3 - Coordinating Fuel Surcharges

Summary

• ◦ In this case study of collusion in the market for air cargo services, coordinating exclusively on surcharges is found to be sufficient to result in supracompetitive final prices, even though the surcharge is only one component of price.

• ◦ The striking feature of the case is not that suppliers coordinated fuel surcharges but they did not coordinate the full freight rates. Since what matters to a customer should be the total price (which is the sum of the freight rate, fuel surcharges, and other items on the invoice), colluding only on surcharges would seem futile for raising the total price because the higher surcharges could simply be offset by lowering the freight rates as airlines compete for customers. This preliminary assessment raises the question: How could this collusive practice have a significant impact on the actual price paid for cargo services?

• ◦ This case study offers an explanation for how supracompetitive surcharges can result in a supracompetitive total (= base + surcharge) price. A critical feature is the division of pricing authority between a firm’s head office and its local offices. By delegating the decision on base prices to each local office and tying the latter’s performance measure exclusively to this price component, a firm weakens the local office’s incentive to reduce the base price in response to an increase in the surcharge. This gives the firm’s head office a way to raise the full price via a higher surcharge.

• ◦ In essence, senior executives agreeing to higher surcharges is effective because they do not control other components of price, having delegated it to lower-level personnel, and they do not have the incentive to fully offset the higher surcharges with lower base prices.