1. Bidding, Bid Rigging, and School Milk Prices
“Ohio v. Trauth”
Bidding, Bid Rigging, and School Milk Prices
Sun Maoning
Xu Xin

2. Outline of Presentation
Introduction
Market Analysis
Collusive Agreements
Behavior Analysis
Conclusion

3. Introduction Schools solicit bids on annual supply contracts for milk.
1993 Ohio (Meyer Diary and Coors Diary) confessed bidding collusion with Trauth. Trauth did not confess.
1994 Ohio accused 13 dairies.

4. Introduction Evidences Incentive to collude Behavior approach
Outcome of bid rigging

5. Market Analysis Outcomes Demand Production process
Competitive among suppliers

6. Market Analysis Demand bid content -Tariff for products
-Extra requirements: cooler, straws, napkins…
-Escalator clauses
-Example of a typical bid

7. Market Analysis Demand elasticity -Insensitive to price charged
-Subsidization
-Price is not statistically significant determinant of demand
Potential suppliers can charge higher price without losing market.

8. Market Analysis Production Process -Raw milk
cost
-Raw milk
-Processing cost: pasteurize, package
-Transportation cost
-Extra cost

9. Market Analysis Competitive among suppliers processors & distributors
Will entrant enter purely for the school milk market?
-cost of building a processing plant
-less than 10% of total revenue
-more exit than entry in Ohio
-No potential entrant

10. Market Analysis Conclusion -Homogeneous product.
-Similar and constant incremental cost.
-Good information about cost of competitors.
-School will accept high price if no other choice.
-Competition is localized due to regulation on raw milk prices and high transportation cost.

11. Collusive Agreements Easy to Reach Compete on price
Small No. of bidders
Similar costs and production processes
Easy to Maintain
Communication
Deviations easily detected
Multimarket contact

12. Collusive Agreements Raise price without stimulating entry:
A scheme of respecting incumbencies.
Assignment of geographic territories to individual firms.

13. Behavior Analysis In competitive market, firms consider :
Whether to bid in a particular district?
How much to bid?

14. Behavior Analysis Methodology: Porter and Zona Regression Analysis:
Create a control group of nondefendant firms
example of data set (table attached)
Market concentration: the Herfindahl index (picture attached)

15. Behavior Analysis Distance In Miles Number Of districts Probability
Of bidding
Proportion
Of all Bids
Of Winning
Proportion of
Winning Bids
(a)
(b)
(c)
(d)
(e)
0-10
2115
19.5%
20.1%
13.6%
22.9%
10-20
3197
14.0
21.7
8.9
22.5
20-30
3840
7.6
14.2
4.9
15.0
30-40
4526
5.5
12.1
3.4
40-50
5637
2.3
6.3
0.9
4.2
50-60
6440
1.9
5.9
1.0
5.0
60-70
5314
1.4
3.7
0.5
2.0
70-80
6732
4.7
0.8
4.4
80-90
5200
2.5
0.6
90-100
4885
1.2
2.8
0.7
26079
6.1
0.3
6.6

16. Behavior Analysis where to bid? Whether to bid?
85% of firms only supply milk to schools located within 75 miles from their plants
Whether to bid?
Given high shipping cost, transparent information leads to small number of bids
45% receive only 1 bid
34% bids
18% bids
Mean bids

17. Behavior Analysis Econometric model for bid submission
1) Firms will only bid if
E (profit) > F+IC
Where
F-fixed cost of preparing the bid
IC-incremental cost of supplying the district

18. Behavior Analysis Econometric model for bid submission
2) Independent variables
-Distance to the school district
-Distributor or processor
-Whether closest supplier
-Whether second closest supplier
-Quantity of order
-Whether extra terms are easy to meet

19. Behavior Analysis Econometric model for bid submission
3) dependent variable
-Bid or not

20. Behavior Analysis
Econometric model for bid submission
4) Regression Result
-Bid only when absolute cost is lower
-Processors are more likely to bid
-Whether closest supplier: insignificant
-Whether second closest supplier: insignificant
-Quantity of order: insignificant
-Whether extra terms are easy to meet: less likely to bid if extra terms
-Likelihood of bidding is a decreasing function of distance

21. Behavior Analysis How much to bid? 1) Objective: maximize profit
E(Profit) =prob (win)*profit+ (1-prob(win))*0

22. Behavior Analysis 2) Model: Bertrand competition
optimal mark-up based on
-cost (transportation cost, escalator clause…)
-characteristic of market (geographical location)
P = MC + t * d2 - e
Where
MC-the marginal production cost,
t-unit transportation cost,
d2-the distance to the second closet supplier,
e-some small positive number

23. Behavior Analysis 3) Regression result
-price increase 1 or 2 cents for distance 100 miles away, then to adjacent districts
-competition is localized
-unlikely bid 100 miles away
-local monopoly power (a limited extent)
control group’s behavior is consistent with competitive market characteristics

24. Behavior Analysis Behavior of Defendants Evidence 1
-Price war unlikely to be observed following periods of unusual turbulent market shares.
-Under conspiracy, such a pattern is possible.

25. Behavior Analysis Behavior of Defendants Evidence 2 -Empirical study
-Two ways of collusion:
1)allocate exclusive territories
2)Bid at inflated level

26. Behavior Analysis Behavior of Defendants Evidence 3 Bid Submission
-all three bid more frequently than control group
-Meyer unusually likely to bid in 100 to 110 miles away
-Trauth bid in 60 to 80 miles away

27. Behavior Analysis Behavior of Defendants Evidence 4
Bid level significantly decreasing function of distance
-Meyer bid at a lower level in 100 to 110 miles away
-Trauth bid at a lower level 60 to 80 miles away

28. Behavior Analysis Behavior of Defendants Evidence 5 Correlation
-complementary bidding & territorial allocation
-knowledge of one cartel member’s behavior helps to predict another
-empirical test of independence or zero correlation indicates
-all correlation are significant at any standard level
-result suggests a complementary bidding scheme

29. Behavior Analysis Behavior of Defendants Summary: Hard to observe!
These three firms are best characterized as collusive in terms of behavior.

30. Behavior Analysis Response of Defendants
-doubt on the credibility of the econometric model
-argue about cohesive group and benchmark

31. Behavior Analysis effect of collusion
-price increase of 6.5% on average

32. Conclusion DOJ - “Corporate Leniency Policy” (1993)
Difficulty in distinguishing between overt conspiracy from tacitly collusive behaviour with economic evidence
Economic evidence typically not regarded as sufficient to establish liability
The detection of collusion is necessarily case specific