Philippine Institute for Development Studies
Policy Notes November 2000
Tacit Price Collusion in the Philippine Cement Industry? Rafaelita A.M. Aldaba*
C
ement is an important input in the construction industry, particularly in the government’s infrastructure and housing programs which are necessary for the country’s socioeconomic growth and development. Cement manufacturing in the Philippines is basically resource-based, with cement plants located in or near limestone quarry areas. There are currently five major natural markets in the country: Northern and Central Luzon, National Capital Region, Southern Luzon, Visayas, and Mindanao. Cement has a limited shelf life from three to six months and is characterized by high transport and handling costs. These high costs provide it with natural protection against cement imports.
History of coordination in the cement industry The Philippine cement industry developed under heavy government protection and promotion in the 1970s
No. 2000-13
through the imposition of high tariffs and import restrictions and the granting of incentives under the Board of Investment’s (BOI) rehabilitation, modernization and rationalization program. It was also subject to government regulation through the Philippine Cement Industry Authority (PCIA) which was created in 1973 to regulate entry in the industry, allocate supply, and control prices and cement exports. The PCIA and the Philippine Cement Corporation (Philcemcor) worked closely together in regulating the industry, with the PCIA delegating the setting of production quotas to Philcemcor. Collusion took place through the firms’ informal agreement to set production quotas and to assign geographic markets among themselves. Philcemcor held regular monthly meetings to set production quotas. It also arranged for the geographical division of the markets wherein the Luzon plants were to sell only in the Luzon area and the Visayas/Mindanao plants to confine their sales only in the area.1 With the liberalization and deregulation of the cement industry in the late 1980s, however, talks about __________ * The author is Research Associate, Philippine Institute for Development Studies. 1
Lamberte, M., E. de Dios et al. (1992).
PIDS Policy Notes are observations/analyses written by PIDS researchers on certain policy issues. The treatise is holistic in approach and aims to provide useful inputs for decisionmaking. This Notes is based on a research paper entitled "The State of Competition in the Philippine Manufacturing Industry" by the same author which was conducted under the auspices of the Philippine APEC Study Center Network (PASCN). The views expressed are those of the author and do not necessarily reflect those of PIDS or any of the study's sponsors.
2
the cement cartel died down. But just as the industry's cartel image was about to be shed off, the industry's observed pricing behavior from January 1999 to May 2000 triggered renewed concerns from some sectors on the possible resurrection of the cartel. Is there indeed such a cartel? Are firms colluding to fix prices in the industry? This Policy Notes aims to answer such questions. It will trace firm behavior and practices that are indicative of a common policy being pursued by the industry and focus on industry characteristics and environment that make it conducive for firms to coordinate their actions.
The economic theory of cartels and collusion Economics textbooks describe collusion as a form of behavior where firms agree to coordinate their actions. Instead of competing against each other in one form or another, they collude to set prices and quantities that would maximize the sum of their profits. When firms get together and attempt to fix prices or levels of outputs, rig bids in auctions or procurements and divide markets by allocating customers, territories, relevant products or supplies in order to maximize total industry profits, they are known as a cartel. Cartels and collusion are anti-competition. They create market power and suppress rival and consumer activities. It is, however, important to distinguish between explicit and implicit cartels. Hard-core cartel or explicit collusion refers to explicit agreements to fix prices or share markets between producers and sellers of substitute products. Soft cartel or tacit collusion refers to collusive agreements that are merely implicit. Tacit collusion would not involve explicit agreement but simply the unspoken acceptance by the firms that it is in their best interests to produce the monopoly output on the understanding that failure to do so would provoke a price war. Implicit coordination may be achieved simply through market interactions without any communication or negotiation between firms. There would be no evidence
Policy Notes
November 2000
of firms having met or having discussed the coordination of market behavior. The only evidence that will be available relates to the firms’ market behavior. It is difficult to spot cartels and collusion as these are often colored or concealed to look like oligopolies. In the real world, there are many facilitating devices that have been developed to help firms achieve successful tacit collusion. Among them are: Trade associations. In many industries, associations are usually organized to handle public relations, organize conventions, trade fairs, and others. However, they may also act as facilitating devices as in collecting and disseminating information on costs, outputs and prices, and in policing both tacit and explicit agreements. ]
] Price leadership. Under this practice, the dominant firm first announces price changes and the other firms follow within a short period of time. It is also possible for a nondominant firm, which is considered the best at judging market conditions, to play this role. This practice of price leadership is a way of addressing the problem of choosing one price agreement in the set of possible agreements. If the leader is good in selecting mutually acceptable prices, the agreement can be entirely tacit.
There are likewise many opportunities for company officials to make their views known to each other on the state of the market and the direction prices should take. Some examples are newspaper interviews, articles in trade publications, or speeches. Industry characteristics such as size and product type may also facilitate collusion. The smaller the number of firms is and the more product homogeneity there is, the easier it is for firms to coordinate their actions. The operation of both implicit and explicit mechanisms will require information on each other’s costs, outputs, prices, and discounts. As the number of firms and product heterogeneity grows, these information requirements likewise expand.
3
Cement, like other homogeneous products such as sugar and flour, is often cited as a market likely to have a cartel. In fact, cement cartel cases were previously found in the Slovak Republic, an economy in transition, in the European Community, and in Norway. Based on material evidence, said cartels in the Slovak Republic and in the European Community2 were successfully prosecuted.
Increasing prices amidst excess supply and overcapacity in the industry To help determine whether there is indeed coordination in the cement industry—explicit or tacit—it is useful to take a look at its economic operations. Table 1 presents a picture of the economic operation of the cement industry from 1990 to 1999. Total supply (domestic production+imports+inventory–exports) and total demand (domestic sales+imports) were estimated alongside with excess supply (total supply–total demand). The Table also shows average ex-plant prices, capacity utilization rates,
No. 2000-13
and annual percentage changes in sales, production, total demand, and total supply. The data indicate strong industry growth between 1993 to 1996. In anticipation of continuous future growth, the industry more than doubled its capacity from 282 million 40-kg bags in 1995 to 641 million 40-kg bags in 1998. To finance their expansion, the firms incurred foreign debts. With the financial crisis in 1997, however, the demand for cement dropped by 13 percent in 1998 and by 4 percent in 1999. Since the cement industry is highly dependent on the construction demand, the slowdown in the construction and property sector resulted in an oversupply of cement in the market, forcing cement firms to cut prices. As firms engaged in a price war, average ex-plant prices were reduced by 6 percent in 1997 and by 23 percent in 1998. Analysts believe that pros———————— 2 World Bank–OECD (1998). Steen, F. and L. Sorgard (1996).
Table 1. Economic indicators in the cement industry, 1990-1999 (In ‘000 40-kg bags)
Indicators
1990
1991
164060 0 23098 187158
172324 0 250 3435 176009
Sales 160625 Imports 23098 Total domestic demand 183723 Excess supply 3435
173002 250 173252 2757
Production Exports Imports Beginning inventory Total domestic supply
Average ex-plant price (in pesos per 40-kg bag) Capacity utilization rate (in %) Percentage changes Production Sales Average ex-plant price Total supply Total demand
1992
1993
1994
1995
1996
1997
1998
1999
166536 201268 0 125 17041 0 2757 4184 186334 205327
236623 263842 0 0 242 12010 5246 1958 242111 277810
310725 0 16990 573 328288
367019 0 8794 4467 380280
322196 2150 4504 8070 332620
313937 17284 11861 10258 318772
165109 200081 17041 182150 200081 4184 5246
239911 265227 242 12010 240153 277237 1958 573
306831 363416 16990 8794 323821 372210 4467 8070
317858 4504 322362 10258
296733 11861 308594 10178
97.41
93.55
77.89
78.58 87.51
84.50 86.44
92.33 93.44
100.97 88.15
94.92 80.05
72.75 50.26
85.17 48.97
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
5.04 7.71
-3.36 -4.56
20.86 21.18
-5.96 -5.70
5.87 5.14
10.19 9.84
17.57 19.91 7.53 17.91 20.03
11.50 10.55 9.27 14.75 15.44
17.77 15.69 9.36 18.17 16.80
18.12 18.44 -5.99 15.84 14.94
-12.21 -12.54 -23.36 -12.53 -13.39
-2.56 -6.65 17.07 -4.16 -4.27
Source: Philcemcor
Policy Notes
4
pects for the sector’s recovery in the short term would remain bleak, with a Phinma report indicating that the overcapacity of the industry would remain until at least the year 2007.3 Table 1 also shows that prior to 1997, the excess supply in the industry was, on the average, 3 million bags. Between 1997 to 1999, this rose to 9.5 million bags. Given the above, it is therefore surprising that average ex-plant prices increased by around 17 percent in 1999 and continued up to the year 2000. A closer scrutiny would reveal a uniformity in pricing behavior exhibited by the firms wherein prices changed almost identically and closely followed one another.
Is there collusion in the Philippine cement industry? Between 1993 to 1996, there was a fairly stable pattern in the movement of average ex-plant prices (Figure 1). The demand for cement is seasonal. It increases during the dry season and declines thereafter. March to June are normally the peak construction months. In April 1997, chaotic movements in the average ex-plant prices started to be felt as a price war broke out. The same declining trend was observed during the whole period of 1998 as the average ex-plant prices of cement dropped from P104 per 40-kg bag in March 1997 to P44 in December 1998. A Philcemcor official noted in an interview that the price war only stopped after Phinma, the leader in the industry, announced that it would no longer engage in any price reduction. As expected, everybody in the industry followed. And from 1999 up to the present, cement prices have increased consistently at a time characterized by excess supply, excess capacity, and depressed demand.
November 2000
Figure 1. Average ex-plant prices
plants (Northern, Grand, Pacific, and Titan), all the remaining firms have foreign equity participation, ranging from 40 to 100 percent. Cemex of Mexico owns 100 percent of Solid, Rizal, and Apo. Holderbank of Switzerland, together with Phinma, controls the largest cement conglomerate consisting of Bacnotan, Hi-Cement, and Davao Union. United Kingdom’s Blue Circle has stakes in four cement firms, namely: Fortune Cement, Mindanao Portland, Republic Cement, and Iligan Cement. Blue Circle plans to merge these firms to become the second largest cement conglomerate in the country. The French firm Lafarge also bought into Republic, FR, Lloyds and Continental Cement. Holderbank, Blue Circle, Lafarge, and Cemex are the world’s largest cement companies. For the thirteen-year period 1987-1999, the cement industry has remained highly concentrated in all five geographic markets. The four-firm concentration ratios shown in Table 2 represent the proportion of the industry’s gross output accounted for by the four leading firms in the industry, i.e., the sum of the leading four firms’ market shares. The higher the ratio, the more concentrated the market becomes. __________ PHINMA. Cement industry evolution: prices and production costs. Joey G. Alarilla. Cement oversupply expected until 2007. Philippine Daily Inquirer. 3
There are currently 19 cement plants operating in the country’s five geographic markets. Except for four
Policy Notes
5
It is very difficult to find material evidence of coordination such as a written document describing the cement industry’s agreement to coordinate their actions. Their pricing behavior, however, indicates that the sequence of observed price increases in the industry from January 1999 to May 2000 is inconsistent with competitive behavior. As the price data in Table 3 show, price changes have been almost identical and followed each other closely. For instance, in February 2000, the largest price increases were initiated by Phinma firms Bacnotan and Hi-Cement whose prices went up by 7.14 percent and 8.25 percent, respectively. In March, the rest of the firms followed and increased their prices by roughly the same amount of change. Northern increased its price by 7.3 percent, Continental by 8.23 percent, Republic by 6.11 percent, FR Pasig by 8.14 percent, FR Teresa by 7.2 percent, and Solid by 8.08 percent. In the Visayas, Lloyds and Grand increased their prices by 9.59 percent and Apo by 11.43 percent. In Mindanao, Mindanao Portland increased by 7 percent, Davao (Phinma firm) by 8.25 percent, Alsons and Iligan by 7 percent, and Pacific by 5 percent in March and 2 percent in April. The variability in ex-plant prices among the firms within each geographic market in the industry is very small as indicated by the standard deviation figures. In February and April 2000, the standard deviation was 1.15 in Northern Luzon, 1.04 and 1.1, respectively in NCR, and 1.1 in Mindanao. In May, it was 1.59 in the Visayas, 1.53 in NCR, and 1.34 in Mindanao.
No. 2000-13
There is also not much variation in the average prices across the three major geographic markets in the country. In February 2000, the average price in Northern Luzon was P101 per bag, P99.17 in NCR, and P100 in Mindanao. The only explanation for this low variation in prices is that firms have more or less a similar cost structure. This does not seem to be the case, though, among cement firms since according to Philcemcor, production and debt servicing costs of its firms amount to much more than P90 per bag while Southeast Asia Cement Holdings, Inc. (FR and Lloyds) estimated theirs at an average cost, including depreciation and interest payments, of about P80 per bag. The industry claimed that the increases in cement prices were due to high production costs brought about by increasing fuel and power prices, and finance charges. As noted earlier, their expansion was financed by dollardenominated loans. Based on a finding of the position paper of the National Economic and Development Authority–Trade, Industry and Utilities Staff (NEDA-TIUS) on cement prices (May 2000), fuel and power accounted for 25 percent and 14 percent of total production costs, respectively. However, most cement plants have already shifted from bunker to coal fuel since the 1970s. And between 1997 and 1999, the price of imported fuel dropped from an average of US$40/MT to about US$31 – US$34/MT, indicating that the fuel cost of the industry has been declining. Moreover, industrial power rates did not change substantially
Table 2. Four-firm concentration levels Four-firm 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 concentration ratios Northern Luzon NCR Southern Luzon Visayas Mindanao
100 100 100 100 100
100 84 100 100 93
100 86 100 100 94
100 91 100 100 94
100 81 100 100 94
100 72 100 100 92
100 74 100 100 96
100 74 100 100 96
100 73 100 100 93
100 81 100 100 94
100 87 100 100 100
100 88 100 100 95
100 99 100 100 93
Source of basic data: Philcemcor
Policy Notes
6
November 2000
Table 3. Monthly changes in average ex-plant prices (Jan-May 2000) Geographic Area
January February March April May Average Average Percentage Average Percentage Average Percentage Average Percentage Price Price Change Price Change Price Change Price Change
Luzon North Northern Bacnotan Limay Average price (in pesos) Standard deviation
96 98 98
97 96.25 98.25 98.25 97.50 99
105 97.25 98.25 98.25 97.25 99
103 105 105
8.25 1.04 (0.26) -
105 105.25 104.25 106.25 104.25 107
98.38
-
98.63
104.25 104.25 105
104.25 104.25 105
-
114.25 114.25 117
104.50 0.43 100 97 100 100 103 100.00 1.10
8.23 6.11 8.14 7.20 8.08
107 105 107 107 108
2.86 4.76
108 107.25 104.25 108.25 106.25 108
9.59 9.59 11.43
2.86 1.90 0.02 1.92 0.93
106.80 2.12
-
108 107.25 107.25 108.25 106.25 108
2.88 -
107.5 1.53
107.25
8.75
107.25
-
114.25 114.25 117
-
115.75 114.25 117
1.31 -
115.17 1.59 7.00 8.25 7.00 7.00 4.85
103 108 110 107.00 3.61
107.00 1.1
115.17 0.43 2.04 2.04 2.04 3.00
103 108 110 107.00 1.15
105.33 2.94
98.38
98 97 98 98 100
7.29 2.94
104.33 4.58
99.17 1.04
Luzon South Fortune
Mindanao Mindanao Davao Union Alsons Iligan Pacific Average price (in pesos) Standard deviation
7.14 4.08
101.00 1.15
NCR Hi-Cement Continental Republic FR (Pasig) FR (Teresa) Solid Average price (in pesos) Standard Deviation
Visayas Lloyds Grand Apo Average price (in pesos) Standard deviation
96 105 102
107 107 107 107 110 107.60 1.10
115.67 1.59 1.90 1.85
107 107 107 107 110
1.59 -
107.60 1.34
Source of basic data: Philcemcor
from 1998 to 1999, with average rates at about P2.38/ kwh and P2.50/kwh in 1998 and 1999, respectively. Thus, there seems to be no valid ground for such increases. The Philippine Constructors Association (PCA), together with other construction groups like the National Confederation of Contractors Associations of the Philippines (NACCAP) and the Association of Concrete and Aggregate Producers of the Philippines (ACAPP), had strongly
Policy Notes
opposed the “unwarranted and concerted increase of cement prices“ by the domestic cement industry. 4 The groups said that the abrupt price increases in March 2000 were not related to any major production cost or market forces but are "meant to recoup past investment losses.”5 __________ 4 BusinessWorld. 2000. Constructors warn cement prices may hit P140 per bag. 30 March. 5 Manila Bulletin. 2000. Construction industry groups object to cement price increase. 30 March.
7
To sum up, it is far from clear that the sequence of observed price increases occurring in the industry since January 1999 could be explained in terms of competitive interactions. How do we explain increasing domestic prices in the presence of excess supply and weak demand due to the slowdown in construction activity in the country? Under competitive conditions, the simultaneous price increases that the firms have been engaged in would be quite unbelievable, considering that demand for cement is still low and imports are able to come in. The firms seem to have different cost structures and yet, the prices that they are quoting have, on the average, very low variation. Why are the cement firms increasing their prices by almost the same amount together in what seems to be a harmonious fashion? As the observed price behavior is inconsistent with competitive behavior, the only way to explain it would be in a framework where firms coordinate their actions, i.e., firms collude on prices. There are relatively few firms in the industry which makes industry coordination easier. The industry also has a very active association, the Philcemcor, that aggregates industry statistics and may also act to facilitate the exchange of individual price and quantity data among competitors. The history of coordination in the industry is also a very significant factor to establish the presumption that the firms are not acting on their own and that coordination still takes place. Philcemcor, of course, denied the existence of a cartel and collusion in the industry. It maintained that the “geographic market arrangement prevailing in the industry is not anti-competitive” and even defended it by saying that “this is legitimate, good business strategy for the industry, [and] devised in order to avoid the high cost of transportation inherent in the industry.”
Dumping in the presence of a cartel Potential competition from imports is important as a mechanism to control market power. In the case of cement, however, this is of little practical value because
No. 2000-13
of the substantial costs of entry. Cement can be imported in bulk, although this will entail a bulk-handling facility which is quite expensive. On the other hand, shipping cement in bags will entail extra handling costs which can easily increase the price. These factors limit the procompetitive effects of imports on the industry. Table 4 presents the country's cement imports from 1990 to 1999. Except for the years 1990 and 1992, imports constituted a small portion of total consumption. Currently, imports are sold P5 cheaper than local cement. The local cement industry, however, reacted, through Philcemcor, by filing a dumping 6 suit against Taiwan Cement Corporation and Japan’s Taiheiyo for allegedly dumping cement at US$36 and US$20 per ton exterminal import price, respectively. As Japan’s Taiheiyo has already increased its prices, Taiwan Cement Corporation has been the main respondent of this antidumping case. At present, what we observe in the cement industry is cyclical dumping, a situation wherein a foreign firm may have set its export price below home market price without predatory intent simply because of the global excess capacity and depressed demand brought about by the 1997 Asian crisis. In India, for instance, the average spot price for cement was US$40 per MT in 1997 and this dropped to between $25-27 per MT in 1998.7 In Thailand, prices ranged from US$16 to US$18 per MT in late November 1998. These are more or less consistent with the ex-terminal import prices of Taiwan and Japan in the Philippines. Although anti-dumping regulations are valid measures to enforce in order to prevent predatory dumping,8 __________ 6 Dumping is defined as export sales below home market price or export price below cost. 7 Business Forum Financial Express. (http://www.FinancialExpress. com/fe/daily). Indian Express newspapers.
Predatory dumping is defined as a case where firms set their export prices below costs with an intention to drive competitors out of business and once they monopolize the market, they increase their prices to obtain monopoly profits. 8
Policy Notes
8
November 2000
Table 4. Cement imports (in 40-kg bags) Year
Bagged
Bulk
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
23097831 250000 13769275 241723 5104175 10885250 8794475 1821775 -
3271400 6906250 6105050 2682500 11860750
Total Total As Percentage of Imports Consumption Total Consumption 23097831 250000 17040675 241723 12010425 16990300 8794475 4504275 11860750
183722831 173252916 182149782 200081411 240152950 277237624 323821577 372209958 322362183 308594848
12.57 0.14 9.36 0.10 4.33 5.25 2.36 1.40 3.84
Source: Philcemcor
the government needs to be cautious in introducing such regulations. Since these regulations may reduce the welfare of the country even more than they do global welfare, the injury to the industry must be carefully weighed against consumers and user industries' welfare gain. The government must also take into account that unrestricted imports are necessary because in the absence of competition laws, they are the only means to provide competitive discipline in an industry characterized by limited competition and a tendency to engage in collusive behavior.
A summing up In a forum on competition policy held recently in Davao City, a cement executive from a Phinma-owned company argued that the price increases were due to increases in production costs brought about by the peso depreciation. But as their major inputs like limestone, clayey and ferrous materials are not imported, the increase in cost could mainly be attributed to their fuel and power costs as well as to their interest payments. By how much have fuel and power costs increased to push cement prices substantially upward? Do firms have uniform fuel and power consumption? Are all the firms paying almost exactly similar interest payments? It would be interesting to see the cost structure of each firm although this data set is very difficult to obtain.
Policy Notes
Based on the currently available cost information from Philcemcor and Southeast Asia Cement Holdings, firms seem to have different cost structures. If their costs are indeed different, why are they quoting almost identical prices? Given this inconsistent behavior, we cannot conclude that the firms are behaving competitively. As such, we have to explain the recent price increases occurring amid excess supply and depressed demand within a framework where price coordination takes place. 4
References Fingleton, J., E. Fox, D. Neven, and P. Seabright. 1995. Competition policy and the transformation of Central Europe, European Communities. Frischtak, C.R. (ed.) 1995. The changed role of the state: regulatory policies and reform in a comparative perspective, chapter 1. In Regulatory policies and reform: a comparative perspective. Lamberte, M., E. de Dios et al. 1992. Barriers to entry study, vols. I and II. A study prepared for the United States Agency for International Development (USAID). Neven, D. et al. Hard and soft cartels, chapter 3. In European competition policy and agreements between firms. Onada Engineering and Consulting Co. 1991. Industrial restructuring studies: cement. Development Bank of the Philippines. Rees, R. Tacit collusion. Oxford Review and Economic Policy 9, No. 2. Steen, F. and L. Sorgard. 1996. A model of semicollusion in the Norwegian cement market. The World Bank and the Organisation for Economic Co-operation and Development. 1998. A framework for the design and implementation of competition law and policy. Varian, H.R. Intermediate microeconomics, 4th ed.
For further information, please contact The Research Information Staff Philippine Institute for Development Studies NEDA sa Makati Building, 106 Amorsolo Street Legaspi Village, Makati City Telephone Nos: 8924059 and 8935705; Fax Nos: 8939589 and 8161091 E-mail: afita@pidsnet.pids.gov.ph jliguton@pidsnet.pids.gov.ph The Policy Notes series is available online at http://www.pids.gov.ph