3 Types of Businesses Ruled By Cartels

Source: Thinkstock

Source: Thinkstock

Blame it on oil.

Recent developments in the petroleum industry have renewed interest in cartels and monopoly industries. A cartel is an association whose members typically control commodity prices in a market by controlling supply and demand. Cartel members span the value chain of that industry. Thus, they are manufacturers and distributors as well. A monopoly industry is not much different. In such an industry, a single player or set of stakeholders control the manufacture and supply chain dynamics (and, consequently, the prices) of the product.

Typically, cartels should be anathema in capitalist societies that espouse free trade. This is because they concentrate the market’s power in the hands of select players. What’s more: The economic effect of cartels is detrimental to product prices and innovation.

In reality, however, history is rife with examples of major players in an industry colluding to set prices or affect industry growth. This is because economic competition, although ideal in theory, can negatively affect market growth for individual players. For example, competition has the effect of driving down prices and reducing margins. Ultimately, it can be the death knell for producers who are unable to cope with low margins and high volumes. In some industries, such as diamonds, cartels are a result of individual players colluding to protect their economic interests and slow down the pace at which an industry moves toward commoditization.

Here are three industries which are run by cartels and monopolies:

Photo by Alexander Klein/AFP/Getty Images

Photo by Alexander Klein/AFP/Getty Images

1. The oil industry

The oil industry has always been amenable to cartels and monopolies. Before there was OPEC, there was Standard Oil. Started by well-known industrialist John D. Rockefeller, the company dominated oil markets and fueled America’s growth at the turn of last century. Its operations spanned the oil industry’s entire value chain, from production to refining to distribution. Standard Oil was eventually disbanded for monopolistic practices in 1911. But, the company’s spin-offs, such as Chevron and Amoco (which was acquired by BP), continue to dominate the petroleum industry.

The Organization of Oil Producing Exporters or OPEC is a much more recent phenomenon. It was formed in 1960 but came into prominence in 1973, when it embargoed exports to the United States, whose oil reserves were fast running out, for the latter’s support to Israel. The 12-member organization manipulates oil prices by controlling supply of the resource. Because it owns the largest oil reserves within OPEC, Saudi Arabia is the swing producer within the group. Effectively, the kingdom determines the cartel’s production quotas, which other producers abide by.

Of course, as recent developments have shown, OPEC’s power is on the wane. The emergence of Canadian and US Shale and Russian natural gas is providing competition to the organization’s hegemony. Still, it might be some time before OPEC loses control of the oil market.

Source: Thinkstock

Source: Thinkstock

2. The diamond industry

Up until the 1950s, a majority of diamonds were used for industrial applications. However, a sustained advertising campaign by Madison Avenue and high profile endorsements in popular culture (such as this one by Marilyn Monroe) made diamonds the de facto standard for engagement rings and expensive gifts.

The popular narrative about diamonds is that they are expensive and rare. In reality, however, diamond scarcity was artificially created by De Beers, the most influential cartel in the history of this industry. At its peak, the company controlled more than 90% of the world’s supply of diamonds.

De Beers was founded by British businessman Cecil Rhodes in the 1870s. He astutely realized that he could control prices in the diamond industry, which was just evolving then, by buying new mines. So, he bought up competition. By 1888, Rhodes owned the entire supply of diamond in the world. He even managed to convince the Oppenheimers, who owned a mine whose output equaled the combined output of Rhodes’ mines, to join him in 1902. From then onwards, De Beers (so named after one of the mines bought by Cecil Rhodes) dominated the industry. Through a mix of coercion, persuasion, and outright threats, the company acquired and controlled the industry’s complex supply chain.

The Central Selling Organization is key to their strategy. It is responsible for collecting and sorting diamonds from all De Beers’ mines and presenting them to 250 “sightholders.” The sightholders do not have a say in the type, price, and quality of diamonds they are offered. In addition, the sightholders have to submit to regular audits by De Beers to ensure that their retail practices do not diverge with the company’s policy. In effect, the CSO is an instrument to reward and punish sightholders. For example, Israeli merchants, who hoarded diamonds to drive up prices in the 1970s, were allocated 20% less diamonds on their next outing and, subsequently, banned from future sights unless they fell in line. Similarly, De Beers flooded the market with cheap diamonds to compete with Zaire after the country’s mines broke away from the De Beers alliance.

The emergence of new mines coupled with bad public relations and hard bargains by governments has taken its toll on the company’s market share. Now, it produces only 35% of the world’s diamonds by volume. In 2011, the Oppenheimer family, which had owned De Beers for almost a century, divested itself of ownership by selling the remaining 40% of its stake to Anglo-American mines.

Source: iStock

Source: iStock

3. The olive oil industry

The olive oil industry was one of the earliest examples of monopoly. Thales, one of the seven wise men of Greece in ancient times, used his skills in astronomy for business gains. He accurately predicted good harvest seasons and, subsequently, rented presses — which were used to squeeze oil out of the olives — during those seasons. As a result, all producers and distributors were forced to use his services for business.

Strictly speaking, the olive industry is not a cartel. However, three Mediterranean countries — Spain, Italy, and Greece — account for more than 75% of the world’s supply of this oil. Spain leads the pack by accounting for approximately 50% of the total production of world’s olive oil. Italy and Greece are a distant second and third with a share of 15% and 13% respectively. Olive oil prices and supply are determined by harvests in Spain. For example, the country’s poor harvest last year resulted in an increase in futures prices for olive oil.

But, economic and social factors have already produced rumblings of change within the industry.

Overall, global olive oil production declined due to competition from vegetable oils (which have a higher smoke point). Countries, which earlier imported olive oil (such as the United States and China), have begun producing it. For example, Italian varieties of olive oil are now produced and available in Chile. However, new producers’ share of the world olive oil production is currently insignificant (less than 2%). And European producers have already embarked on an acquisition spree to ramp up production and neutralize competition. But, they could still face stiff competition in the future.

Social unrest and economic recession have also negatively affected the industry. Establishment of small- to medium-density groves with a high degree of mechanization and automation has displaced labor-intensive small farms. In turn, the displaced producers, who have lost their livelihood, have joined the burgeoning ranks of the unemployed in Spain and Greece.The economic recession has further contributed to the industry’s problems.

Then there is the question of EU subsidies. Although they were first introduced to encourage olive farms, the subsidies could result in ecological disaster. In response, the governments of olive oil producing countries, such as Spain, are also considering removing subsidies for the oil. This could further decrease the competitiveness of these economies in producing oil. Overseas production is fast catching up already: California produces some of the most well-regarded varieties of olive oil in the world.

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