Tacit Collusion Definition
Tacit collusion happens when firms join up in deciding the price of a commodity, such that the firms do not explicitly exchange information. Tacit means unspoken or implied, without being formally stated. Thus, as the name suggests, the competing firms collude with each other, without directly expressing an official collusion.
In this collusion, typically, there is a leader or dominant firm and there are follower firms. The leader or dominant firm sets the price while the followers firms adopt the prices. For instance, the leader might publicly announce its pricing policy and the colluding firms may follow by adopting the policy.
Mostly, such collusions are not explicit because of antitrust laws by the government that prevent such collusions in order to prevent market disruptions and prevent the supplier from overcharging the consumer.
Such ‘coordinated efforts’ lead to an oligopolistic market, where firms are able to earn higher than normal profits if they are able to maintain the collusion. Firms would only decide to come in a collusion, if long terms benefits are higher than short term benefits of breaking away from the collusion and charging a price that is lower than that decided by the collusion, in order to gain a higher market share.
Conditions that Enable a Tacit Collusion
- Homogenous Product: It is easier for firms to collude if the product is homogenous in nature, that is, nearly the same, and satisfying the consumers in a similar way. This is helpful as it makes it easier for firms to decide a common price
- Higher Barriers to Entry and Fewer Firms: If the barriers to entry are high, fewer firms would be able to enter the market. Entry barriers might be high due to many reasons like legal barriers (patent), high start-up costs, access to resources etc. This would make it easier for the firms to collude with each other, decide on the price and trust each other to maintain the collusive price.
- Repeated Interactions: A tacit collusion would be more successful if the firms are able to interact with each other more often, in order to implicitly agree on the price and work on penalty that would be imposed on the firm that deviates from such an arrangement.
- Penalty for Deviation: This implies the collusion’s reaction towards the firm that defaults and breaks away from the collusion. The break-away firm would do so (charge a lower price) if it feels that staying in the collusion is not beneficial for it in the long run. For a tacit collusion to continue, the penalty for the break- away firm must be sufficiently higher than the short-term benefits gained by it and should imply a substantial loss of profit for the break-away firm as compared to had they continued being a part of the collusion. Many a times, the remaining collusion, as a penalty, might lower the price to such an extent that the break-away firm is not able to match it and gets driven away or is left with a much lower market share than it had before.
Conditions that Threaten a Tacit Collusion
- Long terms benefits versus short term gains: If the firm views that short-term gains, factoring in the penalty of breaking-out, are more important for it, than the benefits from having stayed as a part of the collusion, then it could decide to break away.
- Market Share: If the market shares are highly skewed in favor of one or two firms, it might be more beneficial for the firms with smaller share to break away
- Super normal profits: Higher than normal profits in an industry, is a factor significant enough to attract new entrants. As each new firm comes in, including them into the collusion and strategizing on the price becomes difficult. It also reduces their share from the profit pie. As a result, the existing collusion might think more beneficial to break away.
- Innovations: Innovations make it harder for collusions to continue as the innovator might now have significantly lower costs or a differentiated product that enables it to have a competitive advantage over its rivals and thus charge a price different than the collusive price.
- Market fluctuations: Tacit collusions are difficult to sustain in a market that is declining and over-all profits are on a downward trend. As future profits seem lesser than the current profits, firms will be tempted to break away from the collusion.
- Ivaldi, M., Jullien, B. Rey, P., Seabright, P. Tirole, J. The Economics of Tacit Collusion. 2003. IDEI, Toulouse