasts and set a wholesale price that matches the market situation.
To expand the scope
Our research finds that in order to combat the phenomenon of the hidden cartel, the Israel Competition Authority and the courts must examine not only the relationships between the rival companies but also expand the scope of their examination to relationships with suppliers.
When Tnuva dictated to the marketing chains the price to the consumer that they would charge, the Israel Competition Authority began an investigation, and enforcement measures were eventually imposed. But in the case of Gilo and Yehezkel's article, the supplier does not have to dictate the cartel price, which is achieved without dictates or even any communication.
A ban on "shelf commissions," or such and other payments, paid by the supplier to the retailer would make it difficult for such a cartel to exist. The Food Law, which was enacted during Gilo's tenure as Antitrust Commissioner, indeed prohibits such payments.
A market study carried out by the Israel Competition Authority showed that the ban lowered the price charged by the suppliers to the chains. However, the study showed that apparently the chains hardly passed on the price reduction to the consumer. Although it is possible that the price for the consumer did decrease following the ban, and measurement problems in the market research failed to capture this; but a drop in the price charged by suppliers to retailers is also welcome. It can, for example, encourage new retailers to enter the market and into different areas. Secondly, arrangements that encourage retailers to deal exclusively with one supplier can be prohibited.
Thirdly, in the model presented by Shamir, communication is required between the supplier and the retailer related to the data of a competing retailer. A stricter attitude to such communication would help to prevent harm to competition.
The understanding that information that is transferred between a retailer and a supplier can help coordinate prices can be seen, for example, in an investigation conducted by the British Antitrust Authority in 2003. As part of this investigation, the authority claimed that information passed between competing retailers to a common supplier helped the retailers to set minimum prices for soccer kits.
Finally, market entry barriers must be loosened. The more new suppliers, who compete fiercely with the supplier, including parallel imports, will enter the market — the less likely the damage to the competition will be.
Prof. David Gilo is the former Head of the Israel Competition Authority and is today a researcher in the Buchmann Faculty of Law at Tel Aviv University. Prof. Yaron Yehezkel and Dr. Noam Shamir are researchers in the Coller School of Management at Tel Aviv University.