Oligopolistic Cement Industry: The Rising Prices of Cement

This article is based on the article, "Probe warranted if cement makers have pact to raise prices", in The Star.

          Current economic tidings have now shifted from the fairly straightforward world of perfect competition and monopoly into the complex and erratic world of duopoly and oligopoly. It can be observed that many market structures are inclined towards being an oligopoly as time progresses.

Nature of oligopoly

An oligopoly is basically a market dominated by a few producers whereby each has control over the market in industries with high level of market concentration.  A few prominent instances in Malaysia would be Celcom, Digi and Maxis for the telecommunication sector as well as Petronas, Exxon Mobile and Kencana for the oil and gas industry. Oligopoly exists when the number of firms in an industry is so small that each must consider the reactions of the rivals in formulating its price policy. Over the years, major issues have been associated with collusive oligopoly, most notably the interesting case study of the OPEC cartel with their ability to dominate and manipulate market prices and production of oil. However, the main focus of this writing would be in response to the recent issue of cement price hike by the oligopolistic Malaysian cement industry.

Characteristics of cement industry oligopoly

i.                    A few large producers

Malaysia’s cement industry is controlled by six major cement producers, the biggest player being Lafarge, followed by YTL Cement, Tasek Corp, Cement Industries of Malaysia, CMS Cement and Holcim (M).

ii.                  Homogenous product

Despite the existence of several types of cement, this is a fairly homogenous good with limited space for differentiation. While there are various types of cement and the substitution between them is feasible, cement is hardly replaceable by another good.

iii.                Control over price

Cement price issues began back in 2008 when the Malaysian government implemented the automatic price mechanism (APM) whereby prices would be determined by the manufacturers proposing a cost structure that cannot be examined or determined by the consumer or the government, thus giving complete price control to the manufacturers.

iv.                High barrier entry

High capital investments involve the mining concession and the capacity of plant. An important element to be considered in assessing the market entry of cement is associated to the access to raw materials: limestone and gypsum deposits. Regarding structural barriers, the market presents economies of scale and the existence of high sunk costs that could be considered as entry barriers deterring the initiation of operations of a potential competitor.

Three oligopoly models

    

As observed in a normal kinked-demand curve above, competitor and rivals strategizes against each other by ignoring price increase or matching price decrease. Consumers effectively have two partial demand curves and each part has its own marginal revenue part - resulting in a kinked-demand curve to the consumer whereby price and output are optimized at the kink. The kinked-demand curve model of oligopoly is sought to explain the complexities of oligopolistic prices as a natural result of non-collusive behavior. However this is not the case as prices of cement is increasing instead of decreasing.

Therefore, the case of cement price increment is most likely of price leadership. Due to the mutual interdependent nature of oligopolistic firms, it is necessary for firms to maintain price stability. Thus when the firm with a clear and dominant market position changes the price, firms with lower market shares follows the price changes prompted by the dominant firm. We can observe instances of this matter with major petrol retailers and mortgage lenders as most suppliers adopts pricing strategies of leading firms. When Lafarge hiked up its cement prices by 6%, other industry players also duplicated the move. Since the dominant firm keeps prices stable, other firms are reluctant to change.

Lastly, collusive pricing is done in order to accomplish joint-profit maximization within a market or to prevent price and revenue instability in an industry. It represents the attempt by manufacturers to manipulate supply and fix the price at a level near to the level one would expect from a monopoly. To fix prices, they must be able to exert control over the market’s supply.

   

According to the diagram above, a producer cartel fixes the cartel quantity and price at output Qm and price Pm. Allocation on the distribution of cartel output might be based on an output quota system or another process of negotiation. Assuming that the firms have identical cost, demand and marginal revenue, the result of collusion is as if he firms made up a single monopoly firm as shown in the graph below.

Effect of price increase of cement on consumers

Due to the increment in development rate and economic growth prospects in Malaysia as well as the absence of a substitute, demand for cement is relatively inelastic. This means that change in the price yields to less than proportionate change in the quantity demanded resulting in a steep curve.

Consumers ranging from direct users like contractors to indirect users like property buyers have no choice but to soak up the rising cost of cement. Even though the government introduced the automatic price mechanism (APM) to improve transparency between producers and end-users in the name of consumer protection, the effect is deteriorating as consumers are now vulnerable to potential abuse by producers as they are forced to absorb higher costs. The monopoly-type of behavior also creates market inefficiencies, distorts pricing vis-a-vis the global market and underutilizes the installed production capacity.

The sudden increment in cement price when the price of electricity, coal and petrol is constant has made a few number of authorities question the legitimacy of the price increment. Authorities from the Real Estate and Housing Developer’s Association (Rehda) claims that the cement companies are colluding to create an artificial shortage. If the statement is found to be true and that the cement producers have been proven to breach the Competition Act 2010, we can see how collusive oligopoly is harmful to the market.

As supervision is not possible, undesirable effects occur due to the loss of productive and allocative efficiency. Less economies of scale can be seen through the act colluding to create shortage. Notably, CIMB Research has highlighted in a report the possibility of Lafarge reversing the price hike due to public pressure from the Master Builders Association Malaysia as well as political factors, with the looming national polls by June next year.