To a careful observer, the facts are clear. The Law of Duty. No man, I affirm, will serve his fellow-beings so effectually, so fervently, as he who is not their slave; as he who, casting off every other yoke, subjects himself to the law of duty in his own mind…. Individuality or moral self-subsistence is the surest foundation of an all-comprehending love. No man so multiplies his bonds with the community as he who watches most jealously over his own perfection.
Dominick T. Such a scheme may sound reasonable, but it distorts incentives in the drug market. Medicaid uses the existing network of chains and independent pharmacies to distribute drugs to its members, but many of these organizations do not have the scale to bargain for good prices nor the control to influence the prescribing physician. Faced with having to charge Medicaid the lowest price given to any other customer, pharmaceutical firms reduced discounts.
The legislation resulted in an increase in drug expenditures for many private buyers as drug manufacturers tried to raise prices on government sales. However, there are occasions when entrants are discouraged or the information available to one or more parties is poor. In such cases, government may impose price controls in an effort to protect citizens from exploitation. This might occur if patients had to choose drugs without the help of physicians, for example.
In such a case, patients might need government protection from high prices for the wrong medicine. Our modern healthcare system largely removes this concern by employing informed physicians, pharmacists, and formulary committees who affect drug choice. A market failure, such as lack of entry, can be mitigated with the right price control, at least in theory.
The difficulty lies in the execution. Typically, no entity is well informed enough to be able to exactly identify the imperfection, choose the correct price to rectify the situation, and then provide ongoing adjustment and enforcement. Competition is a better tool than price controls for protecting consumers; the Puritans appear to have realized that and gradually ceased using them. Indeed, that seems to have happened. More typically, governments try to fix the bad effects of price controls with subsidies to the discouraged activity.
In the case of the pharmaceutical industry, these subsidies go to research and development. A subsidy could restore the free market outcome by lowering the cost of research. In practice, these are very difficult issues to manage in a way that benefits consumers. The private sector has found several successful methods for reducing the price paid by a buyer. In most cases, government can use similar techniques to get a low price for prescription drugs without disrupting the competitive market.
The most common approach is to take advantage of scale. Moreover, a large buyer provides efficiencies to the seller. Lower transaction costs one invoice, one negotiation, one shipment , guaranteed volume, and economies of scale create cost savings for the supplier that the two parties can share.
A slightly more subtle point of relevance to the pharmaceutical industry is that a buyer with significant volume can often get an even lower price by helping its supplier increase market share. Insurance organizations can agree to educate or encourage physicians to prescribe a certain drug.
In return for altering market share in the provider network, the drug manufacturer offers the provider a lower price. A buyer can explicitly foster competition where none exists. The Detroit airport is otherwise dominated by Northwest Airlines, which charges relatively high prices due to the lack of competition. Another way to obtain lower prices through the market is for an independent organization to provide information on the competing alternatives to individual buyers.
In other words, the price and, therefore, access to some of the most innovative treatments would now be determined by the executive fiat of foreign governments. To find cures, pharmaceuticals must invest billions of dollars in research and development.
Companies would then have no choice but to devote fewer resources to research and development, resulting in fewer cures and fewer treatment options for the American people. This is the great unintended consequence of the HHS proposal: It would actually limit choices and access for patients in the long run. At the U. Senior business managers in industries that have never before known these problems, as well as previous offenders, are probably more concerned now about their corporate exposure to being indicted and convicted of price fixing than they were in any other recent period.
The reasons are not hard to find. As federal agencies, the courts, and Congress respond to the heightened post-Watergate expectations of the public, the law enforcement net has been substantially strengthened. One can regularly read about prominent individuals and organizations that are overwhelmed by the stiff penalties they have incurred for behavior which may have been customary business practice in the past but which now violates social and legal standards.
Executives in large decentralized organizations, however, find it increasingly difficult to carry through on their intentions. The considerable time and money corporations spend developing positive public images can be wasted by the careless actions of just one or two lower level employees. At the same time that organization size and complexity increase, top executives find that the law imposes on them additional responsibility for the business practices of their subordinates.
Executives tremble over what may be going on in the field despite their internal directives and public declarations. One CEO well expressed the frustration common to executives in convicted companies:. Yet we wind up in trouble continually. You begin to wonder about the intelligence of these people. Some executives we interviewed in researching this article believe with the CEO quoted that their employees who collude in price fixing are just not listening or are plain stupid.
In our view it is less likely that the employees are deaf or stupid than that many well-meaning, ethical top managers simply are not getting their message down the line to loyal alert employees. To better understand this lack of communication as well as other forces contributing to employees committing unlawful acts, we thought that it would be enlightening to look at the unfortunate experience of the forest products and paper industry in the midst of antitrust litigation.
Looking just at antitrust cases in , one can see that the paper industry was hit with separate prosecutions for price fixing in consumer paper, fine paper and stationery, multiwall bags, shopping bags, labels, corrugated containers, and folding cartons. In early , over suits have been filed against the industry. In addition, a U. The folding-box litigation has, by far, been the most damaging see the sidebar. The Justice Department has described this case as the largest price-fixing one since It is hard to understand how socially responsible companies could ever have found themselves in such a nightmarish situation.
To find out, we discussed the various pressures and conditions in this industry with 40 senior, division, and middle level executives. In late , a federal judge imposed fines, probation, or jail terms on 47 of 48 executives in 22 companies charged with and found guilty of price-fixing violations in the folding-carton industry.
In terms of the numbers of defendants, this case was the largest one since Following these criminal convictions, the companies faced 45 civil suits filed by customers seeking damages for alleged overcharges. Over the past two years, many of these same companies have been inundated with charges of criminal price-fixing involving felony and misdemeanor violations in virtually every one of the converting ends of the business.
The cost to image and company morale is incalculable. The shock for those companies, with strong, well-publicized ethical positions, is perhaps most severe. In case the reader is skeptical, our interviews with the senior people in these companies left us without a shred of doubt about the sincerity and completeness of their personal commitment to legal compliance.
In fact, the top people we spoke to in the major forest products companies desperately want to know how and why they got on the wrong side of the law so that they can be sure it never happens again. Before we discuss the factors that create a price-fixing-prone industry and organization, we would like to point out that the various problematic situations that contributed to this unhappy end are certainly not unique to the paper industry.
Many economists would consider the folding-carton industry to be one of the least likely to spawn a price-fixing conspiracy.
With this number of companies, one would think that the rivalry among them would be so intense that it would preclude any mutual understandings and tacit agreements. The market was, simply, badly crowded. Other pressures toward collusion were the job-order nature of the business and the fact that the products were undifferentiated. With low barriers to entry, competitors of all sizes saw this area as a great opportunity. Traditionally dominated by small family-run box-making shops, the industry became attractive to very large forest products companies, which integrated forward.
These large companies first supplied the paperboard for box making, and then began to compete with their customers further down the line in making the actual boxes themselves. The tendency toward overcapacity in paperboard production tempted these large paper companies to look on folding boxes as a way to unload excesses. Also harmful to the market in the intervening years was the halt of supermarket expansion as well as the growth of the use of substitute containers, such as plastics, which eroded the market share for paper containers.
The industry is now very mature and has even suffered revenue as well as profit declines. These declines place great pressure on middle level managers who are keenly aware that the constant use of existing capital equipment is the way to drive down unit costs. One general manager commented:. We could have brought on more sophisticated equipment and been more efficient in the use of labor and style of production.
Too much was invested in the paperboard mills and nothing in folding-carton plants. Financial analysts look at these past bad investments and the bad earnings here and refuse to look on this industry with a favorable eye.
Some say a shakeout is long overdue; others complain about vicious customers. Some managers in folding-box companies complain of the predatory influence of the large companies they supply.
One division manager stated:. Anything this industry has done has been more in defense than offense. Business is really dwindling, and we are even more dependent on pleasing the big customers we depend on. They will destroy you. No one here is making much in this industry anymore.
Now the pressures are not to make more money but to keep from going under. Price discussions between competitors are important just to keep from going broke. Our customers should be investigated instead. In the electrical contractors case the issue was also survival. A convicted General Electric division vice president explained:. In the folding-box industry cost-cutting practices are also hampered by the nature of the production process. Boxes are generally manufactured for short job orders.
One general manager said:. No two boxes are the same for us. Even with soap boxes, there are diverse product specifications. Each of these jobs is costed and priced individually. Since each order is custom made, the pricing decisions are made frequently and at low levels of the organization.
One salesman illustrated how a job-order business exposes a company to low-level price collusion:. Dialogue on prices is always on your mind. I think our company has been stupidly naive. It is impossible not to have talked price at some time. Finally, while job specifications vary greatly between orders, the skills and equipment are fairly undifferentiated between companies. Several executives we interviewed concur with the following statement from one vice president:.
The only way to get a buyer is to sell at a lower price. Thus competitors may think that the only way to make it is to get together and fix prices. With such factors as a crowded and mature market, declining demand, difficulty in cutting costs, and no company product differentiation, it is not surprising that profits have been bad.
Several companies have folding-carton divisions that have not seen a real profit in years. Just in the period of time in which we conducted this research, three large box makers announced they were either selling out or closing up.
We heard one convicted executive explain in a quivering voice:.
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