In the past few weeks, the construction sector has been in the news for all the wrong reasons. But before them, the bread baking industry has been in the news for all of the wrong reasons. Major players in both industries have been found guilty of anti-competitive behaviour by the Competition Tribunal and large penalties have been levied against them. Most of the public is outraged and both industries face the threat of further penalties and lawsuits in the future. What do the two industries have in common, how do they differ, and what does the future hold for the South African consumer? By PAUL BERKOWITZ.
The old Latin metaphor of panem et circenses, or ‘bread and circuses’, refers to the basest measures of appeasing the broader population. Keep them fed and entertained and they’ll be happy, the logic goes. It’s an incredibly cynical view of what motivates the person in the street, but that doesn’t mean it’s inaccurate.
In South Africa, the revelations from the competition authorities reveal just how the broader population has been touched on its bread and circuses. The bread baking industry has three dominant players who were found guilty of price-fixing and other uncompetitive practices. One of them, Pioneer Foods (Pty) Ltd, was fined R200 million in 2010. The company and its peers now face a class-action lawsuit.
Recently, 15 construction companies were fined a collective R1.4 billion for collusive behaviour on 140 projects, including big-ticket items like the World Cup stadiums. These companies include the so-called Big Five construction companies. Some of these companies also face the prospect of further legal pain: most of the municipalities that host the stadiums have indicated that they wish to pursue their own lawsuits against the companies.
The bread and construction companies have found very little support from the public or the media; they’ve pretty much become pariahs in the eyes of most South Africans. There has been some support for the construction companies here and here in the business press, but it’s been very thin on the ground.
This article has not been written for the purposes of taking a position for or against the above-mentioned companies, or to wonder why defrauding the public of billions has been met with less outrage than the hundreds of millions wasted on Nkandla. It is trying to make some sense of the history of these two industries and the collusion that goes with them, and what might happen to them – and the rest of us – in the future.
We will also attempt a quick comparison of the baking and building industries in South Africa, why collusion in the former has been so much harder to enforce than the latter, and what lessons this might have for competition policy going forward.
There are a few important characteristics that both industries share. Both exhibit a fairly high level of market concentration (a few big firms have the lion’s share of the market). Both have a high level of vertical integration (the bakers own the mills that supply them with flour, the construction companies typically own divisions that supply related services). Both are low-margin businesses, although this has been somewhat overblown in the case of the construction sector.
Despite the similarities, the bread industry has found it hard to enforce its cartel post-1991, particularly in the Western Cape. The construction sector would probably have continued to collude (or not) quite easily had the Competition Commission not turned up the heat on its operations. What separates the bread from the bricks?
The decision handed down by the Competition Tribunal in the case of Pioneer Foods sheds much light on the structure and conduct of the bread manufacturing industry.
The background and structure of the industry (paragraphs 14 to 24) is useful to understand the present-day levels of industry concentration and collusion. Prior to 1991 there was extensive regulation of the industry, to the point where anti-competitive practices were condoned, and even supported, by the government of the day.
Bread producers met regularly, mostly under the auspices and with the blessing of the Chamber of Baking. Producers had designated areas and production volumes, and they would be penalised if they encroached on the territory of another. The tribunal summarises the situation neatly when it states that “[a] culture of co-operation and information sharing on prices, volume and market allocation was thus entrenched in the industry over many decades.”
This description of government-sanctioned cartels might sound bizarre to anyone who didn’t live through the various Agricultural Boards or to the younger (and not so young) generations who have been taught to equate apartheid with unbridled capitalism and the whims of the free market. The truth is that companies in many industries (and almost all agricultural products) were shielded from competition and allowed to operate like Prohibition-era mafia operations, each with its own captive market.
It’s not surprising that the bread producers found it hard to kick the decades-long habit of meeting regularly to discuss prices and markets, even when this behaviour was outlawed. What is interesting is how lousy the cartel was at fixing prices.
The three dominant producers (Pioneer, Tiger Brands and Premier Foods) account for somewhere between 50% and 60% of the domestic bread market. There are no other producers that come close to these three in terms of market share and levels of vertical integration. Their sales and distribution networks are also far more extensive and sophisticated than any other producers.
Each of the three large bakers sets its prices nationally, and then uses this price list as a benchmark when selling its bread to distributors and retailers. The bakers’ national sales managers will negotiate discounts and rebates with their largest customers (big retailers, forecourts and convenience franchises). The bakery managers will in turn negotiate discounts for the smaller, regional retailers.
A bakery’s national list price is therefore not the final price that the retailer (and consumer) pays for bread. There is a degree of discretion (up to a point) for the sales managers and bakery managers when they negotiate with the distributors and retailers. Factors such as regional competition and the strength of the relationships between managers and retailers come into play.
The indeterminate size of this grey area between the official list price and the final price granted to retailers ended up being one of the biggest threats to the success of the bread cartel, as shall be seen.
Competition theory and game theory suggest that a cartel’s strength is directly related to the degree of market concentration. With only three dominant players, the bread cartel could have been expected to be more successful than the Big Five in the construction sector. The differences between the two sectors are instructive and explain the relative ineffectiveness of the bread cartel.
Firstly, even though the management of the three big bread producers continued to meet in the proverbial dark, smoky rooms and discuss coordinated price increases, the producers consistently defaulted on their gentlemen’s agreements. The tribunal notes (paragraph 40) that “agreements [to fix prices] that arose from these informal meetings were often not honoured.”
The producers would meet and agree upon price increases, and these might even be implemented as per the agreements. This did not, however, stop each of the producers from renegotiating confidential discounts with the larger retailers. These discounts amounted to an effective undercutting of the agreed-upon prices. The tribunal describes how “even these informal meetings were discontinued after a meeting held in October 2003 broke up in considerable acrimony precisely because of perceptions of cheating on pricing agreements.”
Pity the poor bread producers. They continued to meet and to discuss coordinated price increases but the love and trust had left the relationship. They continued to undercut one another, preaching collusion in private while practising competition in public.
These failures to agree upon price increases also demonstrate the strength of the larger retailers in negotiating large discounts from the list price and in passing the pressure back to the producers. The price sensitivity of the retailers was keenly felt by the producers.
The unhappiness of some of the retailers with the size of their discounts also appears to be the source of the leaks to the media, notifying them of the uncompetitive practices in the industry. At least, that was the interpretation of the general manager of Pioneer’s baking division. When the news of an inquiry by the media reached him, his first action was to notify his bakery managers of the allegations and to ask them to make sure that the fixing of discounts was not discussed by the company’s sales staff.
The grey area of the discounts, and the retailers’ unhappiness with the uneven application of these discounts, appears to have had a major role in undermining the strength of the cartel. In the words of the tribunal “it is one thing for a select group of senior people to conspire secretly, it is quite another thing to maintain the secrecy once the foot soldiers have to be engaged.”
The bulk of the investigation focused on the dynamics of the Western Cape market, where competition between the producers appears to be most robust. This didn’t stop the tribunal from levying a penalty of R46 million against Pioneer for its actions there.
The divvying up of the market between the three producers in the rest of the country appears to have been somewhat easier. In some regions the producers had voluntarily exited regional markets years ago under the old system, leaving the entire market of some towns and cities to their rivals. They had never re-entered these markets, long after they were ‘allowed’ back.
(Incidentally, this fact was used against them in the tribunal hearings: the very lack of any evidence to show that they had contested these markets post-1991 was used as evidence that the old practices were being maintained.)
The bread cartel was ultimately hampered by the characteristics of its market: bread is the fastest-moving of all fast-moving consumer goods. It is produced, sold and consumed on a daily basis. It is largely a homogenous product with standardised inputs. It has no seasonal or cyclical demand factors.
It is consumed by millions of people on a very frequent basis. Price comparisons, at least on the retail level, are easy to make. Consumer demand is very sensitive to price. Any producer that raises prices unilaterally will be swiftly punished by the market.
Even the information asymmetries of the secret discounts and rebates are of limited value because of the buying power and price sensitivity of the larger retailers. In fact, this asset became the bread manufacturers’ biggest liability when it became a source of grievance to the retailers and distributors, prompting them to run to the press and the authorities.
In contrast, the outputs of the construction sector are not homogenous and are consumed by far fewer people, particularly the big-ticket projects produced by the biggest firms in the sector. It’s therefore much harder to agree on what is a ‘fair market price’ for these projects.
Many of its outputs are consumed by the public sector, which is much less sensitive to price than private consumers (some would say that governments are not at all sensitive to the prices of public goods).
Demand in the industry is strongly cyclical and the cycles can be many years long. This has been used in the industry’s defence against the charges of greed and profiteering that it faces. As the standard defence goes, the construction companies were virtually compelled to fill their pockets while they could before the lean years returned.
This writer remembers attending a few results’ updates of the Big Five when young analyst for one of the Big Four banks, back in 2007. It was a few months before the global financial crisis and the construction companies were in the rudest of health. Some of them were reporting margins that were well above 5% for domestic projects and double that for their overseas work in the Middle East.
The fact that the companies are charged with collusion for projects that were undertaken during the peak of the industry’s cycle doesn’t invalidate the fact that average margins across the cycle are relatively low. It does make it harder to sympathise with the companies though.
Much of the media’s focus (and the industry’s line of defence) has been on highlighting the World Cup-related projects and the claims that this was ‘business unusual’. Many have emphasised the urgency of the stadium projects and the huge risk to the construction companies of tendering for too many projects. Some other noises have been made about national pride and other such ephemera.
But this is so many red herrings. The stadium construction jobs comprise fewer than ten of the 140 projects that were investigated. They might represent the bulk of the value creamed off by the construction firms but they’re examples of, not exceptions to, the firms’ modus operandi in tendering for public work.
The dubious approach by FIFA to the industry is also not a reason to condone the industry’s actions. If anything, it should prompt a wider investigation of government’s and FIFA’s role in the building of the stadiums. The fact that FIFA is patently dirty does not make the industry clean, not even by comparison.
Where do we go from here? Popular opinion is clearly in favour of harsher penalties and stricter regulation of business. Competition and anti-trust policy is notoriously complex and there is no easy way to stamp out industry collusion – some even say that it’s not a desirable outcome.
It is likely that the hard work has already been done by the commission and the tribunal. They’ve taken on some very big industries and they’ve made them bleed money. In the case of Pioneer, the tribunal delivered a fairly punitive beating. The bread producers are probably scrambling to enter the markets they have stayed away from, just to avoid history repeating itself in a few years time.
In the case of the construction sector, some of the longer-term goals include a reform of the tendering process and a dilution of market concentration. Neither of these would be easy to achieve.
Efforts to introduce and develop new construction companies have been ongoing for the better part of a decade with no visible signs of success. (The Big Five have even been accused of not fulfilling their obligations to subcontract enough of the stadium jobs to smaller companies.) Reforms of the tendering process, which could include reducing the costs of tendering for large projects, will require political will and coordination, and those things cannot be taken for granted.
Ultimately, the case for greater competition is best supported by a microeconomic framework that favours smaller businesses and supports their growth. Until the government of the day prioritises these things, the cycle of collusion and punishment looks set to continue. DM
Photo by REUTERS
"The soul is known by its acts" ~ Thomas Aquinas