Cartels

A cartel is a group of independent companies that collude to rig a market for their own benefit. Instead of competing with each other, they secretly agree to act together as if they were a single, dominant entity—a Monopoly. The goal is simple and sinister: to eliminate competition, control supply, and artificially inflate prices, all at the expense of the customer. Think of it like a secret club where the members, who should be rivals, agree not to fight. Imagine all the major airlines secretly deciding that no one will sell a transatlantic ticket for less than $1,500. With competition off the table, travelers are forced to pay the inflated price, and the airlines share the spoils. This practice is illegal in most countries because it chokes the free market, stifles innovation, and harms consumers. For an investor, a company participating in a cartel is not a shrewd business; it's a ticking time bomb of legal and financial risk.

Cartels use several classic tactics to control a market. While these strategies can temporarily boost profits, they are built on a fragile and illegal foundation.

This is the most common and blatant form of collusion. Members agree to set a minimum price for their products or services. They might coordinate on the exact price, a formula for calculating prices, or a standard level of discounts. This ensures that no member can undercut the others to gain Market Share, effectively killing price competition.

Another powerful tool is limiting supply. By collectively agreeing to restrict production, the cartel creates artificial scarcity. As basic economics dictates, when supply goes down and demand stays the same, prices go up. The most famous example of this is OPEC (Organization of the Petroleum Exporting Countries), an intergovernmental organization that coordinates petroleum policies and production levels among its member nations to influence global oil prices.

Cartel members may also divide the market among themselves to avoid stepping on each other's toes. This can be done by:

• Geography: Company A gets the East Coast, Company B gets the West Coast.
• Customer Type: Company X only sells to large corporations, while Company Y only sells to small businesses.

By carving up the market, each member enjoys a mini-monopoly in their designated segment, free from the threat of competition from other cartel members.

For a value investor, the allure of high, stable profits generated by a company in a cartel is a dangerous illusion. These profits are not sustainable, ethical, or indicative of a healthy business.

• Artificial Profits: A company's success should stem from a durable Competitive Moat—like a strong brand, superior technology, or a low-cost structure. Cartel profits, however, are built on illegal price manipulation, not genuine business excellence. This “moat” can be dynamited overnight by a single whistleblower or government investigation.
• Massive Legal and Reputational Risk: Cartels are illegal under Antitrust Laws in the United States, Europe, and many other jurisdictions. Companies caught colluding face crippling fines that can wipe out years of illicit profits. Executives can face prison time, and the reputational damage can permanently tarnish a brand, leading to lost customers and shareholder value.
• Inherent Instability: A cartel is a pact among rivals, and trust is always in short supply. There is a powerful incentive for any member to cheat by secretly offering a small discount or producing more than its quota to steal business from the others. For this reason, many cartels eventually collapse under the weight of their own greed and suspicion.

While cartels operate in secret, an astute investor can sometimes spot the warning signs in an industry:

• An Oligopoly (an industry dominated by a few large firms) where prices across all competitors move up in perfect unison, even when input costs aren't rising.
• Unusually high and stable Profit Margins across an entire industry that defy normal economic cycles.
• Companies that seem to deliberately avoid competing in each other's core markets or for certain customers.
• Evasive or overly simplistic explanations from management when asked about their pricing strategies relative to competitors.

A true value investor seeks companies that create sustainable, long-term value through innovation, efficiency, and a superior customer offering. Cartels do the exact opposite. They destroy value for society and create a business model based on illegality and immense risk. While the short-term financial statements might look impressive, a business propped up by collusion is a house of cards waiting to collapse. Steer clear.