We have noted repeatedly that the development of tacit coordination among interdependent organizations is likely only when there are few organizations that must monitor each other. Even various interfirm linkages such as joint ventures and interlocking directorates can effect-lively coordinate interdependence only when there are a relatively few large participants in the market. When there are many firms, the organizing effectiveness of a few interfirm linkages is reduced, and coordination is more difficult to achieve except through some sort of centralized or hierarchical structure. We argue that it is under such conditions, when there are a large number of market participants to be .organized, that the emergence of more formalized interorganizational mechanisms, with centralized structures of authority or information, such as trade associations or cartels, is likely.
A similar argument has been implicitly made by Phillips ( 1960 ). Noting the failure of traditional oligopoly theories, Phillips developed a theory of interfirm organization which took into account the environment in which the firms operated. Phillips argued that the parallel action of oligopolists comes when firms recognize their mutual interdependence and, therefore, consider themselves to be members of a group. He advanced four hypotheses about the structure of oligopolistic industries and the extent of formal interorganizational coordination. His first proposition was that the interfirm organization must become more formal, better planned, and better coordinated when there are a larger number of firms in the group (1960:607). Second, the more -asymmetrical the distribution of power, given the number of firms, the less formal the interfirm organizations need to be to achieve efficient coordination (1960:608). Third, as the value systems of individual firms become more unlike, it is necessary to formalize the organization if the effectiveness of the oligopoly is to be maintained. One function of an interfirm organization may be to establish homogeneity through standardization of value systems, costing, and information (1960:609). Finally, Phillips argued that the better organized the groups from which purchases are made and to which sales are made, the more formal and more centralized must be the interfirm organization (1960:610).
Phillips’ analysis hypothesizes some conditions under which oligopolies, if they are to effectively concentrate their power and coordinate actions, must use more formal and centralized structures for doing so. Williamson (1965) was also interested in the determinants of interfirm behavior. He developed a differential equation model which sought to account for alternative price wars and price stability in oligopolistic industries. He considered three variables: (1) a perfor-manee variable, (2) an adherence to group goals variable, and (3) an interfirm communication variable (1965:582). Williamson argued that the group socialization interpretation of oligopoly requires explicit at-tention to the communication process through which interfirm agree-ments are achieved and maintained. He found that environmental munificence appeared mainly responsible for firms shifting between cooperation and conflict (1965:580). When demand was expanding and the environment was relatively good to the business of each firm, the oligopoly was more likely to stay together. When business dimin-ished and the profits in the group started to fall, it was more likely that the firms would begin to shade price and that price wars would occur. .
It is interesting to contrast Williamson’s approach with that taken . by Litwak and Hylton (1962). Like Williamson, Litwak and Hylton ¡ saw the strategic problem in interorganizational analysis as that of,,; analyzing coordination in a setting in which there were both elements of cooperation and elements of conflict. Their analysis focused on coordinating agencies like the United Fund as the device through, which mutual conflicting interests were coordinated. They hypothesized that “co-ordinating agencies will develop and continue in exis-tence if formal organizations are partly interdependent; agencies are aware of this interdependence, and it can be defined in standardized units of action” (1962:400). The principal point of contention derives from the following statement: “If the pool of resources in the community is suddenly decreased while the number of agencies remains the same or increases, then the agencies’ competition for funds should increase and their interdependency increase accordingly” (1962:403). Litwak and Hylton’s argument that community chest organizations should thrive during stringent times is exactly the opposite of William-son’s point about oligopolies. Litwak and Hylton’s evidence for their hypothesis does not, however, really test it at all. They show a graph indicating that in times of major catastrophe, such as during the depression and during World War II, the amount of funds raised by the community chest was relatively greater. Their data really pertain to the amount of funds raised by the community chest, whereas their hy-pothesis refers to the proportion of local social agencies choosing to join or remain in the fund and the proportion of total’ charitable con-tributions developed through the coordinating agency.
A crucial question not discussed by Litwak and Hylton concerns-how viable the coordinating mechanism is under different environmental conditions. One disadvantage of joining an interorganizational network is that the organization loses some autonomy. Part of the difference between Williamson’s analysis and the analysis of Litwak and Hylton may be explainable by recognizing how the different environments of social service organizations and business organizations allow them to pursue individual goals when it is to their advantage to do so. When economic or other community conditions change to make charitable contributions scarce, the participating agencies may willingly exchange their autonomy for the promise of some funding rather than face drastically reduced resources. No other options are available to them. However, when economic conditions decline, industrial firms may be tempted to break away from the oligopoly and attempt to steal business from their competitors to increase profits. A comparable alternative is frequently not available to social service agencies. When such options for independent action are available, social service agencies may, in fact, act more like business firms. Litwak and Hylton, for instance, noted that agencies with national affiliation, such as the .agencies concerned with diseases, may resist participating in coordinating agencies since such organizations have potential insulation from local fluctuations in the buffering provided by the national parent organization.
1. Trade Associations
The trade association is one collective structure that has developed to provide the centralized information and coordination that may be required in unconcentrated industries. Most industries, as well as professions, have associations whose major purpose is to exchange information and exert political influence for the benefit of their members. The formation of such associations has frequently coincided with major changes in the industry caused either by unexpected growth or decline or by threats from new external competition or the government. The American Hardboard Association, for example, was organized in 1952, some time after hardboard had become a viable, mass-produced building material and the postwar housing boom had made hardboard firms major materials suppliers. American psychologists formed the Association for the Advancement of Psychology in 1974 in response to various external pressures and threats. There had been cutbacks in federal funding for research, various federal legislation affecting the research and clinical practices of psychologists, and an attempt by the American Medical Association and the American Psychiatric Association to have the treatment of mental illness defined as a clinical practice limited to medical personnel. This latter move would have affected the payment of bills by Medicare and private insurers such as Blue Cross and would have harmed the business of many clinical psychologists, one of the largest groups within the American Psychological Association.
Gable ( 1953 ) has traced the rise and fall of membership in the National Association of Manufacturers (NAM), a large and heterogeneous association of business firms, to the ebb and flow of political activity relevant to business interests. When major legislation of interest to business is being contested, membership increases. For instance, when NAM was engaging in efforts to have the Taft-Hartley collective bargaining legislation passed, membership increased. After the legislation was passed and signed into law, membership declined again, as business interest in political activity waned.
The growth of trade associations follows somewhat the same historical pattern as that of mergers. Many associations were founded after the Civil War at a time of tremendous industrial development and expansion. After the passage of the Sherman Act in 1890, trade association formation diminished. The First World War caused an- other increase in association activity. In 1917, the War Industrial Board actively encouraged the development of trade associations because it wished to deal with industry in organized groups to facilitate war procurement. The number of associations grew from 800 to 2000 between 1914 and 1919. The prosperity and quiet of the 1920s caused the number of associations to decline. The depression provided new impetus for association activity. The National Industrial Recovery Act of 1933 practically adopted trade associations as the mechanisms for governmental control of industry.
While trade association activity rises and falls as conditions change, it is also the case that trade associations at a point in time vary across industries depending on the industry’s need for government action and for a mechanism to legally coordinate competition. Trade associations do, indeed, have implications for competition. Associations serve as clearinghouses for information about industry sales, prices, and costs. By explicitly sharing cost data and market information, organizations have at least some of the necessary information for planning coordinated actions. Some associations actually have gone so far as establishing pricing systems and attempting to enforce them. In one such case reported by Latham (1952), the Cement Manufacturer’s Association established pricing to allocate markets. The Federal Trade Commission successfully prosecuted this blatant attempt to fix price but other, less obvious effects of information sharing may persist. Frequently, the mere publishing of price is sufficient to obtain compliance. The American Bar Association, a professional association, regularly published fee schedules and, furthermore, implied that charging less than the minimum prescribed fees might be grounds for discipline for professional misconduct. Recently, the justice department has begun to attack the use of fee schedules, which can be found in a variety of occupations and professions.
Industry associations also tend to reduce interorganizational variations by sponsoring research and product definition activities. Research and development jointly sponsored through industry associations allows new developments to be disclosed to all firms, avoiding surprises in design or technology that would disrupt competitive equilibria. Trade associations also restrain competition by providing standard definitions of products as well as guidelines on product quality. The American Hardboard Association, for instance, defines hardboard as “panel manufactured primarily from interfelted ligno- cellulose fibers consolidated under heat and pressure in a hot press to a density of at least thirty-one pounds per cubic foot.” Failure to conform to industry standards can result in denial of approval for use in a variety of settings. Any action taken to standardize products would serve to diminish competitive uncertainty because one dimension of competition, differentiated product characteristics, has been eliminated. Furthermore, by providing standard definitions and operating characteristics, the association facilitates coordination of competitive activity among firms.
In spite of the pervasiveness of trade and industry associations, there is remarkably little literature about them. Stigler (1974), however, has surveyed some associations and provides some evidence that is not inconsistent with our ejarlier position about the conditions under which such associations are more likely to be important. We argued that associations, and other more formalized and centralized mechanisms of interfirm organization, were more likely to occur when there were too many participants in the industry to be coordinated either through tacit coordination or through semiformal interfirm linkages. In a study of some 60 trade associations, Stigler (1974:364) found that both the association budget and the size of the association staff were negatively related to industry concentration, though the relationship was not statistically significant. The direction of the relationship was as predicted, since we have argued that in more concentrated industries, less formal and centralized means of interfirm coordination can be used (e.g., Phillips, 1960). An important variable to examine is the extent to which firms need coordination. Stigler’s analysis combines firms which impinge upon one another with those whose activities have little affect on each other.
Cartels, which are even more overt attempts’to organize a set of interdependent organizations, represent coalitions of organizations, with typically at least normative sanctions applied to members who deviate from proscribed cartel policies. In recent years, the most widely known cartel is OPEC, the Organization of Petroleum Exporting Countries, but there are cartels of other raw material producers. While cartel arrangements are illegal under current United States antitrust legislation, they are acceptable and accepted ways of organizing markets in many parts of the world. Even in the United States some cartels have received specific exemption from antitrust regulations. For instance, the National Football League (NFL) for a long while en- joyed special privileges. The NFL faces the problem of keeping competition interesting and not letting teams get either too strong or too weak. To maintain competitive teams (if not competition among the team owners), the NFL has used a player draft system and a strong . commissioner who can regulate the industry. The draft allows the weaker teams one year to acquire better players the next.
The United Fund is also a form of cartel, attempting to organize and coordinate social service agencies in a given community to avoid competition for donations and excessive overlapping of services. Like a cartel, the United Fund has come to define one of its most important objectives as being in control of as much of the local market for fund raising as possible. Also, like a cartel, member agencies enter or leave the United Fund as it suits their interests. The consequence of this is that the United Fund must distribute payoffs to agencies sufficient to maintain their participation. Such incentives are in the form of distri-, butions from the United Fund collections. In a study of the allocations of 66 United Funds, Pfeffer and Leong (1977) found that the amount of money the agency could raise outside the fund, a measure of its ability to withdraw, was related to the amount of money obtained’ inside the fund, even after accounting for various measures of as-sumed community needs. Further, the relationship between outside support and the allocation from the fund was stronger for those agencies that were less dependent on the fund and on whom the fund was more dependent for visibility and fund-raising credibility.
The United Fund was an appropriate context in which to investigate interorganizational behavior because it was a public and. legally sanctioned organization. Part of the problem involved in. analyzing coordination of industrial organizations is that the analyst must investigate the phenomenon from the outside, developing hypotheses that test observable outcroppings of interorganizational ac- tivity. One does not distribute a questionnaire which asks, “How frequently do you collude with competitors?” Except for cartels that, operate within the antitrust laws or in an international arena, coordination itself is not visible, but only its possible outcomes. However, since such outcomes, such as profits or stability, may be produced by a, variety of other factors as well, the inference is always difficult. The’ relative invisibility of behavior, the reliance on ambiguous effects for. determining whether or not behavior has occurred, and the historical precedents of economic theory, which argued that cartel activity had the single goal of maximizing joint income, have all served to impede the progress of understanding cartel and coalition behavior.
One notable exception is Macavoy’s (1965) examination of the operation of the railroad cartels in the late 1800s. He noted that ‘when conditions in the market make it possible for an individual firm to make more money by being loyal to a cartel agreement than by being ; disloyal, the agreement is not likely to break down” (1965:14). Cartels that are successful guarantee a greater total amount of profits for all the firms involved, tend to lead to higher prices, and are accompanied by stable market shares for the participating firms.
Macavoy s principal contribution is an extremely clever analysis of railroad cartels, concluding that the formation of the Interstate Commerce Commission (ICC) resulted in a higher and more stable price , than the cartel itself could maintain. Cartel behavior was measured by regressing actual prices charged against posted prices. When the cartel was effectively operating, the correlations were close to one. When the cartel was near dissolution, the correlations were quite small. Macavoy’s study indicates that cartel behavior is potentially analyz-able, and his conclusion about the effect of the regulatory agency is insightful.
Cartels, to remain effective, must punish cheaters. When a member firm breaks away from the cartel and offers a lower price to attract business, the cartel must match, and probably undercut, this new lower price. If cheating were permitted, all the firms might be tempted to try it, and the cartel would dissolve. Since the firms in the cartel know that when their cheating is discovered their price will be under-cut, there would seem to be little reason for cutting price below that level set by the cartel. However, the price cut may be accidental or inadvertent, based on some mistake in the information received. The cheating may be difficult to detect, and the firm that cuts price may be able to make enough extra profits to compensate it for the fact that after the price cutting is discovered, the whole price structure of the industry will be substantially lower. Another reason for cheating may be that it is the first step in an agreement among participants reform-ing the cartel with a different allocation of market shares (Macavoy, 1965:23). If the reformation of the cartel leads to a higher market share for the first price cutter, then possibly it can be assumed that the destruction of the cartel was for the sake of the destruction.
Stigler (1964) has also considered the difficulty or ease of en-forcing an oligopoly s higher price. For cartel or oligopoly arrange-ments, the problem is to maintain structure when any member can violate the price agreement, get away with it, and gain larger profits than by conforming. This is an inducement to break up the interorganizational organization, but the inducement is limited by the prob- ability that tie price cheater will get caught and have his profits reduced below that achieved by maintaining the cartel price.
Stigler noted that fixing market shares is the most efficient method of combating secret price reductions. “With inspection of output and an appropriate formula for redistribution of gains and losses from departures from quotas, the incentive to secret price-cutting is eliminated” (1964:46). Assigning buyers to sellers also eliminates the possibility of price cutting, but neither of these approaches are particularly viable where price fixing is illegal. Price cutting, Stigler argued, can be detected primarily from shifts in buyers from one seller to, another. Thus, collusion is easiest to maintain when the buyers report fully and correctly the prices they were offered (the government placing contracts under competitive bidding), and collusion is most difficult to maintain when the significant buyers are constantly changing (1964:48). Stigler’s most important conclusion is that since collusion depends upon being able to detect shifts in buyers, then the level of price is not responsive to the number of rivals, but rather is a function of the number of buyers, the proportion of new buyers, and the relative sizes of firms (1964:56).
An analysis of cartel arrangements must recognize that two sets of factors contribute to the creation and maintenance of the cartel—characteristics of the environment that affect the possibility of developing interfirm coordination and the motivation for organizing a cartel or belonging to one. The mere presence of conditions which might favor, the development of a cartel does not mean that individual firms would be interested in joining. We suspect that the need for formal coordinating organizations would be greatest when conditions of uncertainty are greatest, organizations are interdependent, and the number of organizations to be coordinated, their differences in operating characteristics, or their similarity in size all require a more formal and centralized coordinating structure. The kinds of industries in which cartels have been discovered tend to be those that deal with undifferentiated products (oil, steel, cement, gypsum board). Product or market differentiation or segmentation reduces interdependence and makes cartels,, less necessary.
Source: Pfeffer Jeffrey, Salancik Gerald (2003), The External Control of Organizations: A Resource Dependence Perspective, Stanford Business Books; 1st edition