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The South African Wheat Flour Cartel: Overcharges at the Mill

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Abstract

This paper analyses the South African flour cartel, active from 1999 to 2007 and provides an overcharge estimation by using comparator based methods. The empirical analysis is complemented by a descriptive overview of the history and structure of the South African flour industry. The flour cartel fixed the price of flour and allocated customers from 1999 to 2007. We find that the overcharges to independent bakeries range from 7 % to 42 %. We also show that the cartel profits were approximately two times higher during the cartel than the price war year 2002 or the post collusion year 2008.

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Notes

  1. Section 4 (1) (b) of the Competition Act 1998, as amended, prohibits price fixing, market allocation and bid rigging.

  2. Connor and Lande (2006) and Levenstein and Suslow (2006) offer surveys of contributions to the empirical research on inter-industry studies of samples of cartels.

  3. Government regulation of the milk sector began as early as the 1930s through minimum price regulation for certain products. This was achieved through various milk and dairy control boards. The system of control boards was abolished in 1997 when the Marketing Act of 1968 was abolished. In March 2006, the Commission initiated a complaint against milk processors. The Commission alleged that during the period January 2002 to March 2006, milk processors had directly and indirectly fixed procurement prices for raw milk. See Tribunal Consent Order in the matter between the Commission and Lancewood Cheese. Tribunal Case No 103/CR/Dec06.

  4. See Section 7 Committee Evaluating the Deregulation Process: the wheat to bread value chain report, 1999. National Agricultural Marketing Council.

  5. See Vink (2012).

  6. The increasing population of settlers coupled with the discovery of the diamond and gold fields, led to significant growth in wheat production in South Africa. In addition, the development of railways, in conjunction with reduced freight charges, resulted in wheat cultivation being restricted to areas where natural conditions were most suitable, while shortages were imported from overseas.

  7. The costs and risks attached to these efforts were borne by the co-operative producers.

  8. Under Section 19 of Act No 58 of 1935.

  9. During the first 2 years of its existence the Wheat Board had a difficult task as a bumper crop was reaped in 1935/36 and there was a surplus on hand in 1936/37. By utilising its levy revenue on wheat milled in the country and with the aid of Government, the Wheat Board succeeded in preventing a price collapse, although a decline in prices did take place. Wheat growing was the most profitable branch of farming during the depression years.

  10. Co-operatives and other agents were engaged at a commission, to receive, grade and finance the wheat, and store and deliver it to millers on the instruction of the Wheat Board. The apartheid Government used to protectionist policies to support favoured firms. See also Groenewald (1964). In September 1949, the Wheat Control Scheme became the Winter Cereal Scheme with control extended to include barley, oats and rye.

  11. See Vink and Kirsten (2000).

  12. Post liberalisation the grain value chains generally consist of six key levels; (1) the input (e.g. fertilizer) for agricultural production; (2) agricultural producers (farmers); (3) storage and trading of grain; (4) the milling, processing of grain for supply on a wholesale basis; (5) retail of wheat products; and (6) end-consumption.

  13. See Meyer and Kirsten (2005).

  14. Cartels in flour have also been discovered elsewhere around the world. In Europe, the Dutch, Belgian and German competition authorities have all recently prosecuted flour cartels. For example, on 22 December 2010, the Netherlands Competition Authority concluded that 15 flour milling firms agreed to share the market in order to limit competition and even went as far as to buy out and shut down rivals who would not join the cartel.

  15. The price of wheat on different markets is adjusted to take account of the differences in transport costs, exchange rates, etc., in order to make comparisons possible. Such an adjusted price is called a reference price; it is calculated with respect to a reference point. In the case of grains in South Africa the commonly used reference point is Randfontein. In order to adjust prices to this reference price, the international commodity price (‘free on board’ or FOB Gulf price) has to be adjusted to take account of all the costs incurred in bringing the wheat to Durban. This price, called the CIF price, is adjusted to local currency using the current exchange rate. Once this is done, all local Rand based costs (off-loading, losses, interest, local transport costs) can be added resulting in a final landed (local) price per tonne at the point of consumption, or the reference point.

  16. The Competition Tribunal (“The Tribunal”) highlighted the above dynamics in the matter between CTH and Senwes, noting that “while trading (derivative) market may be national, in the sense that traders are located nationally and compete for supplying processors nationally, geography cannot thereafter be dispensed with.” It further also recognized that in the market for the physical supply of grain there is a competitive advantage to having the best location for storage. Simply put, while millers can procure nationally through SAFEX trading, the regional dynamics will ultimately be reflected in the transactions. See the Competition Tribunal’s decision in Case Number 110/CR/Dec06.

  17. For recent extensive surveys of the evidence of collusive activity, see Levenstein and Suslow (2006).

  18. See Commission press release, 13December 2012 Competition Commission settles milling case with Foodcorp. Available at http://www.compcom.co.za/assets/Uploads/AttachedFiles/MyDocuments/Commission-settles-milling-case-with-Foodcorp-.pdf

  19. See Competition Commission and Pioneer (Consent Order), Case number: 15/CR/Mar10. Available at: http://www.comptrib.co.za/assets/Uploads/1015CRMar10-Pioneer.pdf

  20. Section 1 (1) (xiii) of the Competition Act defines a horizontal relationship as one that exists between competitors.

  21. American Natural Soda Ash Corporation v Competition Commission 2005 6 SA 158 (SCA).

  22. On 14 March 2007, the Commission initiated a complaint against Tiger Brands, Pioneer Foods, Foodcorp and Godrich Milling in respect of alleged collusive activities in the wheat milling industry.

  23. The Tribunal imposed a fine of R98 million on Tiger Brands for its role in the bread cartel. This represented about 5.7 % of its turnover from baking for the financial year 2006. See Commission press statement, 12 November 2007, Tiger Brands admits to participation in bread and milling cartels and settles with Competition Commission. Available at: http://www.compcom.co.za/2007-media-releases/

  24. The Tribunal imposed a fine of R45 million on Foodcorp. This represents 6.7 % of its turnover for baking operations for the financial year 2006. See Commission press release, 5 January 2009, Competition Commission settles with Foodcorp. Available at: http://www.compcom.co.za/assets/Uploads/AttachedFiles/MyDocuments/5-Jan-09-CC-Settles-with-Foodcorp.pdf

  25. The Tribunal ruled that Pioneer Foods had engaged in fixing the price of bread products in the Western Cape province and nationally and imposed a fine of R196 million. See Competition Commission v Pioneer Foods (Pty) Ltd (15/CR/Feb07, 50/CR/May08), Available at http://www.saflii.org/za/cases/ZACT/2010/9.html

  26. See also Bonakele and Mncube (2012) for details on the design and objectives of the Pioneer Foods settlement agreement. The remedies that were concluded with Pioneer Foods constitute a major measure of “success” in the enforcement of competition law in developing countries. They included, among others, an administrative fine, part of which by agreement was set aside for the creation of an Agro-processing Competitiveness Fund aimed at lowering the barriers to entry, as well as a commitment to reduce prices on the sale of flour and bread over an agreed period designed to stimulate rivalry while at the same time enabling smaller non-vertically integrated participants to compete in bread.

  27. The Tribunal imposed a fine of about R89 million which amounted to 10 % of the affected turnover of its 2010 milling division. See Commission press release, 13December 2012 Competition Commission settles milling case with Foodcorp. Available at http://www.compcom.co.za/assets/Uploads/AttachedFiles/MyDocuments/Commission-settles-milling-case-with-Foodcorp-.pdf

  28. See Verboven and van Dijk (2009). There is also a huge empirical literature on the pass-on (also called pass-through), especially in macro and international trade.

  29. Mncube (2013) provides direct evidence of predation through below-cost pricing in the cartelized South African bread industry by comparing prices to average variable costs.

  30. In principle, three different points of reference that can be used for the comparison over time; (1) An unaffected pre-cartel period (comparison ‘before and during’ the cartel. A complication to this assessment in the flour industry in South Africa is that the industry has always been cartelized, establishing the before period is difficult. Recall that the industry was regulated from 1937 to 1996); (2) An unaffected post-cartel period (comparison ‘during and after’ the cartel. A comparison of the prices in the same market during and after the cartel; and (3) Both an unaffected pre- and post-cartel periods (comparison ‘before, during and after’ the cartel).

  31. Some of the advantages of using a reduced form model for estimating dames include, (1) the fact that data requirements are limited to time series of the respected cartelized product; (2) the economic concept behind the approach is simple and straightforward; (3) the estimation of the over-charge itself is relatively easy to implement; and (4) it is not necessary to make any assumptions on industry conduct absent the cartel.

  32. Variables related to market demand appear in the model because the reduced form model tries to explain the equilibrium price.

  33. Another shortcoming of the reduced form model, is the fact that the omission of relevant variables can bias the results. Omitted variables that are correlated with the independent variables would create a bias in the regression coefficients. Furthermore, the results might not be robust to the choice of functional form.

  34. All SAFEX prices are Randfontein-based, this means that if a producer can deliver or a miller can accept delivery at Randfontein, they will receive or pay the SAFEX price for the delivery month contract (the spot price). The delivery usually takes place at points across the various producing regions, all spot prices are SAFEX adjusted prices. For example if the transport costs between Randfontein and the silo where a producer chooses to deliver is R100/tonne, the delivery price for the producer will be equal to the Randfontein price (the delivery month contract price) minus the R100/ton transport cost. The buyer will now collect the maize from the relevant silo at the SAFEX price minus the R80/ton. These transport cost differentials are calculated every year and are available from SAFEX.

  35. See for example, Meyer and von Cramon-Taubadel (2004), Frey and Manera (2007) and Cutts and Kirsten (2006).

  36. While private antitrust class actions have historically been weak in South Africa, the South African Constitutional Court recently ruled in favour of the companies looking to initiate a class action against various bread producers. Note that the firms involved in the bread cartel are the same firms involved in the flour cartel. The Constitutional Court judgment overturned two previous rulings by the Western Cape High Court as well as the Supreme Court of Appeal that denied the distributors the ability to bring a class suit against Pioneer Foods, Tiger Brands and Premier Foods who were found guilty by the Competition Tribunal for price-fixing. This gives the bread distributors another chance to sue the cartelists. The Constitutional Court referred the case to the Western Cape High Court to hear the argument again. See Children’s Resource Centre Trust v Pioneer Food (50/2012) [2012] ZASCA 182 (29 November 2012) and Mukaddam v Pioneer Food(49/12) [2012] ZASCA 183 (29 November 2012). See also https://www.competitionpolicyinternational.com/south-africa-court-overturns-class-action-denial-for-bread-distributors/

  37. This approach assumes that the selected benchmark prices would have been constant during the period of the cartel which implicitly assumes that the key determinants of pricing conduct would have remained entirely unchanged during the period of the cartel as compared to the selected benchmark period. This is a strong assumption and may be difficult to justify where the cartel spans a significant time period during which demand and supply conditions are likely to have changed.

  38. In the logarithmic specification, the approximated price overcharge follows from: \( \log \frac{P_{cartel}}{P_{non\ cartel}}={\beta}_3 \), \( \frac{P_{cartel}}{P_{non\ cartel}}= \exp \left({\beta}_3\right) \) and therefore \( \frac{P_{cartel-}{P}_{non\ cartel}}{P_{non\ cartel}}= \exp \left({\beta}_3\right)-1 \).

  39. This is especially true if the firms have asymmetric cost structures.

  40. Suppose we want to compare the effect of wheat costs on the flour price between the cartel period (D i ) and the non-cartel period (F i ). Equation 2 can be specified as follows: p it  = θ 0 + θ 1 X it  + θ 2 C it F i  + θ 3 C it D i  + ε it , where X it is a vector of other explanatory variables and θ 1 is the corresponding vector of coefficients. D i  + F i  = 1. Eliminating F i through substituting, gives the base specification of the model: p it  = θ 0 + θ 1 X it  + θ 2 C it M i  + (θ 3 − θ 2)C it D i  + ε it . The two models are mathematically equivalent but there are differences in interpreting the results. By dropping out F i which now serves as the base, the coefficient of C it D i it represents the differential effect of the wheat costs during the cartel period over the non collusion period. Thus, the interpretation of results is less straightforward for the base approach.

  41. While for Gauteng province, the estimated overcharge for white bread flour and cake flour is at about 24 % and 33 % respectively.

  42. See Andreu et al. (2011).

  43. Figure 8 uses average EBITDA (earnings before interest, taxes, depreciation, and amortization) margins, more precisely accounting profits. Accounting profits, however, do not correspond to economic profit and consequently maybe misleading in the evaluation of the firms’ ability to raise price above marginal cost. An accounting profit is defined as the difference between a firm’s revenues and its operating expenses (or explicit costs). In contrast, an economic profit is defined as the difference between a firm’s revenues, operating expenses, and the opportunity cost of the inputs used to make the firm’s sales. Economic profits account for real costs, not historical or bookkeeping costs, and the cost of using a unit of a resource is the maximum amount that a unit could earn elsewhere. Only economic profits are possibly relevant and reliable for evaluating market power. Notwithstanding the above, even economic profits are generally not a reliable proxy for market power. For example, factors unrelated to market power can influence a firm’s profit margins, such as a firm’s management, cost structure and exogenous factors beyond the firm’s control. See Bork and Sidak (2013).

  44. While in the first episode the cartel held regular meetings, in the second episode the cartel held regular telephone contacts perhaps because of probability of detection concerns.

  45. The reliability and precision of the analysis depends on whether the analysis has been tackled rigorously.

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  1. Competition Commission South Africa, Private Bag X23, Lynnwood Ridge, 0040, South Africa

    Liberty Mncube

  2. University of Johannesburg, Johannesburg, Gauteng, South Africa

    Liberty Mncube

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Correspondence to Liberty Mncube.

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The views expressed in this article are strictly mine and should not be taken as reflecting the views of the Competition Commission South Africa. I would like to thank Prof James Fairburn for his support.

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Mncube, L. The South African Wheat Flour Cartel: Overcharges at the Mill. J Ind Compet Trade 14, 487–509 (2014). https://doi.org/10.1007/s10842-013-0172-y

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