Cartels and Capital Budgeting

Cartels and Capital Budgeting

Question 1

A cartel entails a group of producers that has been formed to protect their interests. Cartels are formed when a few large producers agree to co-operate in various aspects of their market. They have the ability of fixing prices and level of output in a given industry. These actions are aimed at maximizing profits, while cutting on costs at the same time. Several rules and regulations are put forward, and every member is expected to follow. Cartels operate effectively where the barriers to entry are quite high, hence limiting the number of firms involved (Harding & Joshua, 2011). There is the presence of both public and private cartels.

Examples of Cartels

Unilever and Procter & Gamble

These two companies together with Henkel had coordinated and fixed the price of powder detergents in 8 European Union member states. They own the popular powder detergents in this region, hence had the highest market share in the industry. This occurred between 2002 and 2005. The ultimate objective was to stabilize their market positions in this industry. In 2002, the companies implemented an initiative to improve environmental performance of the products that they used to produce. However, the companies went against this practice, and were involved in anti-competitive cartel practices (McPheters, 2010). They made sure that none of them gained an advantage over the others by decreasing the prices. Later on, Henkel came to blow the whistle. As a result, it was awarded full immunity from investigation and was not liable to any fines. On the other hand, Unilever was fined 104 million Euros, while P&G was fined 211.2 million Euros (Harding & Joshua, 2011).


De Beers

This is a cartel of companies that has dominated the diamond industry in all facets. It has controlled the flow of diamond in the market for decades. This agglomeration of companies was formed with the aim of fixing prices, controlling supply and limiting competition. Over the years, the company has used its popular position to manipulate the international diamond market. Firstly, the company tried to convince independent producers to join its single channel monopoly. It flooded the market with diamonds similar to those of the producers that refused to join the cartel. The company also bought diamonds produced by other manufacturers in large quantities in order to control prices through supply (Harrington, 2007).

Phoebus Cartel

Phoebus is a cartel that existed between 1924 and 1939. Its existence was aimed at controlling the manufacture and sale of light bulbs. The main strategy that the cartel used was to prevent advancement in technology that would have helped in production of longer lasting bulbs. The cartel tied all the manufacturers and divided various continents among themselves. The group entered into an agreement that would help in increasing profits for their members at the expense of consumers. In order to limit competition, this cartel divided its market to different territories where each manufacturer domain received an exclusive control over its home country (Spar, 1994). This way the cartel ensured that low cost of production and marketing costs was obtained. Phoebus cartel also went to the extent of reducing the lifespan of the lighting bulbs by half. This ensured that consumers would double their consumption levels based on the lifespan involved. In the long-run, the aspect increased revenues for the cartel.


Difficulties Faced by Cartels

There are several difficulties that are associated with cartels. Among them is that members involved with cartels cannot have binding contracts among themselves. This is because the act of forming cartels is a breach of the Anti-Trust Law which results in the violations of the Sherman Act. The act stipulates that individuals or co-operations cannot enter into written contracts in an attempt of enforcing cartels (Grossman, 2006). Such occurrences lead members to breach the agreed upon rules and regulations since there are legal consequences to be accrued. This makes it difficult for a cartel to last for a long time.

Another difficulty is associated with the profit levels derived from these industries. The profits are high, and tend to attract other organizations. Almost every firm is in business in order to make profits. This makes industries being controlled by cartels to attract more investors due to the high profits involved. When more firms join the industry, it becomes difficult to control a group with many members (Harrington, 2007). Disagreements will tend to arise, and every firm will opt to do things their own way. In the long-run, the influence possessed by the cartel will diminish.

Some firms opting to cheat on the rules and regulations set forward also presents itself as a difficulty for cartels. The incentive to cheat is created by the prospect of earning even more profits if these firms were to increase their output levels and reduce the prices slightly. The market structure tends to shift from an oligopoly structure to a perfect competition market more so when barriers to entry are mitigated.

Negotiations among cartels also present difficulties. This is because they tend to be slow based on the nature of the firms involved. These firms might be having different production mechanisms hence incurring different costs. It becomes difficult to standardize price levels in a manner that all the firms involved will reap similar profits (Grossman, 2006). Every firm will be bargaining in order to have the advantage. As the negotiation process takes long, the prevailing market conditions might be rendered obsolete in future.

Question 2

Capital Budgeting Decisions

A capital budgeting decision can be defined as a firm’s decision to invest its current cash flows most efficiently in the long-term assets with an anticipation of future benefits. This investment decisions include expansion, acquisition, modernization and replacement among others. Investment decisions can also be categorized in either conventional or non-conventional projects. Among the features of capital budgeting decision is that it has long-term consequences, often involve substantial outlays and may be expensive or difficult to reverse. Several techniques can be used in its calculation including Net Present Value (NPV), Internal Rate of Return(IRR), Profitability Index (PI) and Payback Period.

A numerical example to show these techniques follows in the next page.



Grossman, P. Z. (2006). How Cartels Endure and how They Fail: Studies of Industrial       Collusion. New York: Edward Elgar Publishing.

Harding, C., & Joshua, J. (2011). Regulating cartels in Europe: a study of legal control of corporate delinquency (2nd ed.). Oxford: Oxford University Press.

Harrington, J. E. (2007). How do cartels operate?. Boston: Now.

McPheters, M. (2010). Cartels and Combinations. munchen: Cedar Fort.

Spar, D. L. (1994). The cooperative edge: the internal politics of international cartels. Ithaca:         Cornell University Press.

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