THE ASSESSMENT OF JOINT PURCHASING : CAN TOO MUCH “ BUYING POWER ” EVER BE A PROBLEM ?

The creation of “buying power” through joint purchasing agreements is often positive with direct benefits for consumers in the form of lower prices. Even where joint purchasing agreements lead to the creation of a monopsonist (i.e. a single buyer), economic theory suggests that the welfare effects depend to a large degree on the market context, with some economists proposing that the probability of harm in cases involving monopsony power is considerably lower than in cases of a monopoly. 1


INTRODUCTION
The creation of "buying power" through joint purchasing agreements is often positive with direct benefits for consumers in the form of lower prices.Even where joint purchasing agreements lead to the creation of a monopsonist (i.e. a single buyer), economic theory suggests that the welfare effects depend to a large degree on the market context, with some economists proposing that the probability of harm in cases involving monopsony power is considerably lower than in cases of a monopoly.1 Despite this view, section 4(1)(b) of the South African Competition Act (the "Act") classifies the "fixing of a purchase or selling price or any other trading condition" (emphasis added) by competitors as a per se prohibition.This implies that many joint purchasing arrangementswhich often by their nature require a setting of a common purchase pricemay be afforded the same draconian treatment as hard core selling cartels in the Competition Act.That is, competitors who form buying groups that jointly set a purchase price could fall within section 4(1)(b) of the Act and this practice could not be justified by demonstrating an insignificant impact on competition, or by invoking the defences provided for in section 4(1)(b) of the Act.
Whilst there may be some (arguably limited) scope to suggest that certain joint selling arrangements which require the fixing of a common selling price may ultimately be efficiency enhancing and procompetitive, this would appear to hold abundantly more so for joint purchasing agreements.This would seem to be particularly true within a South African context (as discussed later in this paper).Thus, there is a real danger that South African firms, often small to medium sized firms, steer away from efficiency enhancing and pro-competitive joint buying arrangements out of a potential risk of technically falling foul of the per se prohibition contained in section 4(1)(b) of the Act.This paper considers whether this potentially punitive treatment of joint buying arrangements under section 4(1)(b) is warranted and indeed whether the equivalent treatment of joint buying and selling agreements under this section of the Act is appropriate.Our analysis takes the following approach:  Firstly, the potential theories of harm at which section 4(1)(a) would seem to be aimed are considered;  Secondly, the underlying economic theory and intuition behind a monopsony outcome is explored;  Thirdly, the conditions necessary for competitive harm to be inflicted are examined within a South African context;  Finally we conclude on the matter.

THEORIES OF HARM RELATING TO JOINT BUYING TARGETED UNDER SECTION 4
There would seem to be main two potential theories of harm associated with joint buying conduct which section 4 of the Act would seek to address, namely (i) downstream co-ordination amongst the buyers and (ii) abuse of monopsony power by restricting purchases.
2 These are considered below: Downstream coordination: There is the possibility that buying groups are used as an instrument to facilitate collusion at the downstream level.Co-ordination in the purchasing decisions of buyers regarding quantities purchased, for example, could affect the quantity produced at the downstream level.Buying groups could potentially be used as a tool to enforce collusion downstream through the control of upstream input purchases.Alternatively, even if there is no co-ordination on quantities purchased, the standardization of input costs may also facilitate collusion as variation in costs is one of the factors that contribute towards the instability of collusive arrangements.

Abuse of monopsony power by restricting purchases:
Harmful monopsony behaviour refers to a situation where a powerful buyer essentially has the ability to restrict their own purchases of product and therebyby virtue of their powerful market positiondepress the price of the product in question below the competitive level.The harm from this conduct is essentially exploitative in nature and is equivalent (from a welfare perspective) to a monopoly exploiting its market power on selling side.The mechanics behind this behaviour and its welfare implications are discussed in detail in the next section.

Theory of harm under section 4(1)(b)
It is generally accepted that the main concern which motivates a per se prohibition of co-ordinated horizontal behaviour is the exploitative effect of prices being raised above the competitive level in the case of selling-side co-ordination, and prices being depressed below the competitive level in the case of buying-side coordination.
Whist recognizing the potential for buying groups to facilitate tacit collusion downstream it cannot be assumed that buying groups automatically result in downstream collusion.Rather, a careful consideration of the facts of the case is required.For instance, it may be that the downstream market itself is not conducive to collusion, or those participants to the purchasing agreement account for a small combined share of the downstream market where they compete.Furthermore, the sharing of final selling prices and quantities is seen as more problematic as it eliminates uncertainty regarding a competitor"s conduct, whilst knowing the input price of a competitor may be of limited value to a competitor, particularly if the input comprises only a small portion of final costs.Therefore a minimum requirement for joint buying to impose this form of harm would be for the parties concerned to (i) also be competitors downstream and (ii) for the input in question to be significant in the overall build-up of the downstream product (around which the downstream coordination could occur).Therefore given this indirect link to downstream harm which cannot automatically be assumed, it would seem convoluted and incorrect to consider all joint buying as per se prohibited (under section 4(1)(b)) on the basis that it may facilitate downstream collusion under certain conditions.Rather if this were the primary concern with joint buying arrangements it would appear more appropriate for them to be considered under the rule-of-reason approach of section 4(1)(a).Indeed in the EU and US this indirect theory of harm would generally not justify a joint purchasing agreement being considered as per se illegal.
As such the primary mechanism of harm stemming from joint buying activities which section 4(1)(b) would seem to be aimed at curtailing, would appear to be the abuse of monopsony power and the associated depression of prices below the competitive level.The remainder of this paper therefore focuses on this theory of harm and assesses whether it is appropriate, from an economic point of view, to treat the joint purchasing as a per se contravention.The analysis of this theory of harm also provides insight into whether the equivalent treatment of joint purchasing and selling agreements has merit.

THE ECONOMICS OF BUYER POWER
A useful definition of buyer power is "the ability of a buyer to reduce the price profitably below a supplier"s normal selling price, or more generally the ability to obtain terms of trade more favourable than a supplier"s normal terms"

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. Buyer power can arise when there is a single buyer of an input (a monopsonist) or where there are a few large buyers (an oligopsony).It can also arise from joint purchasing agreements which form the basis for buyer groups and which enable smaller firms to act collectively to mimic the outcomes of a monopsonist.If a buyer group is formed for the purpose of gaining market power over the group"s suppliers, the effects of such buyer power can be analysed in more or less the same as in the case of a single buyer 4 .
A distinction is often made in the literature between two types of buyer power: monopsony power and bargaining power 5 .For the purposes of this paper, we define monopsony power as the ability to restrict the market price of an input to below the competitive level by withholding purchases,6 whilst bargaining power refers to the bargaining strength that a buyer has with respect to its suppliers 7 .This section describes the standard economic theory behind the exercise of monopsony power and discusses the welfare implications for sellers, end consumers and total social welfare.The model is also extended to consider the welfare effects of monopsony power where there is imperfect competition upstream.

The basic model of monopsony
The standard theory of monopsony discussed in this section draws from the analysis provided in standard microeconomics texts 8 . Since it is difficult to sustain monopsonies by end users of a commodity, this type of behaviour is generally exhibited in input markets where a firm may have monopsony power in the purchase of inputs that it uses to manufacture and sell final products downstream, which is the model used in this case and is the standard model used in the literature.
The basic model is discussed first, in which the presence of a monopsonist is the only market imperfection.More specifically, the basic model makes the following assumptions: (i) It is assumed that in the upstream market, perfectly competitive firms (the sellers) produce a perfectly homogeneous commodity "x' which is used as the only input in the production process of a firm (the monopsonist) that sells the final product to end consumers downstream; (ii) the buyer is a monopsonist in the upstream market but sells the final product in a perfectly competitive market downstream 9; and (iii) it is assumed that the marginal costs for the input suppliers are rising over the relevant ranges of output.Since the short run supply curve for each competitive seller is exactly the portion of the marginal cost curve lying above the average cost curve If the monopsonist lacked buying power (in other words if it were a competitive buyer), it would equate w(x) (which represents the supply curve of the sellers) with the derived demand and purchase Q C at price P C .By contrast, the monopsonist equates his actual marginal cost or MFC (which lies above w(x)) with the derived demand and purchases Q M at price P M .Thus a pure monopsony effect involves restricting output and lowering the price paid to the upstream supplier as compared to the competitive outcome.This also creates a deadweight loss to society given by the shaded triangle abc.The rationale for this loss is that if output were expanded beyond Q M up to Q C , it would enhance efficiency for society since the price that the buyer would be willing to pay would still exceed the price at which the suppliers would be willing to supply.
The exercise of monopsony power has the following implications on welfare:  Sellersthe monopsonist makes use of its buying power in order to restrict output and thus lowers the price paid for commodity x relative to the competitive outcome 12 .Consequently, the producer"s surplus (in this case the sellers) unambiguously declines by the area P C dcbP M .Out of this, the area P C dbP M represents a wealth transfer from the sellers to the monopsonist buyer 13 .The rest of the area becomes part of the deadweight loss to society.
 Total Welfarethere is an unambiguous decline in total welfare.Monopsonistic behaviour creates a deadweight loss to society (represented by the area acb) which results in an overall inefficiency that would be absent in a competitive outcome.
 Final Consumersthe welfare impact on end consumers in the case where there is competition downstream is the subject of some debate in the literature.According to the OECD, the impact on end consumers is negative even with the presence of perfect competition downstream 14 .This is because even with perfect competition downstream, the monopsonist restricts the purchase of output (owing to its higher marginal cost or MFC).As a result, total output reduces downstream and prices to end consumers increase 15 .If however, the supply by the competitors in the downstream market is perfectly elastic, it has been argued that there is no impact on end consumers 16 since other firms in the market are expected to make up for the shortfall in output resulting in no change in prices or quantity.Noll (2005) however has suggested that even in this situation, the impact on end consumers is negative17 .His argument hinges on a varying productivity of the inputs (in the preceding analysis, inputs have been assumed to be completely homogeneous).According to Noll, if monopsonistic behaviour results in lower purchase of productive inputs and if the corresponding shortfall in output is made up by other downstream firms employing less productive inputs, then more inputs will now be required to produce the final good as compared to a competitive outcome.As a result the real price of the downstream good would increase, making consumers worse off overall.The preceding arguments thus suggest that even though the monopsonist pays lower prices upstream, the price impact on end consumers is either negative or neutral.
The basic model assumes that the monopsonist possesses buying power in the input market and is one of many competitive price takers downstream in the output market.However, harm is exacerbated if the monopsonist is also a monopoly seller of its own product.This is because profit maximization by such a firm would result in a further reduction of the price and quantity in the input market (by affecting the marginal revenue downstream and thus the marginal value from input purchases).This reduction carries through to the output market of the monopsonist and therefore raises prices to the final consumer whilst increasing the margin of the monopsonist.

Bilateral monopoly
The basic model can be extended to consider the case when market power is present on the selling side of the input market.A market structure where a monopolist sells its output to a monopsonist is called a bilateral monopoly 18 . For simplicity, it is assumed that the monopsonist operates as a perfectly competitive firm downstream.As noted in the appendix, the VMP curve is the derived demand curve of the monopsonist.However, this is also the Average Revenue curve of the monopolist since it tells the monopolist the price it can expect to receive for different quantities of input sold.Further, since the monopolist has selling power, it knows that it faces a downward sloping demand curve and that it must reduce the price of the commodity x if it wants to sell more.Therefore, as is standard in the case of a monopoly, the marginal revenue curve for the seller will lie below its average revenue curve and the monopolist would like to sell that quantity where its marginal revenue equals marginal cost.
The analysis follows Griffiths and Wall (2000, p.403-404).As noted in the text, the relevant demand curve of the monopsonist considered is the MRP curve since the downstream market is assumed to have seller power.This extension considers the downstream market to be competitive so the relevant curve is the VMP curve instead.See Griffiths and Wall (2000, p. 404) However, the presence of the monopsonist on the other side of the input market implies that this is not necessarily the case.The exact outcome is ambiguous and depends on the relative bargaining strengths of the two parties.It is only possible to determine the boundaries within which the solution must lie 19 .
As shown in the figure above, the competitive outcome results at price P C and quantity Q C .This is where the marginal cost of production equals the demand for the input.If the monopsonist possesses all the bargaining power, it effectively makes the monopsonist act as a competitive supplier.As a result, the w(x) curve becomes the supply curve and the basic monopsony outcome results at price P M and quantity Q M .If, however, the monopolist has all the bargaining power, it equates its marginal cost with its marginal revenue and the outcome is price P A and quantity Q A .Thus depending on the relative bargaining strengths, the actual price of the input could be either above or below the competitive level.
The welfare effects in a bilateral monopoly situation are the following 20 :  Total welfaresince the exact outcome in the case of a bilateral monopoly is uncertain, so is the welfare impact.It is possible that the exercise of monopsony power in such a situation could have a beneficial impact on total welfare 21 .As an example, consider the situation where the buyer in the upstream market could exert no monopsony power.In this case, the seller would possess monopoly power.It would decide to sell the quantity of input where its marginal revenue equalled marginal cost and would sell quantity Q A and price P A .In this situation, there would be a deadweight loss to society given by the area abc.If however, the buyer were able to start exerting monopsony power, it would do no worse than the monopoly outcome (since it could simply accept the monopolist"s offer) but depending on the relative 19  Griffiths and Wall (2000, p. 310) 20 Another possibility to be considered is the case when a bilateral monopoly exists in the upstream market combined with selling power in the downstream market.The results in this setting continue to remain ambiguous for the same reasons discussed. 21OECD (2008, p.36)  bargaining strength, it could force the monopolist to increase the quantity sold towards Q M and bring the price down towards the competitive level, thereby reducing the distortions in the market.This argument suggests that monopsony power might have a beneficial impact on society, especially when it develops as a response to monopoly power in the input market 22 .However, it should be emphasised that even in the extreme case where the monopsonist has all the bargaining power, there is still a welfare loss to society given by the area dec.
 Final consumersthe analysis above suggests that since the price and quantity of purchase of inputs in the upstream market is uncertain, the impact on end consumers is also uncertain.Depending on whether the bargaining power of the involved parties results in an increase or decrease in inputs purchased (from the competitive level) final output and thus prices paid by end consumers is accordingly uncertain

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. If the exercise of monopsony power acts as a countervailing force to market power on the selling side, it would result in an increased purchase of inputs, greater output and lower prices to end consumers 24 .

Efficiencies
In addition to the benefits that arise from reducing upstream market power, efficiencies that flow from buyer power may off-set, at least to some extent, the deadweight loss associated with monopsony power.Off-setting efficiencies are not explicitly modelled in the textbook monopsony representation, yet the notion that joint purchasing arrangements have the potential to yield pro-competitive and efficient outcomes is uncontroversial 25 .Buyer power can result in lower prices by reducing transaction costs.This could occur in situations where it is cheaper it deal with a single buyer instead of a number of individual buyers.For example, there may be economies of scale to a supplier"s distribution system such that the average cost of processing a large purchase order is lower than that of a small order 26 .When such a situation arises, a supplier may offer volume discounts to encourage large purchase orders and smaller buyers may be able to receive the volume discounts by pooling their purchases.The extent to which lower prices are passed through to final consumers depends on the degree of competition downstream.The more downstream competition there is, the higher the degree of passthrough expected and the greater the benefit to consumers 27 .

Conclusion on welfare effects
Intuitively it may appear that any practice that leads to a lower price is beneficial and should therefore be encouraged, the standard monopsony theory reveals that monopsony power results in a deadweight loss to society which is analogous to the deadweight loss associated with a monopoly.Furthermore, lower prices are not necessarily passed onto final consumers, even when competition is present downstream.However, the economics literature also reveals that the monopsony outcome depends on a number of factors, which are explored further in the subsequent section. 22Ibid 23 Ibid 24 Ibid 25 See OFT (2007, p.8-12), Chen (2007, p.27) and Areeda and Hovenkamp (2003, vol XII, p.96) 26 (Chen 2007, p.28) 27 OECD (2008, p. 10) and OFT (2007, p.59-60)

THE IMPLICATIONS OF BUYER POWER
The welfare effects of buyer power are dependent on the market context with some arguing that "competition authorities are more likely to be confronted with situations where the monopsony assumptions fail" .This is in contrast to selling power, where collaboration amongst sellers on price is almost always anticompetitive (unless it involves substantial efficiency benefits which require the fixing of a selling price).A perusal of the economic literature reveals that the monopsony result hinges on a few key factors, namely: (i) the degree of seller power upstream, (ii) the shape of the supply curve and (iii) the presence of off-setting efficiencies 29 .These factors are discussed in turn in this section.

Seller power
As illustrated by the bilateral monopoly scenario, a pre-condition for harm is that the seller market is competitive.It is recognised in the EU case law that where there is market power in the upstream selling market, countervailing buyer power can be used to moderate price increases 30 .The criticism of a monopsony may thus be less valid when market imperfections exist on both the purchasing and supply side.This point is particularly relevant to the South African context, as it is generally acknowledged that the South African economy is highly concentrated 31 .Moreover, it has been argued that concentration levels are generally high upstream, in intermediate goods industries owing to large economies of scale, high transport costs and a lack of regional competition in these industries 32 .
The view that many upstream manufacturing industries in South Africa are concentrated is also reflected in the table below, which shows concentration measures for a few industries that are likely to be considered upstream industries 33 .In a number of the industries listed, the ratios suggest that they are concentrated, with the relative share of the four largest firms above 60% and the share of the ten largest firms above 70%.Many of these industries, such as basic iron and steel, chemicals and rubber products are likely to be significant inputs in a range of downstream manufacturing industries 34 .
28 OFT (2007, p. 54) 29 In addition to these criteria it should be recognised that if a monopsonist could practice perfect price discrimination in purchasing inputs (i.e.pay for each unit its exact cost of production as opposed to a single market price) then the purchaser could capture the entire producer surplus and thus eliminate any deadweight loss to society. 30This was recognised in Grovvareforeninger v. Dansk Landbrugs Grovvareselskab as noted in OECD (2008, p, 257) 31 Studies such as Fedderke and Szalontai (2005) have compiled concentration measures for 24 different manufacturing industries in South Africa from 1972-1996.The general consensus is that these industries have historically been highly concentrated and the trend over the years has been an increase in concentration rather than a decrease 32 Roberts and Zalk (2004, p.1) 33 CR4 and CR10 are commonly used concentration measures.These indicate the market share owned by the largest firms in an industry and are obtained by simply summing up the market shares of the 4 or 10 largest firms in an industry respectively.CR4 and CR10 are expressed as a percentage -A low percentage indicates a high level of competition since this means that the largest firms themselves have low market share, while a high percentage indicates an oligopoly or monopoly. 34See also Malikane and Roberts (2001) and Roberts (2004) which discusses concentration in the South African plastics and steel industries respectively.The table below reports concentration ratios for certain industries that are considered to be downstream.The concentration ratios suggest that that the downstream industries are generally less concentrated than the industries that are considered to be upstream, although there are also instances of downstream industries that are highly concentrated, such as motor vehicles and paper products.Albeit crude, this analysis does suggest that market power is more likely to arise on the selling side and where buying power exists (possibly created through joint purchasing agreements), this is likely to be exercised against suppliers that have market power.This suggests that it is more likely to result in a situation of bilateral monopoly rather than the exercise of direct monopsony power.Where bargaining power exercised by buyers is countervailing, it may increase output in the upstream market.It may also increase the welfare of consumers in the downstream market, depending on the state of downstream competition.However, there may be instances where buying power concerns may be warranted.For instance, Cutts and Kirsten (2006) analyse price transmission along the value chain in four agro-food industries, namely the maize, bread, cooking oil and milk industries.The authors find that though there are many farmers at the first step of the value chain in all of these industries, the degree of concentration further downstream at the storage, milling or processing levels is significantly higher 35 .

Shape of the supply curve
The supply curve of the sellers has been assumed to be upward sloping, which is necessary for the exercise of monopsony behaviour since it enables the buyer to achieve a lower price by restricting the quantity demanded 36 .If, for example, the input supply curve is horizontal, a reduction in the purchase of input has no effect on price.Consequently there is no monopsony effect.Similarly, if the supply curve is downward sloping, a reduction in input purchased would result in higher prices and this would not be an optimal strategy for the monopsonist.These possibilities are not merely of theoretical interest and although an upward sloping supply curve is standard in economic literature, the slope of the supply curve is a subject of debate 37 , with the EU noting that for many goods "particularly in manufacturing industries, supply curves may not be upward sloping, limiting the ability for a buyer to restrict output" 38 .It is noted that in the case of a monopoly the corresponding requirement is for a downward sloping demand curve, which is not a key consideration for competition authorities when assessing the ability of monopolies to raise price.

Efficiencies
It is widely recognised that efficiencies often arise from joint buying arrangements that have the potential to yield direct benefits to consumers.Through pooling purchasing volumes, a buyer group may be able to reduce its buying price, which often forms the rationale for forming a buyer group in the first place.If a buyer group is able to secure lower prices, the buyer will generally be able to buy more inputs and not less as found in the standard monopsony outcome.Moreover, it would seem that the realisation of efficiencies may often require setting the purchasing price jointly, as would be the case in securing volume discounts.In contrast, it is more difficult to imagine many circumstances which would require the parties of a joint selling arrangement to jointly set selling prices in order to harness the potential efficiencies associated with co-operative selling arrangements.

CONCLUSION
Joint purchasing arrangements often require the setting of a common purchase price which may technically be captured under the per se prohibition of section 4(1)(b).However these agreements also often carry with them real efficiency benefits, and as such, can often be pro-competitive in their nature.This would is particularly true within the South African context where upstream concentration is common across industries which would suggest that many joint buying arrangements would be operating in an environment of a bilateral monopoly.
Given the mechanisms of possible competitive harm, these agreements would not seem to necessarily convey the same extent of likely harm that would normally be associated with a joint 35 In the maize supply chain, for example, 3 silo owners control 70.3% of the total grain storage capacity.Further, in the milk market, though there are many dairy farmers, there are only 13 milk buyers and 2 main dairy processors and since dairy products are mostly sold through supermarkets and large retailers, there appears to be a situation of market power on both the processing and retail levels of the market 36 Such a requirement regarding the slope of a supply curve is not a prerequisite for a monopolist to be able to abuse its selling power. 37If an industry enjoys constant or increasing returns to scale, the supply curve is correspondingly flat or downward sloping as increased production can take place at constant or declining costs.If however, an expansion of the industry"s output causes the prices of some key factor inputs to rise (which would happen if inputs were scarce, which may be the case with natural resources and labour) the supply curve would in general be upward sloping. 38OECD (2008, p. 259)  selling agreement which involves the fixing of a selling price.This point has been recognised within the US antitrust environment where Hovenkamp has insightfully pointed out that: "Indeed, the gains to be had from joint buying are both more frequently enjoyed and more visible than the comparable gains that can be obtained from joint selling" 39 As such there may well be scope for a somewhat differential treatment between joint purchasing and joint selling behaviourif not in law then practically in terms of prosecution priority.
From an economic point of view there would appear to be scope to take a less draconian approach to the joint purchasing agreements and to assess many of them on a rule of reason basis.This is not to say that joint purchasing agreements will never be anti-competitive or that joint buying cannot impose a harmful monopsony effect on the market.However assuming competitive harm on a per se basis is not a reliable heuristic as in many cases this anticompetitive intention or effect will simply not be present.It may also be that the considerations noted in this paper may be relevant in terms of a more accurate "characterisation" of specific joint purchase agreementsto the extent that such characterisation of behaviour is indeed relevant as to whether behaviour should, or should not, fall under section 4(1)(b).
This would seem to be broadly consistent with the approach in foreign jurisdictions.For example, Competition Authorities in the US and EU would appear to have sufficient flexibility in their characterisation of joint purchasing agreements so as to only consider the more hard-core buying cartels (whose intention and effect is to depress output and the purchase price below the competitive level) as per se illegal.Joint purchasing agreements are however more generally considered in these jurisdictions under a rule of reason approach.In this regard the European Commission has noted that most purchasing agreements will have to be analysed through a rule of reason approach and are not per se illegal.

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The current ambiguity regarding the treatment of joint buying agreements under section 4(1)(b) could have negative implications for South African business.The risk is that South African firmsoften small to medium-sized businessesdecline from engaging in efficiency enhancing and procompetitive joint buying arrangements due to the potential risk of technically falling foul of the per se prohibition contained in section 4(1)(b) of the Act.simply be W(x).Thus the marginal cost to the monopsonist (or MFC) must always be greater than a situation in which it lacked buying power.