Richard Sicotte, University of Calgary
The international shipping industry has been characterized by a remarkable degree of collusion for more than a century. The two features that are most astonishing are the length of time that some of these cartels have endured, and the wide latitude that regulatory authorities have given them. Firms in many industries have attempted to collude but typically they have met with only fleeting success. Also, since the late nineteenth century the United States has prosecuted firms that fix prices under the Sherman Antitrust Act (until quite recently, most other countries were relatively lenient in their treatment of cartels). Yet in both instances ocean shipping is an exception to the rule.
Fixed Costs and the Rise of Collusion
The rise of collusive practices in ocean shipping coincides with developments in the industry that considerably raised the costs — especially the fixed costs (costs that do not vary with the amount of cargo carried) — of engaging in the business. Many economists believe that fixed costs are important because the higher that they are relative to variable costs, the more likely it is that vigorous price competition will lead to business bankruptcies. This threat of bankruptcy in the presence of price competition provides a strong incentive for firms to collude.
Liner Service vs. Tramp Shipping
The particular developments in ocean shipping that are associated with raising fixed costs are the rise of liner service and the increased use of steamships. Liner service refers to that portion of the shipping industry that follows regular schedules. Liner shipping firms promise to depart a port on a given day regardless of whether the ship is full. Liner shipping is contrasted with so-called “tramp” shipping, which involves ships setting sail at indeterminate dates, often only when they have filled their cargo or passenger capacity. Liner services involve higher fixed costs than tramp shipping not only because of larger administrative overhead, but also because the necessity of following a fixed schedule creates more stringent capacity requirements. The number of vessels required for a given liner service is determined principally by frequency, distance and speed. For example, a weekly liner service between New York and Hamburg may require four ships. Some of those vessels may depart the ports only partially full; a tramp service carrying the same amount of cargo between New York and Hamburg could conceivably require fewer ships, because the tramps can wait until they are full before departing.
Liner shipping is most often associated with steamships, although regularly scheduled service by sailing vessels was not uncommon in the early nineteenth century. But with steamships, firms found it easier to comply with the fixed schedules characteristic of liner service because steamships, unlike sailing vessels, did not depend on favorable winds in order to maintain speed. Most steamships were also much more expensive than sailing vessels. Because the cost of the vessel represents a fixed cost in the shipping industry – interest or time charter payments must be made independent of the quantity of cargo or passengers carried – the transition to steamships represented a major increase in fixed costs.
Early Attempts at Collusion
Historical accounts of steamship companies in the nineteenth century confirm that much of the motivation for collusion was to raise prices and thwart further price competition. Steamship firms serving North Atlantic routes attempted to collude as early as the 1840s, shortly after the steamship was first applied there. The first cartels that had some staying power, however, served the trade between Britain and India, and Britain and China. By the beginning of the twentieth century, liner shipping companies had established cartels on nearly all world trade routes.
Shipping Conferences and Collusion
The principal activity of shipping conferences is to meet frequently in order to fix freight rates (or passenger fares in the case of passenger shipping conferences). Freight rates are typically set by commodity, with the highest value commodities charged higher rates than lower value commodities. The process of fixing rates can be immensely complicated, because lower cost carriers will prefer that the cartel fix lower rates than higher cost carriers will prefer. Simple fixing of rates may not be satisfactory, however. On the one hand, there is no control over non-price competition. For example, carriers might all wish to schedule vessels in a similar way with the result that vessels are still not carrying at full capacity. This is especially likely if the conference rates are higher than the competitive rates, which results in a lower quantity demanded. It might also be true that if firms are not competing on price, they may have an incentive to invest in higher quality vessels so as to attract more customers. Finally, collusion on prices must be enforceable. The cartels must be able to detect and deter member firms from secretly cutting rates and thereby attracting larger volumes. Clearly ocean carriers have much to gain from colluding on more than price.
Some cartels coordinate sailing schedules or create exclusive territories (control over specific ports or ranges of ports), and there has been at least one case in which the firms even restricted investment in newer, larger and faster ships. One of the most prevalent innovations introduced by conferences is a mechanism known as the “pool.” In a pool, the firms are each assigned a percentage of the total freight (or passengers) carried or revenue earned. The secretary of the conference collects data from the firms in order to make the pool operational. The firms that exceed their quotas must make payments to the firms that do not achieve their quotas. In this manner, the incentive to compete for greater volumes is diminished substantially. Similarly, quota arrangements might be devised and enforced such that lower cost firms carry greater amounts of freight than higher cost firms, which leads to greater aggregate profits. Still, agreements that extend beyond simple price-fixing are more costly to negotiate and carry out.
Factors Associated with Successful Collusion
In a study of a large number of freight cartels in the early twentieth century, it was found that approximately half of shipping conferences were of a stricter variety that included mechanisms like the pool or coordinated schedules. Evidence suggests that certain factors facilitated the negotiation and maintenance of these more complex cartel contracts. One of the most important factors was multi-market contact among cartel firms. Multi-market contact occurs when ocean carriers engage one another on more than one trade route. For example, if the firms in a given conference also participated together in other conferences, the conferences that they participated in were more likely to be of the stricter variety than if the firms in a given conference participated in other conferences, but not with each other. Evidence that multi-market contact facilitates collusion has also been found in other industries, such as airlines and hotels. Multi-market contact is thought to be important for two reasons. First, firms will be less likely to violate agreements because if they do so, they risk retaliation in many, if not most of the routes that they serve. Second, when firms have more experience working together, this may build trust and otherwise reduce the organizational and monitoring costs of maintaining higher degrees of collusion.
Another factor that was an important determinant of the extent of collusion was if a given conference happened to be dominated by a very large firm. Presumably, such dominant firms were more able to impose and enforce the terms of a complex agreement. Conferences with fewer members were also more likely to reach pooling or quantity agreements in addition to price-fixing. This is consistent with other works on cartels that have found that the fewer the number of firms, the easier it is to negotiate a cartel contract.
Responses to the Threat of Entry
A vital issue for shipping conferences is the threat of entry by non-conference (independent) ocean carriers, including tramps. The more successful that a cartel is in obtaining profits, the more incentives there are for new firms to enter the route to share in the spoils. Shipping conferences typically have employed two kinds of strategies against entrants and potential entrants. First, they often engage in predatory behavior (drastic cutting of rates) in response to entry. Rate wars reduce entrants’ incentives to stay in the business. Rate wars also send a signal to potential entrants that the cartel will respond strongly to any entry. This is meant to deter firms from entering the conference’s domain. There is evidence that conferences were more likely to engage in predatory behavior against weak entrants than well-established firms with substantial financial resources.
The second strategy that shipping conferences employ against entrants is to offer exclusive contracts to their customers. With such contracts, exporters or importers receive a discounted freight rate in exchange for a commitment to exclusively use the services of conference vessels. Breaches of the commitments carried financial penalties. In the case of one such exclusive contract, the deferred rebate, conferences withhold all or a portion of the rebate earned during a given period of time until continued allegiance to the conference could be verified, usually through the examination of statistics or by simply having agents observe the loading of competitors’ ships.
The Effects of Shipping Cartels on Social Welfare
Shipping conferences have been embroiled in a long-running controversy about their ultimate effects on social welfare. On the one hand, there is a school of thought that the cartel behavior is clearly detrimental, because through their participation in cartels firms are able to charge higher rates than would otherwise be obtained. On the other hand, the conferences themselves defend their practices as necessary for the very existence of the liner industry and undeniable benefits that regularly scheduled service brings for businesses and passengers. They argue that competition in liner shipping is unsustainable and destructive, and that the conferences are an efficient solution to an otherwise intractable market problem. If competition were to reign, the conferences argue that rates would immediately fall to un-remunerative depths and firms would all be driven to bankruptcy, or that only a monopoly would remain, which would be far worse than the cartel system. The destructive competition argument has recently been advocated by economic theorists using the economic concept of the core, which is the set of competitive equilibria. These theorists argue the core of the liner shipping market is empty – that is, there does not exist a competitive equilibrium and that conferences represent an efficient response to the problem. The controversy remains unresolved.
Governments’ Responses to Shipping Cartels
Throughout most of the past 125 years, governments have been very receptive to the arguments of destructive competition as applied to the ocean shipping industry. In 1909 the United Kingdom’s Royal Commission on Shipping Rings (conferences) issued a report in which the majority of the commission found that the conference system was necessary and its practices justified. The United States Congress first investigated the phenomenon immediately prior to World War I, and issued a report in 1914 also accepting the basic tenets of the destructive competition argument. The United States Shipping Act of 1916 granted shipping conferences conditional immunity from the nation’s antitrust laws, although Congress prohibited deferred rebates, which it deemed excessive. Other countries’ policies ranged from acquiescence to open support and encouragement.
The United States policy was relatively hard-line by contrast. After World War I, the United States required that all conferences be “open,” that is that any firm that wished to join the conference could not be excluded. This contrasted with the “closed” conference system employed on trade routes not involving the United States. Further, conferences were required to file copies of their agreements with a government agency charged with oversight of the industry.
After World War II, governments’ attitudes toward shipping conferences gradually hardened. The United States Congress again investigated the conference system after complaints of abuse were made in the 1950s. Court challenges to the conference system and some of its practices were made in the United States in the 1950s and 1960s. The United Nations also issued a Code of Conduct for Liner Conferences in 1974 (although it did not come into effect until 1983) to ensure that conferences accepted the lines of less developed countries as members.
Containerships and the Decline of Conferences
The liner shipping business was transformed after 1960 by the introduction of containerships. Containerships are one element in a global transportation network of unprecedented speed and security. Sea containers are inter-changed between ocean vessels, railcars and trucking chassis. Global point-to-point transportation firms and alliances are increasingly common and there is some question as to the continued relevance of shipping conferences in this inter-modal competitive environment. Indeed, non-conference carriers have become more prevalent in recent years and are carrying a greater proportion of freight than they did in the past.
Further, the United States Shipping Acts of 1984 and 1998 have weakened the ability of conferences to police their own members by mandating that firms have the right of “independent action” on rates and that they are permitted to negotiate large quantity “service contracts” with customers outside the conference price-fixing agreement. The European Commission has also regulated conferences more severely since the late 1980s. Additionally, exporters and importers are increasingly organized on an international level and have expressed their concerns about the conference system with increasing force. With their prodding, the Organization for Economic Cooperation and Development is currently reviewing liner conference pricing policies and other practices. The current decade is likely to see some very interesting developments in the area of international shipping conferences.
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Citation: Sicotte, Richard. “International Shipping Cartels”. EH.Net Encyclopedia, edited by Robert Whaples. August 14, 2001. URL http://eh.net/encyclopedia/international-shipping-cartels/