Price-Fixing

Price-fixing is a secret and illegal agreement between competitors to raise, lower, maintain, or stabilize prices or price levels. In essence, it’s a conspiracy against the customer. Instead of competing fairly in the open market to win your business, companies collude behind closed doors to set prices, effectively rigging the game. This practice eliminates competition, leading to higher prices for consumers and artificially inflated profits for the companies involved. This isn't just a friendly chat about pricing trends over coffee; it's a deliberate act of market manipulation that violates antitrust laws in most developed economies, including the United States and the European Union. For a value investor, price-fixing is one of the brightest red flags imaginable, as it creates a house of cards built on illegal activity rather than genuine, sustainable value.

At its core, price-fixing is about replacing the natural forces of supply and demand with a coordinated, artificial price structure. This can happen in several ways, some more blatant than others.

• Horizontal Price-Fixing: This is the most common and clear-cut form. It involves agreements between direct competitors operating at the same level of the production or distribution chain. Think of two rival airlines agreeing to set a minimum price for flights between London and New York.
• Vertical Price-Fixing: This occurs between companies at different levels of the supply chain, such as a manufacturer and a retailer. For example, a high-end handbag brand might dictate the minimum price at which department stores can sell its products. The legality here can be more complex, sometimes overlapping with concepts like Manufacturer's Suggested Retail Price (MSRP), but explicit agreements to fix resale prices are generally illegal.

The conspiracy itself can take many forms, from formal written contracts (rare and foolish) to informal “wink-and-a-nod” understandings. Common tactics include:

• Agreeing to set a minimum price for a product.
• Eliminating or standardizing discounts.
• Adhering to a common pricing formula.
• Agreeing not to “poach” each other's customers with lower prices.

These cartels often go to great lengths to conceal their activities, knowing they are breaking the law.

For an investor, a company engaged in price-fixing is a ticking time bomb. The seemingly robust profits and stable profit margins are an illusion that will shatter the moment the scheme is exposed.

A core tenet of value investing is to find companies with a durable competitive advantage, often called a “moat.” Price-fixing is the opposite of a real moat; it's a temporary, illegal barrier that is destined to fail.

1. Artificial Profits: The extra earnings generated through price-fixing are not the result of innovation, efficiency, or a superior product. They are stolen from the customer. Once the authorities step in, these profits disappear, and the company's stock price will likely plummet to reflect its true, much weaker, competitive position.
2. Catastrophic Risk: The consequences of getting caught are severe. They include:
   • Massive Fines: Regulators can levy fines worth hundreds of millions, or even billions, of dollars, wiping out years of illicit profits.
   • Civil Lawsuits: Customers who were overcharged can sue for damages, leading to further financial drains.
   • Criminal Charges: Executives can, and do, go to prison.
   • Reputational Ruin: The damage to a company's brand can be irreversible, destroying customer trust and shareholder value.
3. Toxic Corporate Culture: A willingness to engage in criminal activity points to a fundamental breakdown in corporate governance and ethics. If management is comfortable with price-fixing, what other skeletons are hiding in the closet? Prudent investors flee from such leadership.

One of the most infamous price-fixing cases involved Archer-Daniels-Midland (ADM) and other global producers of Lysine, an animal feed additive. In the early 1990s, these companies secretly met to fix the global price and allocate market share. The scheme was uncovered by an FBI informant inside ADM, Mark Whitacre (whose story was later turned into the movie “The Informant!”). The fallout was immense. ADM paid a $100 million criminal fine (a record at the time), and several of its top executives were sentenced to prison. The company's stock suffered as the market realized its stellar performance in the Lysine division was a sham. This case serves as a perfect lesson: the “stable” and “predictable” earnings that might have looked attractive to an unsuspecting investor were actually the product of a massive criminal conspiracy, not a sound business.