Concrete Collusion
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Strategy Economics Oct 1, 2011

Con­crete Collusion

Eco­nom­ic data reveals lit­tle com­pe­ti­tion in Brazil’s cement industry

Based on the research of

Alberto Salvo

In Feb­ru­ary 2007, Brazil’s antitrust divi­sion announced dra­mat­ic raids on eight major cement man­u­fac­tur­ers for alleged col­lu­sion in set­ting prices, carv­ing up mar­kets, and push­ing out com­peti­tors. Alber­to Sal­vo, an assis­tant pro­fes­sor of man­age­ment and strat­e­gy at the Kel­logg School of Man­age­ment, does not mince words on the sub­ject. The alle­ga­tions that cement pro­duc­ers had been divid­ing region­al mar­kets did not sur­prise me one bit,” he says.

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The rea­son behind that cer­tain­ty is that by 2007, Brazil­ian-born Sal­vo already had been study­ing that country’s cement indus­try for six years, and his analy­sis of the data, he says, indi­cat­ed loud and clear what the antitrust author­i­ties were just dis­cov­er­ing: there was some­thing rot­ten in the state of Alagoas — and the state of Sergipe — and the states of São Paulo and Minas Gerais — in fact, in all 27 of Brazil’s polit­i­cal divisions.

Recent evi­dence indi­cates that car­tels are an impor­tant phe­nom­e­non in the con­tem­po­rary glob­al econ­o­my,” Sal­vo, an assis­tant pro­fes­sor of man­age­ment and strat­e­gy, wrote in 2010 in the Cana­di­an Jour­nal of Eco­nom­ics. His work on Brazil’s tacit/​explicit cement car­tel has earned him the Cana­di­an Jour­nal of Eco­nom­ics 2010 Robert Mundell Prize, pre­sent­ed to the young econ­o­mist whose arti­cle is adjudged best for the year of its publication.

A Weighty Indus­try

Cer­tain­ly Salvo’s arti­cle top­ic, cement, hard­ly seems sexy at first glance. But what makes it so is its urgent impor­tance to a devel­op­ing econ­o­my like Brazil’s, where cement indus­try sales jumped from 45 mil­lion tons in 2007 to 59 mil­lion tons in 2010. Anoth­er fac­tor is the upcom­ing surge in cement demand, in part because Brazil will host both the 2014 World Cup and the 2016 Olympics, with their accom­pa­ny­ing needs for new infra­struc­ture. A third con­sid­er­a­tion: Brazil, accord­ing to the U.S. Geo­log­i­cal Sur­vey, is the world’s fifth fastest-grow­ing cement mar­ket in the world, behind Chi­na, India, the Unit­ed States, and Turkey.

Cement is high-pro­file and com­pelling in Brazil. Yet when Sal­vo ini­tial­ly exam­ined the industry’s spa­tial sup­ply arrange­ment, mean­ing its geo­graph­ic seg­men­ta­tion of mar­kets, he found a bit of a puz­zle,” he says, both in seg­men­ta­tion and in the expect­ed flow of cement trad­ed between and among Brazil’s 27 states. The expect­ed, recur­ring pat­terns — what econ­o­mists call grav­i­ty”— were not at all what was expect­ed at pre­vail­ing prices, Sal­vo explains.

Nor­mal­ly, ele­ments that affect trade flows include dis­tance, bor­der effects,” and home bias. The dis­tance effect is obvi­ous: the far­ther removed the sell­er is from the buy­er, the low­er the lev­el of trans­ac­tions, or trade flows”; the pres­ence or absence of water­ways also plays a big role. What we’re find­ing in the mod­ern econ­o­my,” Sal­vo says, is that the effect of dis­tance remains very large, even in dig­i­tal goods trad­ed over the Inter­net — infor­ma­tion and cul­tur­al prox­im­i­ty.” Even for prod­ucts with­out a phys­i­cal com­po­nent, he says, Dis­tance has a big, big effect.”

Inter­na­tion­al bor­ders are the sec­ond issue. If bor­ders sep­a­rate the buy­er and sell­er, that too may reduce trade flows, as may the pres­ence of bor­der offi­cials with their hands out, demand­ing bribes to ensure the move­ment of goods to their intend­ed des­ti­na­tion. Final­ly, home bias” affects trade flows, as in the case of, say, a pref­er­ence for the yogurt made only by local farm­ers or the abil­i­ty of pro­duc­ers to under­stand and respond to local tastes.

Brazil­ian cement was dif­fer­ent, Sal­vo found. Some of these trade flow obsta­cles were not oper­at­ing there. What he found instead were sce­nar­ios like the one in two small and adja­cent north­east states, Alagoas and Sergipe, each of which host­ed one cement plant, owned by a dif­fer­ent cement pro­duc­er. Bren­nand Cimen­tos in Alagoas held an 83 per­cent mar­ket share of its home state and did not even sell in neigh­bor­ing Sergipe but did sell in oth­er states. That seemed strange: Giv­en cement prices and costs, both man­u­fac­tur­ing and trans­port costs, it would actu­al­ly be quite prof­itable in the short run to sell to Sergipe,” Sal­vo says he real­ized. What’s stop­ping it from cross­ing that state bor­der?” he won­dered. The sole pro­duc­er in Sergipe, Votoran­tim Cimen­tos, mean­while, had an 89 per­cent share in its home state but only 7 per­cent in neigh­bor­ing Alagoas.

This pat­tern of trade is very odd,” Sal­vo knew, after ana­lyz­ing data he whee­dled out of the cement indus­try asso­ci­a­tion over time. There are moments in time when Brennand’s Alagoas-based plant is actu­al­ly ship­ping to far­ther-away states than Sergipe.” But, If you take prices in Sergipe in a giv­en year — the price of cement is 9.44 reais per 50-kilo bag — and cal­cu­late the cost of sell­ing to the state they don’t sell to, from their plant in Alagoas, the cost of doing busi­ness would be 5.68 reais. So we’re not talk­ing about peanuts: their cost is 5.68 and their price is 9.41, so we’re talk­ing about almost a 4-reais mar­gin, almost 40 percent.”

His con­clu­sion as an econ­o­mist? There’s some­thing that’s stop­ping them from sell­ing to Sergipe.” And that some­thing was nei­ther dis­tance nor a bor­der effect, because Brazil is a fed­er­a­tion of states, much like the Unit­ed States, where trav­el­ing back and forth is seamless.

Fur­ther, the same kind of pat­tern was repeat­ed else­where, Sal­vo found. Brazil’s largest mar­kets are the adja­cent states of São Paulo and Minas Gerais, respec­tive­ly the num­ber one and num­ber two mar­kets in terms of per­cent of nation­al GDP. Between them, the three largest cement pro­duc­ers are Votoran­tim again, the Swiss com­pa­ny Hol­cim, and the French com­pa­ny Lafarge. All three com­pa­nies have plants in both states.

Curi­ous­ly Uncom­pet­i­tive

Yet despite this fer­tile ground for com­pe­ti­tion, Sal­vo found prac­ti­cal­ly none. Votoran­tim had a dis­pro­por­tion­ate share of the mar­ket — 50 per­cent — in São Paulo, and only a small share, 8 per­cent, in Minas. Hol­cim had a large share, 24 per­cent, in Minas Gerais and only 9 per­cent in São Paulo. Lafarge was large in Minas Gerais, with 25 per­cent, and very small, 5 per­cent, in São Paulo. In addi­tion, there were a small num­ber of pro­duc­ers, which increas­es the poten­tial for col­lu­sion. Brazil had 19 cement com­pa­nies when Sal­vo began study­ing them in 1991 and only 12 when he fin­ished in 1999.

What Sal­vo was look­ing at, he knew, was a very con­trolled set­ting: a sim­ple prod­uct, with lit­tle dif­fer­en­ti­a­tion or home bias, and a sin­gle coun­try with the same tax and legal sys­tem, lan­guage, and cur­ren­cy. Fur­ther, unlike oth­er devel­op­ing coun­tries such as India, where in-state trade flows tend to receive more favor­able tax treat­ment, Brazil’s gov­ern­ment has actu­al­ly insti­tut­ed tax laws to encour­age trade between states.

Look­ing at the data, Sal­vo real­ized it could not be explained by high trade costs. You should allow for oth­er things to explain such a pat­tern of ship­ments, for exam­ple the fact that pro­duc­ers are behav­ing strate­gi­cal­ly and agree­ing to stay out of each other’s ter­ri­to­ries,” he says. That’s the idea of the paper: we econ­o­mists have to do a bet­ter job of mod­el­ing what we call oli­gop­o­lis­tic interaction.”

The sto­ry does not end there, with eco­nom­ic con­cepts; indeed at times it has the feel of a crime thriller. On any giv­en day in 2007 there was an antitrust raid on the cement indus­try — at just about every pro­duc­er and trade asso­ci­a­tion in the coun­try,” Sal­vo says. It was the fed­er­al police…they simul­ta­ne­ous­ly raid­ed the offices of all these dif­fer­ent pro­duc­ers. Trust­busters claimed at the time that they had hard evi­dence there was an explic­it car­tel. They claimed to have tes­ti­mo­ny by whistle­blow­ers.” News­pa­per accounts describe a for­mer Votoran­tim employ­ee who alleged that the eight com­pa­ny direc­tors met reg­u­lar­ly to estab­lish prices and agree upon region­al divisions.

By start­ing the inves­ti­ga­tion, we will put the jig­saw puz­zle togeth­er. If we con­clude that a car­tel exist­ed, the harm [to soci­ety] will have been huge.”

One of the high-rank­ing offi­cials among Brazil’s antitrust bod­ies,” Sal­vo con­tin­ues, splashed all over the news­pa­per, We’re going after these guys, and these guys have been run­ning a car­tel; we’ve got the smok­ing gun.’ ” Indeed, Mar­i­ana Tavares de Arau­jo, head of the Sec­re­tari­at for Eco­nom­ic Law (SDE, of the Min­istry of Jus­tice), spoke of direct evi­dence” of a car­tel impact­ing the build­ing and con­struc­tion sec­tor. Tavares described meet­ings among the exec­u­tives at hotels, agree­ments on carv­ing up ter­ri­to­ries. By start­ing the inves­ti­ga­tion, we will put the jig­saw puz­zle togeth­er,” Tavares told the press. If we con­clude that a car­tel exist­ed, the harm [to soci­ety] will have been huge.”

Clear­ly, the cement mak­ers were unhap­py. They faced poten­tial fines of between 1 per­cent and 30 per­cent of their 2005 rev­enues, which would have been a hefty punch. But not much hap­pened. A local judge gave the pro­duc­ers what they want­ed: impound­ment of the seized evi­dence — which the pro­duc­ers claimed was com­mer­cial­ly sen­si­tive” — under court seal, where it has remained ever since. Sal­vo was, and is, dis­ap­point­ed but not sur­prised. It is wide­ly accept­ed that Brazil’s antitrust author­i­ties do not have much bite.

At times he has stepped out of his aca­d­e­m­ic role to get involved. He has pre­sent­ed his work on cement at var­i­ous insti­tu­tions and antitrust author­i­ties in Brazil and tells of the time, in 2005, in Rio’s Fun­dação Getulio Var­gas, when into his sem­i­nar room walked a some­what intim­i­dat­ing crew of three cement exec­u­tives, one of whom he had inter­viewed four years ear­li­er. After the talk, the cement exec­u­tive and oth­er peo­ple with him approached me and asked if I want­ed to go back to the trade association’s Rio-based offices and talk about my work,” Sal­vo says. We reg­u­lar­ly hire con­sul­tants and we pay very, very well,” he says the exec told him.

But Sal­vo had an out”: an imme­di­ate flight to catch back home to Lon­don, where he was liv­ing at the time, which he jok­ing­ly describes as for­tu­nate”. I nev­er con­sult­ed on cement,” he says. Even still, both the indus­try and Brazil’s antitrust author­i­ties at dif­fer­ent times have tried to hire me…it seemed they want­ed to be more seri­ous on their casework.”

The econ­o­mist demurs when asked if he is a whistle­blow­er: The fact is that every­thing I say could be explained by tac­it, non-explic­it col­lu­sion,” he says. I have not had a role exam­in­ing case evi­dence — that’s some­thing I have con­sid­ered doing after these raids, but it quick­ly became appar­ent that every­thing they had seized was going to be con­fi­den­tial, which is a shame.”

Beyond Brazil

What­ev­er the out­come in Brazil, there are lessons to be learned. Cement pro­duc­ers have fig­ured into sim­i­lar car­tel accu­sa­tions else­where: the Unit­ed King­dom, India, and South Africa, among oth­ers; and evi­dence points to car­tels in oth­er indus­tries, espe­cial­ly in the Euro­pean Union, whose inter-coun­try trade has remained sus­pi­cious­ly frag­ment­ed over the years. Sal­vo has con­tem­plat­ed suing to make those seized mate­ri­als pub­lic. Soci­ety has much to gain from learn­ing how car­tels oper­ate in emerg­ing mar­kets such as these, he says. In 2010 I asked a for­mer head of anoth­er antitrust body, CADE, whether they thought there was any chance that all the mate­r­i­al seized three years ear­li­er from the cement trade association’s head­quar­ters and the many firms’ offices — and imme­di­ate­ly impound­ed — would ever come to light,” Sal­vo recalls.

He says CADE’s head replied — off the record — that the author­i­ties were actu­al­ly sign­ing bilat­er­al agree­ments with indi­vid­ual pro­duc­ers. Sal­vo spec­u­lates that those doc­u­ments for­gave the col­lu­sive behav­ior with no admis­sion of guilt in return for a slap-on-the-wrist fine, rather than make the whole seedy mess pub­lic. The offi­cial believed that the infor­ma­tion seized on the inner work­ings of the car­tel would nev­er come to light.

But Sal­vo says he is talk­ing to col­leagues in Brazil, includ­ing econ­o­mists and lawyers, about that nation’s equiv­a­lent of a Free­dom of Infor­ma­tion Act. He refus­es to let the cement industry’s col­lu­sive prac­tices sim­ply fade away.

Relat­ed read­ing on Kel­logg Insight

Con­crete Threats: Infer­ring mar­ket pow­er under the threat of entry

An Unhealthy Mar­ket for Com­pe­ti­tion: Health insur­ance com­pa­nies in the U.S., not con­sumers, con­trol the market

Coun­ter­feit Com­pe­ti­tion: Dri­ving up price and quality

Mem­ber­ship Has Its Pun­ish­ments: Loy­al­ty pro­grams dis­suade firms from pric­ing prod­ucts competitively

Featured Faculty

Alberto Salvo

Member of the Department of Strategy faculty from 2005 to 2013

About the Writer

Joan Oleck is a freelance writer based in Brooklyn, New York.

About the Research

Salvo, Alberto. 2010. “Trade Flows in a Spatial Oligopoly: Gravity Fits Well, but What Does It Explain?” Canadian Journal of Economics. 43(1): 63-96.

Read the original

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